Overview
This lecture surveys major schools of economic thought, highlighting their core theories, how they view markets, government intervention, and human behavior.
Classical Economics
- Adam Smith's "invisible hand" suggests individual self-interest leads to economic order and efficiency.
- Markets, prices, and wages naturally adjust without government interference (laissez-faire).
- David Ricardo's comparative advantage: countries benefit by specializing in what they are relatively best at.
Marxian Economics
- Karl Marx argued capitalism inherently exploits workers via surplus value (difference between what workers produce and what they are paid).
- Marx predicted capitalism would collapse due to internal contradictions, leading to socialism and communism.
- Historical materialism: economic systems evolve through stages driven by class struggle.
Game Theory
- Focuses on strategic decision-making where each personβs choices depend on others.
- Prisoner's dilemma: rational self-interest can lead to worse outcomes than cooperation.
- Nash equilibrium: a stable strategy set where no one benefits by changing their choice alone.
Neoclassical Economics
- Emphasizes marginal utility (the value of one more unit) over labor as the source of value.
- People are rational actors maximizing utility; firms maximize profits.
- Supply and demand curves naturally move markets toward equilibrium.
Keynesian Economics
- John Maynard Keynes emphasized aggregate demand and argued government intervention is necessary during recessions.
- The multiplier effect: government spending stimulates broader economic activity.
- Saving during downturns worsens recessions (paradox of thrift).
Supply Side Economics
- Argues that reducing taxes and regulations stimulates production and economic growth.
- Laffer Curve illustrates there is an optimal tax rate to maximize revenue.
- Trickle-down theory: tax cuts for the wealthy lead to broader economic benefits.
Monetarism
- Milton Friedman claimed inflation is always caused by excessive money supply.
- Advocates for steady, predictable money growth rather than active government intervention.
- Introduced the concept of the natural rate of unemployment.
Development Economics
- Studies why nations grow at different rates, considering institutions, culture, and history.
- Poverty traps: self-reinforcing cycles that keep people and economies poor.
- Targeted interventions (e.g., microfinance, cash transfers) can break poverty cycles.
Austrian School
- Emphasizes the importance of individual choices and the limits of mathematical models.
- Criticizes central banks for causing business cycles via artificially low interest rates.
- Champions spontaneous order arising from free markets and decentralized information.
Behavioral Economics
- Challenges the assumption of rational actors, showing people are influenced by biases and emotions.
- Bounded rationality: people make decisions that are "good enough," not optimal.
- Introduced "nudges" to help people make better choices without restricting freedom.
New Institutional Economics
- Focuses on the role of institutions (laws, corporations, property rights) in reducing transaction costs.
- Path dependence: historical evolution of institutions shapes economic outcomes.
- Good institutions are crucial for sustained economic development.
Public Choice Theory
- Applies economic analysis to political behavior, viewing politicians and bureaucrats as self-interested actors.
- Concentrated benefits and dispersed costs explain why inefficient policies persist.
- Proposes rules and competition to limit government favoritism.
Key Terms & Definitions
- Invisible Hand β self-interest drives economic efficiency without central control.
- Comparative Advantage β producing goods with the lowest opportunity cost.
- Surplus Value β difference between value produced by labor and wages paid.
- Prisoner's Dilemma β scenario where rational choices lead to worse collective outcomes.
- Marginal Utility β added satisfaction from one more unit of a good.
- Aggregate Demand β total spending in an economy.
- Laffer Curve β relationship between tax rates and tax revenue.
- Natural Rate of Unemployment β baseline, healthy unemployment in an economy.
- Poverty Trap β cycle that keeps people poor.
- Bounded Rationality β people make satisfactory, not always optimal, decisions.
- Transaction Costs β costs of making economic exchanges.
- Nudge β subtle change in presentation to influence decisions.
Action Items / Next Steps
- Review each schoolβs key concepts for comparative essays.
- Prepare to define and apply key terms in class discussions or exams.
- Read assigned chapters on economic schools of thought.