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A. THE CLASSICAL SCHOOL

Classical economics refers to work done by a group of economists in the

eighteenth and nineteenth centuries. They developed theories about the way

markets and market economies work. The study was primarily concerned with

the dynamics of economic growth. It stressed economic freedom and promoted

ideas such as laissez-faire and free competition. Economic thought until the late

1800’s. Adam Smith’s Wealth of Nations, published in 1776 can be used as the

formal beginning of Classical Economics but it actually it evolved over a period

of time and was influenced by Mercantilist doctrines, Physiocracy, the

enlightenment, classical liberalism and the early stages of the industrial

revolution.

Classical economics as the predominant school of mainstream economics ends

with the ‘Marginalist Revolution’ and the rise of Neoclassical Economics in the

late 1800’s. In the 1870’s William Stanley Jevons’ and Carl Menger’s concept of

marginal utility and Leon Walras’ general equilibrium theory provided the

foundations. Henry Sidgwick, F.Y. Edgeworth,Vilfredo Pareto and Alfred

Marshall provided the tools for Neoclassical economics. Neoclassical economics

is an extension of Classical economics but, the focus of the questions changed as

well as the tools of analysis. In spite of the dominance of Neoclassical thought,

Classical Economics has persisted and influences modern economics, particularly

the ‘New Classical Economics.’ The belief in the efficacy of a ‘free market’ is

central to both classical and neoclassical ideology. Famous economists of this

school of thought included Adam Smith, David Ricardo, Thomas Malthus and

John Stuart Mill. While Adam Smith would be regarded as the originator and

leader of the school, David Ricardo should be credited with establishing the form

and methods of the school. The debates between Thomas Malthus and David

Ricardo about policy issues such as the ‘Corn Laws’ and the ‘Poor Laws’

contributed to the focus and form of the school. Smith was concerned about the

nature of economic growth. Malthus, Ricardo and other classical economists were

concerned about the question of ‘distribution.’ One important debate among

classical economists was whether there was or wasn’t a ‘surplus’ or ‘glut.’ Jean

Baptiste Say and Malthus were the two major protagonists in the question about

the existence of a surplus and its effects on a market economy.

Commented [21]: Laissez-faire, also called laissez-faire

economics, a policy that advocates minimum interference

by government in the economic affairs of individuals

Commented [22]: Marginalism is a theory

of economics that attempts to explain the discrepancy

in the value of goods and services by reference to their

secondary, or marginal, utility.

Eg: Diamond-Water paradox

1. Adam Smith

Adam Smith was born in Kirkcaldy, Fife, Scotland. The exact date of his

birth is unknown; however, he was baptized on June 5, 1723. Smith was the

Scottish philosopher who became famous for his book, ‘The Wealth of

Nations’ written in 1776, which had a profound influence on modern

economics and concepts of individual freedom. In 1751, Smith was appointed

professor of logic at Glasgow University, transferring in 1752 to the chair of

moral philosophy. His lectures covered the field of ethics, rhetoric,

jurisprudence and political economy, or ‘police and revenue.’ In 1759 he

published his Theory of Moral Sentiments, embodying some of his Glasgow

lectures. This work was about those standards of ethical conduct that hold

society together, with emphasis on the general harmony of human motives and

activities under a beneficent Providence. Smith moved to London in 1776,

where he published An Inquiry into the Nature and Causes of the Wealth of

Nations, which examined in detail the consequences of economic freedom. It

covered such concepts as the role of self-interest, the division of labour, the

function of markets, and the international implications of a laissez-faire

economy. ‘Wealth of Nations’ established economics as an autonomous

subject and launched the economic doctrine of free enterprise. Smith laid the

intellectual framework that explained the free market and still holds true

today. He is most often recognized for the expression ‘the invisible hand,’

which he used to demonstrate how self-interest guides the most efficient use

of resources in a nation’s economy, with public welfare coming as a by–

product. To underscore his laissez-faire convictions, Smith argued that state

and personal efforts, to promote social good are ineffectual compared to

unbridled market forces. In 1778, he was appointed to a post of commissioner

of customs in Edinburgh, Scotland. He died there on July 17, 1790, after an

illness. At the end it was discovered that Smith had devoted a considerable

part of his income to numerous secret acts of charity. His Important works are:

‘The Theory of Moral Sentiments’ (1759). ‘An Inquiry into the Nature and

Causes of the Wealth of Nations’ (1776).

Commented [23]: Invisible Hand

Commented [24]: Personal act of social good

1.1 Invisible Hand Theory:

It is a term coined by Adam Smith in his 1776 book ‘An Inquiry into the

Nature and Causes of the Wealth of Nations’. One of the greatest

contributions of Adam Smith was the invisible hand theory. He said that if

the government doesn’t do anything, there’s a controlling factor of people

themselves who can guide markets. I believe that the government should

be responsible in defining the property rights, to set up honest courts, to

impose minor taxes and to compensate for well defined ‘market failures’

If I sell candies for 1 peso each and Christian sells them for 2 pesos for 3

pieces, he will get all the business making me lose mine so in order to

compensate for my loss I should be forced to lower my price as to stay

alive in the business. I am guided by an invisible hand which is my self-

interest to gain profit or as Adam Smith would say everyman for himself.

The theory of the Invisible Hand states that if each consumer is allowed to

choose freely what to buy and each producer is allowed to choose freely

what to sell and how to produce it, the market will settle on a product

distribution and prices that are beneficial to all the individual members of

a community, and hence to the community as a whole. The reason for this

is that self-interest drives actors to beneficial behaviour. Efficient methods

of production are adopted to maximize profits. Low prices are charged to

maximize revenue through gain in market share by undercutting

competitors. Investors invest in those industries most urgently needed to

maximize returns, and withdraw capital from those less efficient in creating

value. Students prepare for the most needed (and therefore most

remunerative) careers. All these effects take place dynamically and

automatically. According to Wealth of Nations ‘By preferring the support

of domestic to that of foreign industry, he intends only his own security;

and by directing that industry in such a manner as its produce may be of

the greatest value, he intends only his own gain, and he is in this, as in

many other cases, led by an invisible hand to promote an end which was

no part of his intention. Nor is it always the worse for the society that it

was not part of it. By pursuing his own interest he frequently promotes that

of the society more effectually than when he really intends to promote it. I

have never known much good done by those who affected to trade for the

public good. It is an affectation, indeed, not very common among

merchants, and very few words need be employed in dissuading them from

it.’ This is as how Adam Smith explained it that being led by an invisible

hand is actually profitable in the sense that it uses the will of a person’s

self-interest which drives him to create more and better ideas to overcome

the other competitors as long as he would be doing it in a legal way.

1.2. Naturalism and Optimism:

Naturalism denotes the spontaneous and natural origin of economic institutions

while Optimism refers to the belief that economic institutions so created were

beneficial in their effects. Smith was emphatic that human actions guided by

their selfish interests were bound to result in social good. To Smith spontaneity

and beneficence went together. The presence of one implied the presence of the

other. Every individual is motivated by self-interest. Every man, so to say, is the

maximiser of gain and minimizer of loss. Therefore, every man undertakes that

activity which appears to him to be the most profitable. The entire society is

based on this conceptualization. Everybody wants to make his conditions better.

Being guided by such a rationale, when people undertake different activities, the

society gets many types of economic institutions. These economic institutions

are spontaneous in character. But, although the institutions are primarily based

on self-interest, they ultimately increase social welfare. It is not from the

benevolence of butcher, the brewer or the baker that we expect our dinner, but

from their regard to their on interest. Every man is naturally the best judge of

his own interest and should, therefore, be allowed to pursue his own way. Adam

Smith pointed out that in pursuing his own advantage, every individual is led by

an invisible hand to promote an end which was no part of his intention. Smith