1. Major Schools of Economic Theory
Adam Smith, father
Of modern economics

2. Introduction
The word “economics” is derived from the Greek word oikonmikos which means skilled in household management.
Although the word is very hold the discipline of economics is a relatively recent development.
Modern economic thought emerged in the 17th and 18th centuries as the western world transformed from an agrarian to an industrial society.

3. Despite the enormous differences between then and now, the economic problems with which society struggles remain the same:
How do we decide what to produce with our limited resources?
How do we ensure stable prices and full employment of our resources?
How do we provide a rising standard of living both for ourselves and for future generations?

4. Mercantilists and Mercantilism
Mercantilism was the economic philosophy that held a nation’s wealth came primarily from the accumulation of gold and silver. Nations without mines could obtain gold and silver only by selling more goods than they bought from abroad.
Thomas Paine

5. Physiocrats Physiocrats, was a group of 18th century
philosophers, developed the idea of the
the economy as a circular flow of income
and output. They also advocated laissez-
faire economics. They opposed the
Mercantilist idea of promoting trade at the
expense of agriculture.
Francois Quesnay

6. Classical School of Economics
The Wealth of Nations
by Adam Smith

7. In the Wealth of Nations, Adam Smith identified the three factors of production: land, labor, and capital.
Smith believed the “ideal economy was a self-regulating one. That is to say, that it automatically satisfies the needs of the populace. He called as the “invisible hand.”
Smith also supported the idea of laissez-faire capitalism.

8. David Ricardo focused on the
“distribution of wealth” among landowners
on one side and capital on the other. He
believed when population growth and capital
“pressed down” on a fixed supply of land,
that this would push rents up and wages and
profits down.

9. Thomas Malthus used the idea of
“diminishing returns” to explain low living
standards. He believed that a rapidly
growing population against a limited amount
of land meant diminishing returns to
labor. He believed this would lead to
chronically low wages, which would limit the
standard of living.
He also questioned idea of a market
economy that would be able to produce
full employment.

10. John Stuart Mill parted company from the other Classical economists in the area of distribution of income.
Mill believed that society may be efficient in allocating resources but not in distributing income. He maintained that society must get involved.

11. Marginalist School
Marginalist economists emphasized that prices also depend
on the level of demand, which in turn depends upon the
amount of consumer satisfaction provided by individual
goods and services.
They provided modern macroeconomics with basic analytical
tools of demand and supply and consumer utility.
Finally they pushed the idea that land, labor, and capital
receive returns equal to their contributions to production.
Sometimes this was used to justify existing distribution of
income.

12. Marxist School The Marxist School challenged Classical
theory. Karl Marx saw capitalism as an
“evolutionary” phase in economic
development. He believed capitalism
would eventually destroy itself.
Marx believed in the labor theory of value which states that
all production belongs to labor because workers produce all
value in society. He also believed that the market system
allows capitalists, (the owners of machinery and factories) to
exploit workers by denying them a fair share of what they
produce.
He believed workers would eventually rise up and overthrow
this type of capitalism.

13. Institutionalist School
Institutionalists believed in government controls and social reform to bring about a more equal distribution of income.

14. Reacting to the worldwide depression,
John Maynard Keynes broke from the
Classical tradition and wrote
General Theory of Employment,
Interest, and Money.
In the Classical view, most economists
believed that in a recession, wages and
prices would decline to restore full
employment. Keynes believed that the
direct government intervention was
necessary to increase total spending.
These theories are the modern
Rationale for the use of government
Spending and taxing to stabilize the
economy (fiscal policy).

15. Summary Monetarism updates the Quantity Theory, the macroeconomic
analysis before Keynes. It reemphasizes the role of monetary
growth.
Rational Expectations Theory provides a contemporary rationale
for the pre-Keynesian tradition of limited government in the
economy.
Supply-side Economics recalls the Classical School’s concern
with economic growth as a fundamental prerequisite for improving
society’s material well-being. It emphasizes the need for
incentives to save and invest if the nation’s economy is to grow.