Overview
This lecture surveys major schools of economic thought, from classical and Marxian economics to more modern perspectives like behavioral economics and public choice theory.
Classical Economics
- Originated with Adam Smith's "Wealth of Nations" (1776) and the idea of the Invisible Hand.
- Believes markets, prices, and wages adjust naturally without government intervention.
- David Ricardo's theory of comparative advantage: countries benefit by specializing in what they produce relatively best.
- Warns that government interventions disrupt natural market order ("laissez-faire").
Marxian Economics
- Founded by Karl Marx during the Industrial Revolution.
- Labor theory of value: products’ value comes from the labor put in.
- Surplus value: workers create more value than they receive in wages; the rest is taken as profit by capitalists (exploitation).
- Predicts capitalism's eventual collapse due to inherent contradictions, leading to socialism and communism.
Game Theory
- Analyzes strategic decision-making where outcomes depend on others' choices.
- Famous example: Prisoner's Dilemma—rational self-interest can lead to worse outcomes for all.
- Nash Equilibrium: a stable state where no player can benefit by changing strategies alone.
Neoclassical Economics
- Focuses on individual choices, marginal utility, and rational decision-making.
- Marginalism: value comes from the extra satisfaction from one more unit of a good.
- Envisions supply and demand curves seeking equilibrium; assumes perfect competition.
Keynesian Economics
- Founded by John Maynard Keynes during the Great Depression.
- Emphasizes the importance of aggregate demand in the economy.
- Advocates for government intervention (spending, tax cuts) to boost demand during recessions.
Supply-Side Economics
- Argues that lower taxes and fewer regulations boost production and economic growth.
- Introduced the Laffer Curve: cutting taxes can sometimes increase government revenue.
- Associated with 1980s Reagan policies; controversial regarding deficits and inequality.
Monetarism
- Led by Milton Friedman; focuses on controlling the money supply to manage inflation.
- Inflation is caused by printing too much money.
- Advocates for steady, predictable growth in money supply and minimal government intervention.
Development Economics
- Studies why some nations prosper while others remain poor.
- Identifies "poverty traps" and the importance of institutions, culture, and targeted interventions.
- Small programs like microfinance and conditional cash transfers can break vicious cycles of poverty.
Austrian School
- Emphasizes human action and criticizes mathematical models.
- Argues central banks cause business cycles by distorting interest rates.
- Stresses spontaneous order and the limits of central planning.
Behavioral Economics
- Studies how human biases and bounded rationality affect economic decisions.
- People often act irrationally due to heuristics, framing, and loss aversion.
- Introduces the concept of "nudges" to improve decision-making.
New Institutional Economics
- Emphasizes the role of institutions in reducing transaction costs and shaping development.
- Path dependence: historical evolution of institutions impacts economic outcomes.
- Good institutions are crucial for prosperity; bad ones trap countries in poverty.
Public Choice Theory
- Applies economic analysis to politics, assuming politicians and bureaucrats act in self-interest.
- "Concentrated benefits and dispersed costs" explain persistent inefficient policies.
- Suggests constitutional rules and competition between jurisdictions to check government power.
Key Terms & Definitions
- Invisible Hand — Market self-regulation through individual self-interest.
- Comparative Advantage — Specializing in goods one produces most efficiently.
- Surplus Value — Value created by workers above their wages, taken by capitalists.
- Nash Equilibrium — Situation where no player can benefit by changing strategy alone.
- Marginal Utility — Additional satisfaction from consuming one more unit.
- Aggregate Demand — Total spending in an economy.
- Laffer Curve — Shows relationship between tax rates and government revenue.
- Poverty Trap — Self-reinforcing cycle keeping people or countries poor.
- Path Dependence — Influence of historical choices on present economic outcomes.
- Transaction Costs — Costs associated with making an economic exchange.
Action Items / Next Steps
- Review provided definitions and examples for each school.
- Prepare to compare and contrast different economic theories for upcoming assignments.