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Overview of Economic Schools

Jun 24, 2025

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 person’s 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 school’s 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.