Classical Economics

Classical Economics

Classical economics, English school of economic thought that originated during the late 18th century with Adam Smith and that reached maturity in the works of David Ricardo and John Stuart Mill. The theories of the classical school, which dominated economic thinking in Great Britain until about 1870, focused on economic growth and economic freedom, stressing laissez-faire ideas and free competition.

Many of the fundamental concepts and principles of classical economics were set forth in Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations (1776). Strongly opposed to the mercantilist theory and policy that had prevailed in Britain since the 16th century, Smith argued that free competition and free trade, neither hampered nor coddled by government, would best promote a nation’s economic growth. As he saw it, the entire community benefits most when each of its members follows his or her own self-interest. In a free-enterprise system, individuals make a profit by producing goods that other people are willing to buy. By the same token, individuals spend money for goods that they want or need most. Smith demonstrated how the apparent chaos of competitive buying and selling is transmuted into an orderly system of economic cooperation that can meet individuals’ needs and increase their wealth. He also observed that this cooperative system occurs through the process of individual choice as opposed to central direction.
 
In analyzing the workings of free enterprise, Smith introduced the rudiments of a labour theory of value and a theory of distribution. Ricardo expanded upon both ideas in Principles of Political Economy and Taxation (1817). In his labour theory of value, Ricardo emphasized that the value (i.e., price) of goods produced and sold under competitive conditions tends to be proportionate to the labour costs incurred in producing them. Ricardo fully recognized, however, that over short periods price depends on supply and demand. This notion became central to classical economics, as did Ricardo’s theory of distribution, which divided national product between three social classes: wages for labourers, profits for owners of capital, and rents for landlords. Taking the limited growth potential of any national economy as a given, Ricardo concluded that a particular social class could gain a larger share of the total product only at the expense of another.
 
These and other Ricardian theories were restated by Mill in Principles of Political Economy (1848), a treatise that marked the culmination of classical economics. Mill’s work related abstract economic principles to real-world social conditions and thereby lent new authority to economic concepts.
 
The teachings of the classical economists attracted much attention during the mid-19th century. The labour theory of value, for example, was adopted by Karl Marx, who worked out all of its logical implications and combined it with the theory of surplus value, which was founded on the assumption that human labour alone creates all value and thus constitutes the sole source of profits.
 
More significant were the effects of classical economic thought on free-trade doctrine. The most influential was Ricardo’s principle of comparative advantage, which states that every nation should specialize in the production of those commodities it can produce most efficiently; everything else should be imported. This idea implies that if all nations were to take full advantage of the territorial division of labour, total world output would invariably be larger than it would be if nations tried to be self-sufficient. Ricardo’s comparative-advantage principle became the cornerstone of 19th-century international-trade theory.
 
History
 
The classical economists produced their "magnificent dynamics" during a period in which capitalism was emerging from feudalism and in which the industrial revolution was leading to vast changes in society. These changes raised the question of how a society could be organized around a system in which every individual sought his or her own (monetary) gain. Classical political economy is popularly associated with the idea that free markets can regulate themselves.
 
Classical economists and their immediate predecessors reoriented economics away from an analysis of the ruler's personal interests to broader national interests. Adam Smith, and also physiocrat Francois Quesnay, for example, identified the wealth of a nation with the yearly national income, instead of the king's treasury. Smith saw this income as produced by labour, land, and capital. With property rights to land and capital held by individuals, the national income is divided up between labourers, landlords, and capitalists in the form of wages, rent, and interest or profits.
 
Modern legacy
 
Classical economics is generally agreed (but see section 5 below) to have developed into neoclassical economics – as the name suggests – or to at least be most closely represented in the modern age by neoclassical economics, and many of its ideas remain fundamental in economics. Other ideas, however, have either disappeared from neoclassical discourse or been replaced by Keynesian economics in the Keynesian revolution and neoclassical synthesis. Some classical ideas are represented in various schools of heterodox economics, notably Marxian economics – Marx being a contemporary of the classical economists and their immediate successors – and Austrian economics, which split from neoclassical economics in the late 19th century.
 
Value theory
 
Classical economists developed a theory of value, or price, to investigate economic dynamics. William Petty introduced a fundamental distinction between market price and natural price to facilitate the portrayal of regularities in prices. Market prices are jostled by many transient influences that are difficult to theorize about at any abstract level. Natural prices, according to Petty, Smith, and Ricardo, for example, capture systematic and persistent forces operating at a point in time. Market prices always tend toward natural prices in a process that Smith described as somewhat similar to gravitational attraction.
 
The theory of what determined natural prices varied within the Classical school. Petty tried to develop a par between land and labour and had what might be called a land-and-labour theory of value. Smith confined the labour theory of value to a mythical pre-capitalist past. Others may interpret Smith believed in value as derived from labour. He stated that natural prices were the sum of natural rates of wages, profits (including interest on capital and wages of superintendence) and rent. Ricardo also had what might be described as a cost of production theory of value. He criticized Smith for describing rent as price-determining, instead of price-determined, and saw the labour theory of value as a good approximation.
 
Some historians of economic thought, in particular, Sraffian economists, see the classical theory of prices as determined from three givens:
 
1.The level of outputs at the level of Smith's "effectual demand",
2.Technology
3.Wages
 
From these givens, one can rigorously derive a theory of value. But neither Ricardo nor Marx, the most rigorous investigators of the theory of value during the Classical period, developed this theory fully. Those who reconstruct the theory of value in this manner see the determinants of natural prices as being explained by the Classical economists from within the theory of economics, albeit at a lower level of abstraction. For example, the theory of wages was closely connected to the theory of population. The Classical economists took the theory of the determinants of the level and growth of population as part of Political Economy. Since then, the theory of population has been seen as part of Demography. In contrast to the Classical theory, the determinants of the neoclassical theory value:
 
1.tastes
2.Technology
3.Endowments
 
are seen as exogenous to neoclassical economics.
Classical economics tended to stress the benefits of trade. Its theory of value was largely displaced by marginalist schools of thought which sees "use value" as deriving from the marginal utility that consumers finds in a good, and "exchange value" (i.e. natural price) as determined by the marginal opportunity- or disutility-cost of the inputs that make up the product. Ironically, considering the attachment of many classical economists to the free market, the largest school of economic thought that still adheres to classical form is the Marxian school.
  • Recommend Us