CLASSICAL SCHOOL OF ECONOMICS

Classical Economics Origin The Classical School of economics was developed about 1750 and lasted as the mainstream of economic thought until the late 1800s. it 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 School of economic theory began with the publication in 1776 of Adam Smith's monumental work, The Wealth of Nations. The book identified land, labor, and capital as the three factors of production and the major contributors to a nation's wealth. In Smith's view, the ideal economy is a self-regulating market system that automatically satisfies the economic needs of the populace. He described the market mechanism as an "invisible hand" that leads all individuals, in pursuit of their own self-interests, to produce the greatest benefit for society as a whole. Smith incorporated some of the Physiocrats' ideas, including laissez-faire, into his own economic theories, but rejected the idea that only agriculture was productive. 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 landand-labour theory of value. Smith confined the labour theory of value to a mythical precapitalist 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, and 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, and 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. Monetary Theory British classical economists in the 19th century had a well-developed controversy between the Banking and the Currency school. This parallels recent debates between proponents of the theory of endogenous money, such as Nicholas Kaldor, and monetarists, such as Milton Friedman. Monetarists and members of the currency school argued that banks can and should control the supply of money. According to their theories, inflation is caused by banks issuing an excessive supply of money. According to proponents of the theory of endogenous money, the supply of money automatically adjusts to the demand, and banks can only control the terms (e.g., the rate of interest) on which loans are made. Role of Government Under classical economics, the role of government is to provide national defense, a system of justice that includes enforcement of contracts and a system of public

works, including infrastructure and education. Benefits Under classical economics, the self-regulating market transforms a seemingly chaotic process of buying and selling among consumers and producers into an orderly system of transactions that meets individual needs and increases national wealth. Influences Classical economics gave rise to neoclassical economic thought in the late 19th century. Neoclassical built on Classical ideas, giving them greater mathematical support and precision. Classical Economist While Adam Smith emphasized the production of income, David Ricardo focused on the distribution of income among landowners, workers, and capitalists. Ricardo saw a conflict between landowners on the one hand and labor and capital on the other. He posited that the growth of population and capital, pressing against a fixed supply of land, pushes up rents and holds down wages and profits. Thomas Robert Malthus used the idea of diminishing returns to explain low living standards. Population, he argued, tended to increase geometrically, outstripping the production of food, which increased arithmetically. The force of a rapidly growing population against a limited amount of land meant diminishing returns to labor. The result, he claimed, was chronically low wages, which prevented the standard of living for most of the population from rising above the subsistence level. Malthus also questioned the automatic tendency of a market economy to produce full employment. He blamed unemployment upon the economy's tendency to limit its spending by saving too much, a theme that lay forgotten until John Maynard Keynes revived it in the 1930s. Coming at the end of the Classical tradition, John Stuart Mill parted company with the earlier classical economists on the inevitability of the distribution of income produced by the market system. Mill pointed to a distinct difference between the market's two roles: allocation of resources and distribution of income. The market might be efficient in allocating resources but not in distributing income, he wrote, making it necessary for society to intervene.

Adam Smith (The Father of Economics)

Adam Smith is often touted as the world's first free-market capitalist. While that designation is probably a bit overstated, Smith's place in history as the father of modern economics and a major proponent of laissez-faire economic policies is quite secure. Read on to learn about how this Scottish philosopher argued against mercantilism to become the father of modern free trade. Early Life The recorded history of Smith's life begins on June 16, 1723, at his baptism in Scotland. His birthday is undocumented. Smith attended the University of Glasgow at age 14, later transferring to Balliol College in Oxford, England. He spent years teaching and tutoring, publishing some of his lectures in "The Theory of Moral Sentiments" in 1759. The material was well received and laid the foundation for the publication of "An Inquiry into the Nature and Causes of the Wealth of Nations" (1776) , which would cement his place in history. Invisible Hand Theory "An Inquiry into the Nature and Causes of the Wealth of Nations" documented the industrial and development in Europe. While critics note that Smith didn't invent many of the ideas that he wrote about, he was the first person to compile and publish them in a format designed to explain them to the average reader of the day. As a result, he is responsible for popularizing many of the ideas that underpin the school of thought that became known as classical economics. Laissez-faire philosophies, such as minimizing the role of government intervention and taxation in the free markets, and the idea that

an "invisible hand" guides supply and demand are among the key ideas Smith's writing is responsible for promoting. These ideas reflect the concept that each person, by looking out for him- or herself, inadvertently helps to create the best outcome for all. "It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest," Smith wrote. By selling products that people want to buy, the butcher, brewer and baker hope to make money. If they are effective in meeting the needs of their customers, they will enjoy the financial rewards. While they are engaging in their enterprises for the purpose of earning money, they are also providing products that people want. Such a system, Smith argued, creates wealth not just for the butcher, brewer and baker, but for the nation as whole when that nation is populated with citizens working productively to better themselves and address their financial needs. Similarly, Smith noted that a man would invest his wealth in the enterprise most likely to help him earn the highest return for a given level of risk. Published Philosophy "The Wealth of Nations" is a massive work consisting of two volumes divided into five books. The ideas it promoted generated international attention and helped to drive the move from land-based wealth to wealth created by assembly-line production methods driven by division of labor. One example Smith cited involved the labor required to make a pin. One man undertaking the 18 steps required to complete the tasks could make but a handful of pins each week, but if the 18 tasks were completed in assembly-line fashion by 10 men, production would jump to thousands of pins per week. He applied a similar logic regarding wealth generation and efficiency to British rule over the American colonies. According to his calculations, the cost of maintaining the colonies was simply not worth the return on investment. Interestingly, while much of the philosophy behind Smith's work is based on self-interest and maximizing return, his first published work, "The Theory of Moral Sentiments", was a treatise about how human communication relies on sympathy. While this may seem to be at odds with his economic views of individuals working to better themselves with no regard for the common good, the idea of an invisible hand that helps everyone through the labor of self-centered individuals offsets this seeming contradiction. Today, the invisible hand theory is often presented in terms of a natural phenomenon that guides free markets and capitalism in the direction of efficiency, through supply and demand and competition for scarce resources, rather than as something that results in

the well-being of individuals.

Thomas Robert Malthus

Early Life The sixth of seven children of Daniel and Henrietta Malthus, Thomas Robert Malthus grew up in The Rookery, a country house near Westcott in Surrey. Petersen describes Daniel Malthus as "a gentleman of good family and independent means and a friend of David Hume and Jean-Jacques Rousseau". The young Malthus received his education at home in Bramcote, Nottinghamshire, and then at theDissenting Warrington Academy. He entered Jesus College, Cambridge in 1784. There he took prizes in English declamation, Latin and Greek, and graduated with honours, Ninth Wrangler in mathematics. He took the MA degree in 1791, and was elected a Fellow of Jesus College, Cambridge two years later. In 1797, he took orders and in 1798 became an Anglican country curate at Okewood near Alburyin Surrey. Personal Life Malthus married his cousin Harriet on 12 April 1804 and had three children: Henry, Emily and Lucy. In 1805 he became Professor of History and Political Economy at the East India Company College (now known as Haileybury) in Hertfordshire. His students affectionately referred to him as "Pop" or "Population" Malthus. In 1818 Malthus became a Fellow of the Royal Society. Malthus died on 23 December 1834. His tomb is in Bath Abbey. An Essay on the Principle of Population Between 1798 and 1826 Malthus published six editions of his famous treatise, An Essay on the Principle of Population , updating each edition to incorporate new material, to address criticism, and to convey changes in his own perspectives on the subject. He

wrote the original text in reaction to the optimism of his father and his father's associates (notably Rousseau) regarding the future improvement of society. Malthus also constructed his case as a specific response to writings of William Godwin (17561836) and of the Marquis de Condorcet (17431794). Malthus regarded ideals of future improvement in the lot of humanity with skepticism, considering that throughout history a segment of every human population seemed relegated to poverty. He explained this phenomenon by arguing that population growth generally expanded in times and in regions of plenty until the size of the population relative to the primary resources caused distress: "Yet in all societies, even those that are most vicious, the tendency to a virtuous attachment is so strong that there is a constant effort towards an increase of population. This constant effort as constantly tends to subject the lower classes of the society to distress and to prevent any great permanent amelioration of their condition". "The way in which these effects are produced seems to be this. We will suppose the means of subsistence in any country just equal to the easy support of its inhabitants. The constant effort towards population... increases the number of people before the means of subsistence are increased. The food therefore which before supported seven millions must now be divided among seven millions and a half or eight millions. The poor consequently must live much worse, and many of them be reduced to severe distress. The number of labourers also being above the proportion of the work in the market, the price of labour must tend toward a decrease, while the price of provisions would at the same time tend to rise. The labourer therefore must work harder to earn the same as he did before. During this season of distress, the discouragements to marriage, and the difficulty of rearing a family are so great that population is at a stand. In the mean time the cheapness of labour, the plenty of labourers, and the necessity of an increased industry amongst them, encourage cultivators to employ more labour upon their land, to turn up fresh soil, and to manure and improve more completely what is already in tillage, till ultimately the means of subsistence become in the same proportion to the population as at the period from which we set out. The situation of the labourer being then again tolerably comfortable, the restraints to population are in some degree loosened, and the same retrograde and progressive movements with respect to happiness are repeated". Malthus also saw that societies through history had experienced at one time or another epidemics, famines, or wars: events that masked the fundamental problem of populations overstretching their resource limitations: "The power of population is so superior to the power of the earth to produce subsistence for man that premature death must in some shape or other visit the human race. The vices of mankind are active and able ministers of depopulation. They are the precursors in the great army of destruction, and often finish the dreadful work themselves. But should they fail in this war of extermination, sickly seasons, epidemics, pestilence, and plague advance in terrific array, and sweep off their thousands and tens of thousands. Should success be still incomplete, gigantic inevitable famine stalks in the rear, and with one mighty blow levels the population with the food of the world". Proposed solutions

Malthus argued that two types of checks hold population within resource limits: positive checks, which raise the death rate; and preventive ones, which lower the birth rate. The positive checks include hunger, disease and war; the preventive checks, abortion, birth control, prostitution, postponement of marriage and celibacy. Regarding possibilities for freeing man from these limits, Malthus argued against a variety of imaginable solutions. For example, he satirically criticized the notion that agricultural improvements could expand without limit: "We may be quite sure that among plants, as well as among animals, there is a limit to improvement, though we do not exactly know where it is. It is probable that the gardeners who contend for flower prizes have often applied stronger dressing without success. At the same time, it would be highly presumptuous in any man to say, that he had seen the finest carnation or anemone that could ever be made to grow. He might however assert without the smallest chance of being contradicted by a future fact, that no carnation or anemone could ever by cultivation be increased to the size of a large cabbage; and yet there are assignable quantities much greater than a cabbage. No man can say that he has seen the largest ear of wheat, or the largest oak that could ever grow; but he might easily, and with perfect certainty, name a point of magnitude, at which they would not arrive. In all these cases therefore, a careful distinction should be made, between an unlimited progress, and a progress where the limit is merely undefined." He also commented on the notion that Francis Galton later called eugenics: "It does not... by any means seem impossible that by an attention to breed, a certain degree of improvement, similar to that among animals, might take place among men. Whether intellect could be communicated may be a matter of doubt; but size, strength, beauty, complexion, and perhaps longevity are in a degree transmissible... As the human race, however, could not be improved in this way without condemning all the bad specimens to celibacy, it is not probable that an attention to breed should ever become general". In the second and subsequent editions Malthus put more emphasis on moral restraint. By that he meant the postponement of marriage until people could support a family, coupled with strict celibacy (sexual abstinence) until that time. "He went so far as to claim that moral restraint on a wide scale was the best meansindeed, the only means of easing the poverty of the lower classes This plan appeared consistent with virtue, economic gain and social improvement. Malthus emphasizes the difference between government-supported welfare, and public charity. He proposed the gradual abolition of poor laws by gradually reducing the number of persons qualifying for relief. Relief in dire distress would come from private charity. He reasoned that poor relief acted against the longer-term interests of the poor by raising the price of commodities and undermining the independence and resilience of the peasant. In other words, the poor laws tended to "create the poor which they maintain. It offended Malthus that critics claimed he lacked a caring attitude toward the situation of the poor. In the 1798 edition his concern for the poor shows in passages such as the following:

Nothing is so common as to hear of encouragements that ought to be given to population. If the tendency of mankind to increase be as great as I have represented it to be, it may appear strange that this increase does not come when it is thus repeatedly called for. The true reason is, that the demand for a greater population is made without preparing the funds necessary to support it. Increase the demand for agricultural labour by promoting cultivation, and with it consequently increase the produce of the country, and ameliorate the condition of the labourer, and no apprehensions whatever need be entertained of the proportional increase of population. An attempt to effect this purpose in any other way is vicious, cruel, and tyrannical, and in any state of tolerable freedom cannot therefore succeed. In an addition to the 1817 edition he wrote: I have written a chapter expressly on the practical direction of our charity; and in detached passages elsewhere has paid a just tribute to the exalted virtue of benevolence. To those who have read these parts of my work, and have attended to the general tone and spirit of the whole, I willingly appeal, if they are but tolerably candid, against these charges ... which intimate that I would root out the virtues of charity and benevolence without regard to the exaltation which they bestow on the moral dignity of our nature. Some, such as William Farr and Karl Marx, argued that Malthus did not fully recognize the human capacity to increase food supply. On this subject, however, Malthus had written: "The main peculiarity which distinguishes man from other animals, in the means of his support, is the power which he possesses of varies greatly increasing these means. On religion As a believer and a clergyman, Malthus addressed the question of how an omnipotent and caring God could permit suffering. In the First Edition of his Essay (1798) Malthus reasoned that the constant threat of poverty and starvation served to teach the virtues of hard work and virtuous behavior. "Had population and food increased in the same ratio, it is probable that man might never have emerged from the savage state, he wrote, adding further, "Evil exists in the world not to create despair, but activity. Nevertheless, although the threat of poverty could be understood to be a prod to motivate human industry, it was not God's will that man should suffer. Malthus wrote that mankind itself was solely to blame for human suffering: "I believe that it is the intention of the Creator that the earth should be replenished; but certainly with a healthy, virtuous and happy population, not an unhealthy, vicious and miserable one. And if, in endeavoring to obey the command to increase and multiply, we people it only with beings of this latter description and suffer accordingly, we have no right to impeach the justice of the command, but our irrational mode of executing it.

Demographics, wages, and inflation

Malthus wrote of the relationship between population, real wages, and inflation. When the population of laborers grows faster than the production of food, then real wages fall, because the growing population causes the cost of living (i.e., the cost of food) to go up. Difficulties of raising a family eventually reduce the rate of population growth, until the falling population again leads to higher real wages:
"A circumstance which has, perhaps, more than any other, contributed to conceal this oscillation from common view, is the difference between the nominal and real price of labour. It very rarely happens that the nominal price of labour universally falls; but we well know that it frequently remains the same, while the nominal price of provisions has been gradually rising. This, indeed, will generally be the case, if the increase of manufactures and commerce is sufficient to employ the new labourers that are thrown into the market, and to prevent the increased supply from lowering the money-price. But an increased number of labourers receiving the same money-wages will necessarily, by their competition, increase the money-price of corn. This is, in fact, a real fall in the price of labour; and, during this period, the condition of the lower classes of the community must be gradually growing worse. But the farmers and capitalists are growing rich from the real cheapness of labour. Their increasing capitals enable them to employ a greater number of men; and, as the population had probably suffered some check from the greater difficulty of supporting a family, the demand for labour, after a certain period, would be great in proportion to the supply, and its price would of course rise, if left to find its natural level; and thus the wages of labour, and consequently the condition of the lower classes of society, might have progressive and retrograde movements, though the price of labour might never nominally fall. In later editions of his essay, Malthus clarified his view that if society relied on human misery to limit population growth, then sources of misery (e.g., hunger, disease, and war, termed by Malthus "positive checks on population") would inevitably afflict society, as would volatile economic cycles. On the other hand, "preventive checks" to population that limited birthrates, such as later marriages, could ensure a higher standard of living for all, while also increasing economic stability.

Surplus theory

Whereas Malthus's main body of work presents a theory of irremediable, if not untreatable, scarcity, three of his other works present a theory of surplus: The Nature of Rent, Principles of political economy,and Definitions in Political Economy.
The Nature of Rent proposes rent as a kind of surplus, whereas the previous general definition of rent portrayed it as a societal economic loss caused by personal financial gain derived from land scarcity.[ Principles of Political Economy and Definitions in Political Economy defend the concept of the general glut, a theory that surplus value can present a problem. Rent as surplus, and a glut or surplus of goods as problems differ somewhat or stand in contradistinction to Malthus's earlier scarcity theory of The Principle of Population.

David Ricardo

David Ricardo - His Life David Ricardo was born in 1772. He was the third of seventeen children. His family was descended from Iberian Jews who had fled to Holland in the early 18th Century. Ricardos father, a stockbroker, emigrated to England shortly before David was born. Ricardo began working full-time for his father at the London Stock Exchange when he was fourteen. When he was 21 his family disinheriated him when he married a Quaker. Luckily he already had an excellent reputation in finance and he set up his own business as a dealer in government securities. He quickly became very rich.

David Ricardo retired from business in 1814 and was elected into the British parliament in 1819 as an independent representing a borough in Ireland, which he served up to his death in 1823. In parliament his main interests were in the currency and commercial questions of the day. When he died, his estate was worth over $100 million in today's dollars. His Work Ricardo read Adam Smith's Wealth of Nations (1776) when he was in his late twenties. This sparked an interest in economics that lasted his whole life. In 1809 Ricardo began to write down his own ideas in economics for newspaper articles.In his Essay on the Influence of a Low Price of Corn on the Profits of Stock (1815), Ricardo articulated what came to be known as the law of diminishing returns. (This principle was also discovered simultaneously and independently by Malthus, Robert Torrens and Edward West).In 1817 David Ricardo published Principles of Political Economy and Taxation. In this text Ricardo integrated a theory of value into his theory of distribution. David Ricardos attempts to answer important economic issues took economics to an unprecedented degree of theoretical sophistication. He outlined the Classical system more clearly and consistently than anyone before had done. His ideas became known as the "Classical" or "Ricardian" School. While his ideas were followed they slowly were replaced. However, even today the "Neo-Ricardian" research program exists. John Stuart Mill

Life John Stuart Mill, the eldest son of the philosopher, James Mill, was born inLondon on 20th May, 1806. Educated a home by his father, John Stuart had studied the works of Aristotle, Plato, Jeremy Bentham, Thomas Hobbes, David Ricardo and Adam Smith by the time he had reached the age of twelve. Mill was especially impressed by the work of Jeremy Bentham. He agreed with Bentham when he argued in Introduction to the Principles of Morals and Legislation (1789), that the proper objective of all conduct and legislation is "the greatest happiness of the greatest number". Mill became a Utilitarian and at the age of seventeen formed a discussion group called the Utilitarian Society.

Mill also began having articles published in the Westminster Review, a journal founded by Jeremy Bentham and James Mill to propagate Radical views. John Stuart Mill also wrote for other newspapers and journals including the Morning Chronicle and Parliamentary History & Review . Jeremy took an active role in the campaign for parliamentary reform, and was one of the first to suggest that women should have the same political rights as men. In 1830 John Stuart Mill became a close friend of Harriet Taylor. Taylor was attracted to Mill, the first man she had met who treated her as an intellectual equal. Mill was impressed with Taylor and asked her to read and comment on the latest book he was working on. Over the next few years they exchanged essays on issues such as marriage and women's rights. In 1833 Harriet negotiated a trial separation from her husband. She then spent six weeks with Mill in Paris. On their return Harriet Taylor moved to a house at Walton-on-Thames where John Start Mill visited her at weekends. Although Harriet Taylor and Mill claimed they were not having a sexual relationship, their behaviour scandalized their friends. As a result, the couple became socially isolated. After the death of John Taylor in 1849, Mill married Harriet Taylor. John Stuart Mill died on 8th May, 1873.

Theory of liberty Mills On Liberty addresses the nature and limits of the power that can be legitimately exercised by society over the individual. One argument that Mill develops further than any previous philosopher is the harm principle. The harm principle holds that each individual has the right to act as he wants, so long as these actions do not harm others. If the action is self-regarding, that is, if it only directly affects the person undertaking the action, then society has no right to intervene, even if it feels the actor is harming himself. He does argue, however, that individuals are prevented from doing lasting, serious harm to themselves or their property by the harm principle. Because noone exists in isolation, harm done to oneself may also harm others, and destroying property deprives the community as well as oneself. Mill argues that despotism is an acceptable form of government for those societies that are backward, as long as the despot has the best interests of the people at heart, because of the barriers to spontaneous progress. Though this principle seems clear, there are a number of complications. For example, Mill explicitly states that harms may include acts of omission as well as acts of commission. Thus, failing to rescue a drowning child counts as a harmful act, as does failing to pay taxes, or failing to appear as a witness in court. All such harmful omissions may be regulated, according to Mill. By contrast, it does not count as harming someone if without force or fraud the affected individual consents to assume the risk: thus one may permissibly offer unsafe

employment to others, provided there is no deception involved. (Mill does, however, recognize one limit to consent: society should not permit people to sell themselves into slavery). In these and other cases, it is important to keep in mind that the arguments in On Liberty are grounded on the principle of Utility, and not on appeals to natural rights. On Liberty involves an impassioned defense of free speech. Mill argues that free discourse is a necessary condition for intellectual and social progress. We can never be sure, he contends, that a silenced opinion does not contain some element of the truth. He also argues that allowing people to air false opinions is productive for two reasons. First, individuals are more likely to abandon erroneous beliefs if they are engaged in an open exchange of ideas. Second, by forcing other individuals to reexamine and re-affirm their beliefs in the process of debate, these beliefs are kept from declining into mere dogma. It is not enough for Mill that one simply has an unexamined belief that happens to be true; one must understand why the belief in question is the true one. John Stuart Mills view on liberty, which was influenced by Joseph Priestley and Josiah Warren, is that the individual ought to be free to do as he wishes unless he harms others. Individuals are rational enough to make decisions about their good being and choose any religion they want to. Government should interfere when it is for the protection of society.

Jeremy betham

Life Jeremy Bentham, the son of a lawyer, was born in London in 1748. A brilliant scholar, Bentham entered Queen's College, Oxford at twelve and was admitted to Lincoln's Inn at the age of fifteen. Bentham was a shy man who did not enjoy making public speeches. Bentham produced a series of books on philosophy, economics and politics. Bentham's family had been Tories and for the first period of his life he shared their conservative political views.

In 1798 Bentham wrote Principles of International Law where he argued that universal peace could only be obtained by first achieving European Unity. He hoped that some form of European Parliament would be able to enforce the liberty of the press, free trade, the abandonment of all colonies and a reduction in the money being spent on armaments. Jeremy Bentham died in 1832. Human Nature For Bentham, morals and legislation can be described scientifically, but such a description requires an account of human nature. Just as nature is explained through reference to the laws of physics, so human behavior can be explained by reference to the two primary motives of pleasure and pain; this is the theory of psychological hedonism. At the beginning of the Introduction to the Principles of Morals and Legislation, Bentham writes: Nature has placed mankind under the governance of two sovereign masters, pain and pleasure. It is for them alone to point out what we ought to do, as well as to determine what we shall do. On the one hand the standard of right and wrong, on the other the chain of causes and effects, are fastened to their throne. They govern us in all we do, in all we say, in all we think: every effort we can make to throw off our subjection, will serve but to demonstrate and confirm it. From this we see that, for Bentham, pleasure and pain serve not only as explanations for action, but they also define ones good. It is, in short, on the basis of pleasures and pains, which can exist only in individuals, that Bentham thought one could construct a calculus of value. Bentham believed that the nature of the human person can be adequately described without mention of social relationships. To begin with, the idea of relation is but a fictitious entity, though necessary for convenience of discourse. And, more specifically, he remarks that the community is a fictitious body, and it is but the sum of the interests of the several members who compose it. Thus, the extension of the term individual is, in the main, no greater and no less than the biological entity. Benthams view, then, is that the individualthe basic unit of the social sphereis an atom and there is no self or individual greater than the human individual. A persons relations with otherseven if importantare not essential and describe nothing that is, strictly speaking, necessary to its being what it is. Moral Philosophy Benthams moral philosophy reflects what he calls at different times the greatest happiness principle or the principle of utilitya term which he borrows from Hume. In adverting to this principle, however, he was not referring to just the usefulness of things or actions, but to the extent to which these things or actions promote the general

happiness. Specifically, then, what is morally obligatory is that which produces the greatest amount of happiness for the greatest number of people, happiness .Bentham admits that his version of the principle of utility is something that does not admit of direct proof, but he notes that this is not a problem as some explanatory principles do not admit of any such proof and all explanation must start somewhere. But this, by itself, does not explain why anothers happinessor the general happinessshould count. Poltical Philisophy In his earliest work, A Fragment on Government (1776), which is an excerpt from a longer work published only in 1928 as Comment on Blackstones Commentaries, Bentham attacked the legal theory of Sir William Blackstone. Benthams target was, primarily, Blackstones defense of tradition in law. Bentham advocated the rational revision of the legal system, a restructuring of the process of determining responsibility and of punishment, and a more extensive freedom of contract. This, he believed, would favor not only the development of the community, but the personal development of the individual. Benthams attack on Blackstone targeted more than the latters use of tradition. Bentham repudiated many of the concepts underlying their political philosophies, such as natural right, state of nature, and social contract. Bentham then attempted to outline positive alternatives to the preceding traditionalisms. Not only did he work to reform and restructure existing institutions, but he promoted broader suffrage and self (that is, representative) government.

MARXIAN SCHOOL

OF ECONOMICS

Marxian Economics Origin The term Marxist (or Marxian) economics refers to the branch of economics that is based on the theories created and advocated by Karl Marx, a highly influential thinker, especially when one considers how much of the worlds population has been, at one point or another in the twentieth century, under the control of governments that claim themselves to be Marxist to varying degrees. Perhaps the most central principal that underlies Marxist economics is known as the labor theory of value. It posits that the value of any item can be known by determining the amount of time it takes to make it. (The theory has since been proven false and has been overtaken by the theory of subjectivism which states that value is not inherent but rather determined by desire for the item.) The theory already existed before Marx adopted it, but he took it to a new level by including laborers as one of the commodities. He referred to this as labor power, and believed that the commodity being sold was the labor of the employee for the price of a wage. Thus, he said, the value of this commodity (the employees labor) should be based on the number of labor hours it takes society to make him fit for work (through feeding, clothing, etc.) Marxian Theory Marx employed a labour theory of value, which holds that the value of a commodity is the socially necessary labour time invested in it. In this model, capitalists do not pay workers the full value of the commodities they produce; rather, they compensate the worker for the necessary labor only (the worker's wage, which cover only the necessary means of subsistence in order to maintain him working in the present and his family in the future as a group). This necessary labor is, Marx supposes, only a fraction of a full working day - the rest, the surplus-labor, would be pocketed by the capitalist. Marx theorized that the gap between the value a worker produces and his wage is a form of unpaid labour, known as surplus value. Moreover, Marx argues that markets tend to obscure the social relationships and processes of production; he called this commodity fetishism. People are highly aware of commodities, and usually don't think about the relationships and labour they represent. Labor Theory The labor theory of value is a major pillar of traditional Marxian economics, which is evident in Marxs masterpiece, Capital (1867). The theorys basic claim is simple: the value of a commodity can be objectively measured by the average number of labor hours required to produce that commodity.

If a pair of shoes usually takes twice as long to produce as a pair of pants, for example, then shoes are twice as valuable as pants. In the long run, the competitive price of shoes will be twice the price of pants, regardless of the value of the physical inputs. Although the labor theory of value is demonstrably false, it prevailed among classical economists through the mid nineteenth century. ADAM SMITH, for instance, flirted with a labor theory of value in his classic defense of capitalism, The (1776), and DAVID RICARDO later systematized it in his Principles of Political Economy(1817), a text studied by generations of free-market economists. So the labor theory of value was not unique to Marxism. Marx did attempt, however, to turn the theory against the champions of capitalism, pushing the theory in a direction that most classical economists hesitated to follow. Marx argued that the theory could explain the value of all commodities, including the commodity that workers sell to capitalists for a wage. Marx called this commodity labor power. Labor power is the workers capacity to produce goods and services. Marx, using principles of classical economics, explained that the value of labor power must depend on the number of labor hours it takes society, on average, to feed, clothe, and shelter a worker so that he or she has the capacity to work. In other words, the long-run wage workers receive will depend on the number of labor hours it takes to produce a person who is fit for work. Suppose five hours of labor are needed to feed, clothe, and protect a worker each day so that the worker is fit for work the following morning. If one labor hour equaled one dollar, the correct wage would be five dollars per day. Marx then asked an apparently devastating question: if all goods and services in a capitalist society tend to be sold at prices (and wages) that reflect their true value (measured by labor hours), how can it be that capitalists enjoy PROFITSeven if only in the short run? How do capitalists manage to squeeze out a residual between total revenue and total costs? Capitalists, Marx answered, must enjoy a privileged and powerful position as owners of the means of production and are therefore able to ruthlessly exploit workers. Although the capitalist pays workers the correct wage, somehowMarx was terribly vague here the capitalist makes workers work more hours than are needed to create the workers labor power. If the capitalist pays each worker five dollars per day, he can require workers to work, say, twelve hours per daya not uncommon workday during Marxs time. Hence, if one labor hour equals one dollar, workers produce twelve dollars worth of products for the capitalist but are paid only five. The bottom line: capitalists extract surplus value from the workers and enjoy monetary profits. Although Marx tried to use the labor theory of value against capitalism by stretching it to its limits, he unintentionally demonstrated the weakness of the theorys logic and

underlying assumptions. Marx was correct when he claimed that classical economists failed to adequately explain capitalist profits. But Marx failed as well. By the late nineteenth century, the economics profession rejected the labor theory of value. Mainstream economists now believe that capitalists do not earn profits by exploiting workers. Instead, they believe, entrepreneurial capitalists earn profits by forgoing current consumption, by taking risks, and by organizing production. Alienation There is more to Marxism, however, than the labor theory of value and Marxs criticism of profit seeking. Marx wove economics and philosophy together to construct a grand theory of human history and social change. His concept of alienation, for example, first articulated in his Economic and Philosophic Manuscripts of 1844, plays a key role in his criticism of capitalism. Marx believed that people, by nature, are free, creative beings who have the potential to totally transform the world. But he observed that the modern, technologically developed world is apparently beyond our full control. Marx condemned the FREE MARKET, for instance, as being anarchic, or ungoverned. He maintained that the way the market economy is coordinatedthrough the spontaneous purchase and sale of private property dictated by the laws of SUPPLY andDEMANDblocks our ability to take control of our individual and collective destinies. Marx condemned capitalism as a system that alienates the masses. His reasoning was as follows: although workers produce things for the market, market forces, not workers, control things. People are required to work for capitalists who have full control over the means of production and maintain power in the workplace. Work, he said, becomes degrading, monotonous, and suitable for machines rather than for free, creative people. In the end, people themselves become objectsrobot like mechanisms that have lost touch with human nature, that make decisions based on cold profit-and-loss considerations, with little concern for human worth and need. Marx concluded that capitalism blocks our capacity to create our own humane society. Marxs notion of alienation rests on a crucial but shaky assumption. It assumes that people can successfully abolish an advanced, market-based society and replace it with a democratic, comprehensively planned society. Marx claimed that we are alienated not only because many of us toil in tedious, perhaps even degrading, jobs, or because by competing in the marketplace we tend to place profitability above human need. The issue is not about toil versus happiness. We are alienated, he maintained, because we have not yet designed a society that is fully planned andcontrolled, a society without COMPETITION, profits and losses, money, private property, and so ona society that, Marx predicted, must inevitably appear as the world advances through history.

Here is the greatest problem with Marxs theory of alienation: even with the latest developments in computer technology, we cannot create a comprehensively planned system that puts an end to scarcity and uncertainty. But for Marxists to speak of alienation under capitalism, they must assume that a successfully planned world is possible. That is, Marx believed that under capitalism we are alienated or separated from our potential to creatively plan and control our collective fate. But if comprehensive socialist planning fails to work in practiceif, indeed, it is an impossibility, as we have learned from MISES and Hayekthen we cannot be alienated in Marxs use of the term. We cannot really be separated from our potential to comprehensively plan the economy if comprehensive planning is impossible. Scientific Socialism A staunch antiutopian, Marx claimed that his criticism of capitalism was based on the latest developments in science. He called his theory scientific socialism to clearly distinguish his approach from that of other socialists (Henri de Saint-Simon and Charles Fourier, for instance), who seemed more content to dream about some future ideal society without comprehending how existing society really worked (see SOCIALISM). Marxs scientific socialism combined his economics and philosophyincluding his theory of value and the concept of alienationto demonstrate that throughout the course of human history, a profound struggle has developed between the haves and the have-nots. Specifically, Marx claimed that capitalism has ruptured into a war between two classes: the bourgeoisie (the capitalist class that owns the means of production) and the proletariat (the working class, which is at the mercy of the capitalists). Marx claimed that he had discovered the laws of history, laws that expose the contradictions of capitalism and the necessity of the class struggle. Marx predicted that competition among capitalists would grow so fierce that, eventually, most capitalists would go bankrupt, leaving only a handful of monopolists controlling nearly all production. This, to Marx, was one of the contradictions of capitalism: competition, instead of creating better products at lower prices for consumers, in the long run creates MONOPOLY, which exploits workers and consumers alike. What happens to the former capitalists? They fall into the ranks of the proletariat, creating a greater supply of labor, a fall in wages, and what Marx called a growing reserve army of the unemployed. Also, thought Marx, the anarchic, unplanned nature of a complex market economy is prone to economic crises as supplies and demands become mismatched, causing huge swings in business activity and, ultimately, severe economic depressions.

The more advanced the capitalist economy becomes, Marx argued, the greater these contradictions and conflicts. The more capitalism creates wealth, the more it sows the seeds of its own destruction. Ultimately, the proletariat will realize that it has the collective power to overthrow the few remaining capitalists and, with them, the whole system. The entire capitalist systemwith its private property, money, market exchange, profitand-loss accounting, labor markets, and so onmust be abolished, thought Marx, and replaced with a fully planned, self-managed economic system that brings a complete and utter end to exploitation and alienation. A socialist revolution, argued Marx, is inevitable. An Appraisal Marx was surely a profound thinker who won legions of supporters around the world. But his predictions have not withstood the test of time. Although capitalist markets have changed over the past 150 years, competition has not devolved into monopoly. Real wages have risen and profit rates have not declined. Nor has a reserve army of the unemployed developed. We do have bouts with the business cycle, but more and more economists believe those significant recessions and depressions may be more the unintended result of state intervention (through MONETARY POLICY carried out by central banks and government policies on TAXATION and spending) than an inherent feature of markets as such. Socialist revolutions, to be sure, have occurred throughout the world, but never where Marxs theory had predictedin the most advanced capitalist countries. On the contrary, socialism was forced on poor, so-called Third World countries. And those revolutions unwittingly condemned the masses to systemic poverty and political dictatorship. In practice, socialism absolutely failed to create the nonalienated, selfmanaged, and fully planned society. It failed to emancipate the masses and instead crushed them with statist, domination, and the terrifying abuse of state power. Nations that have allowed for private property rights and full-blown market exchange, in contrast to those democratic socialist republics of the twentieth century, have enjoyed remarkable levels of long-term ECONOMIC GROWTH. Free-market economies lift the masses from poverty and create the necessary institutional conditions for overall political freedom. Marxs theory of value, his philosophy of human nature, and his claims to have uncovered the laws of history fit together to offer a complex and grand vision of a new world order. If the first three-quarters of the twentieth century provided a testing ground

for that vision, the end of the century demonstrates its truly utopian nature and ultimate unworkability. In the wake of communisms collapse, traditional Marxism, which so many mainstream economists criticized relentlessly for decades, is now seriously questioned by a growing number of disillusioned radicals and former Marxists. Today there is a vibrant postMarxism, associated with the efforts of those active in the scholarly journal Rethinking Marxism, for instance. Rather than trying to solve esoteric puzzles about the labor theory of value or offering new theoretical models of a planned economy, many of todays sharpest post-Marxists appreciate marginal analysis and the knowledge and incentive problems of collective action. In this new literature, FRIEDRICH HAYEK seems to be getting a more positive reception than Marx himself. Exactly what will come out of these developments is hard to predict, but it is unlikely to look like the Marxism of the past.

Karl Heinrich Marx

Marx was first and foremost a philosopher who felt that his job was not merely to interpret and analyze society but also to promote the changes in society that he considered desirable. As a partisan advocate of change, he does not differ from Smith, Ricardo, or J. S. Mill. In contrast to the classical economists, however, Marx advocated a fundamental revolution in the society and economy, not small, marginal changes. Because Marx is popularly associated with the economic systems of socialism and communism, people often assume that he wrote about these systems. Nothing could be further from the truth. Marx studied what he called capitalismhis major work is titled Das Kapital, or Capital. In all the vast literature produced by Marx and his collaborator, Friedrich Engels (1820-1895), there is little reference to how a socialist or communist economy is to be organized, other than a short list of items characterizing the nature of communism that appeared in The Communist Manifesto (1848). Marx's economic theory is an application of his theory of history to the capitalist economy. He wanted to lay bare the laws of the dynamics of capitalism. Whereas other classical economists focused on the static equilibrium of the economy, Marx focused on the dynamic process of change. Paul M. Sweezy, an important American Marxist economist, has suggested that Marxian economics is the economics of capitalism and that capitalist economics is the economics of socialism. In other words, Marxian economics helps one to understand the forces underlying the market, whereas the standard classical analysis is useful in organizing and operating a socialist economy. The late Oskar Lange, a Marxist who taught in the United States and later returned to his native Poland to become an economic planner, reiterated that view. He contended that Marxian and orthodox economic analysis should be looked upon as complementary rather than mutually exclusive. Whereas an understanding of the everyday operation of the market can be achieved by using orthodox neoclassical theory, an understanding of the evolutionary development of capitalism, Lange said, is possible only within the Marxian framework.

In discussing growth, Marx emphasized the deterministic role of technology and increasing returns. He argued that firms would get bigger and bigger for technological reasons. In this emphasis he anticipated work by modern endogenous growth theorists, who have returned modern economics to a focus on growth and increasing returns. While Marx's discussion was broader and more far-reaching than this modern work, it focused on the same issuesthe importance of technology in determining the working of the economy, and the implications of increasing returns. Intellectual Sources of Marx's Ideas A study of Marx's life discloses the intellectual sources of his system. Born into a Jewish family that turned to Christianity, the young Marx began studying law but soon became interested in philosophy. Early in his studies he was attracted by the intellectual framework of G. W F. Hegel, another German writer. That framework, as we shall see, became an important element in Marx's system. After receiving his doctorate in philosophy, Marx was unable to find an academic appointment because of his radical views, so he turned to journalism. His political views, radical for the Germany of his time but still not socialistic, caused him to be expelled from Germany. In Paris and Brussels he began to study French socialist thought and classical political economy. Marx had tremendous intellectual powers coupled with a strong drive to read and study. After being expelled from Paris and Brussels, he moved to London and spent the last thirtythree years of his life reading and writing in one of the world's great libraries, the British Museum.

INSTITUTIONAL SCHOOL OF ECONOMICS

Institutional Economics

Institutional economics focuses on understanding the role of the evolutionary process and the role of institutions in shaping economic behavior. Its original focus lay in Thorstein Veblen's instinct-oriented dichotomy between technology on the one side and the "ceremonial" sphere of society on the other. Its name and core elements trace back to a 1919 American Economic Review article by Walton H. Hamilton. Institutional economics emphasizes a broader study of institutions and views markets as a result of the complex interaction of these various institutions (e.g. individuals, firms, states, social norms). The earlier tradition continues today as a leading heterodox approach to economics. Institutional economics focuses on learning, bounded rationality, and evolution (rather than assume stable preferences, rationality and equilibrium). It was a central part of American economics the first part of the 20th century, including such famous but diverse economists as Thorstein Veblen, Wesley Mitchell, and John R. Commons. Some institutionalisms see Karl Marx as belonging to the institutionalism tradition, because he described capitalism as a historically-bounded social system; other institutionalism economists disagree with Marx's definition of capitalism, instead seeing defining features such as markets, money and the private ownership of production as indeed evolving over time, but as a result of the purposive actions of individuals. "Traditional" institutionalism ejects the reduction of institutions to simply tastes, technology, and nature Tastes, along with expectations of the future, habits, and motivations, not only determine the nature of institutions but are limited and shaped by them. If people live and work in institutions on a regular basis, it shapes their world-views. Fundamentally, this traditional institutionalism (and its modern counter-part institutionalist political economy) emphasizes the legal foundations of an economy (see John R. Commons) and the evolutionary, habituated, and volitional processes by which institutions are erected and then changed (see John Dewey, Thorstein Veblen, and Daniel Bromley.) The vacillations of institutions are necessarily a result of the very incentives created by such institutions, and are thus endogenous. Emphatically, traditional institutionalism is in many ways a response to the current economic orthodoxy; its reintroduction in the form of institutionalist political economy is thus an explicit challenge to neoclassical economics, since it is based on the fundamental premise that neoclassicists oppose: that economics cannot be separated from the political and social system within which it is embedded. Some of the authors associated with this school include Robert H. Frank, Warren Samuels, Mark Tool, Geoffrey Hodgson, Daniel Bromley, Jonathan Nitzan, Shimshon Bichler, Elinor Ostrom, Anne Mayhew, John Kenneth Galbraith and Gunnar Myrdal, but even the sociologist C. Wright Mills was highly influenced by the institutionalist approach in his major studies.

Thorstein Veblen

Thorstein Veblen (18571929) wrote his first and most influential book while he was at the University of Chicago, on The Theory of the Leisure Class (1899). In it he analyzed the motivation in capitalism to conspicuously consume their riches as a way of demonstrating success. Conspicuous leisure was another focus of Veblen's critique. The concept of conspicuous consumption was in direct contradiction to the neoclassical view that capitalism was efficient. In The Theory of Business Enterprise (1904) Veblen distinguished the motivations of industrial production for people to use things from business motivations that used, or misused, industrial infrastructure for profit, arguing that the former is often hindered because businesses pursue the latter. Output and technological advance are restricted by business practices and the creation of monopolies. Businesses protect their existing capital investments and employ excessive credit, leading to depressions and increasing military expenditure and war through business control of political power. These two books, focusing on criticism first of consumerism, and second of profiteering, did not advocate change. Through the 1920s and after the Wall Street Crash of 1929 Thorstein Veblen's warnings of the tendency for wasteful consumption and the necessity of creating sound financial institutions seemed to ring true. Veblen remains a leading critic, which cautions against the excesses of "the American way". Thorstein Veblen wrote in 1898 an article entitled "Why is Economics Not an Evolutionary Science" and he became the precursor of current evolutionary economics.

John Kenneth Galbraith

John Kenneth Galbraith (19082006) worked in the New Deal administration of Franklin Delano Roosevelt. Although he wrote later, and was more developed than the earlier institutional economists, Galbraith was critical of orthodox economics throughout the late twentieth century. In The Affluent Society (1958), Galbraith argues voters reaching a certain material wealth begin to vote against the common good. He coins the term "conventional wisdom" to refer to the orthodox ideas that underpin the resulting conservative consensus. In an age of big business, it is unrealistic to think only of markets of the classical kind. Big businesses set their own terms in the marketplace, and use their combined resources for advertising programmes to support demand for their own products. As a result, individual preferences actually reflect the preferences of entrenched corporations, a "dependence effect", and the economy as a whole is geared to irrational goals. In The New Industrial State Galbraith argues that economic decisions are planned by a private bureaucracy, a technostructure of experts who manipulate is marketing and public relations channels. This hierarchy is self-serving, profits are no longer the prime motivator, and even managers are not in control. Because they are the new planners, corporations detest risk, requiring steady economic and stable markets. They recruit governments to serve their interests with fiscal and monetary policy. While the goals of an affluent society and complicit government serve the irrational technostructure, public space is simultaneously impoverished. Galbraith paints the picture of stepping from penthouse villas on to unpaved streets, from landscaped gardens to unkempt public parks. In Economics and the Public Purpose (1973) Galbraith advocates a "new socialism" (social democracy) as the solution, with nationalization of military production and public services such as health care, plus disciplined salary and price controls to reduce inequality.

AUSTRIAN SCHOOL OF ECONOMICS

Austrian Economics History In the late 19th century, attention then focused on the concepts of marginal cost and value. The subjectivist and marginalist approaches are generally considered to be precursors to the Austrian School. Austrian economist Murray Rothbard has argued that the roots of the Austrian School came from the teachings of the School of Salamanca in the 15th century and Physiocrats in the 18th century. Carl Menger's 1871 book, Principles of Economics, is generally considered the founding of the Austrian School. The book was one of the first modern treatises to advance the theory of marginal utility. The Austrian School was one of three founding currents of the marginalist revolution of the 1870s, with its major contribution being the introduction of the subjectivist approach in economics. Thorstein Veblen introduced the term neoclassical economics in hisPreconceptions of Economic Science (1900) to distinguish marginalists in the objective cost tradition of Alfred Marshall from those in the subjective valuation tradition of the Austrian School. The school originated in Vienna, in the Austrian Empire. However, later adherents of the school such as > The School owes its name to members of the German Historical School of economics, who argued against the Austrians during the Methodenstreit ("methodology struggle"), in which the Austrians defended the reliance that classical economists placed upon deductive logic. Carl Menger contributions to economic theory was closely followed by that of BhmBawerk and Friedrich von Wieser. These three economists became what is known as the "first wave" of the Austrian School. Austrians developed a sense of themselves as a school distinct from neoclassical economics during the economic calculation debate with socialist economists. Mises and his student Friedrich Hayek represented the Austrian position in contending that without monetary prices and private property, meaningful economic calculation is virtually impossible. Bhm-Bawerk wrote extensive critiques of Karl Marx in the 1880s and 1890s, as was part of the Austrians' participation in the late 19th Century Methodenstreit, during which they attacked the Hegelian doctrines of the Historical School. By the mid-1930s, much of mainstream economics had absorbed what were seen as the important contributions of the Austrians. After World War II, Austrian economics was ill-thought of by most economists because it rejected mathematical and statistical methods in the study of economics. Austrian economics after 1940 can be divided into two schools of economic thought, and the school "split" to some degree in the late 20th century. One camp of Austrians, exemplified by Mises, regards neoclassical methodology to be irredeemably flawed; the

other camp, exemplified by Friedrich Hayek, accepts a large part of neoclassical methodology. he Mises view was carried on by Murray Rothbard and economists such as Jesus Huerta de Soto. The other was subsumed within more conventional mainstream free-market thinking and was more conciliatory to government economic policy, fiat money, and central banking. Lawrence White and George Selgin are advocates for this more conciliatory approach. A controversial issue regarding Austrian economics is whether or not F.A. Hayek opposed the Fed's deflationary policy during the 1930s. Lawrence White argues that the business cycle theory of Hayek and Lionel Robbins did not prescribe a monetary policy which would permit a severe contraction of the money supply. Nevertheless, during the deflationary period of the early 1930s, Hayek and Robbins did not advise policy makers to pursue a monetary policy aimed at preventing a sharp decrease in the money supply. White says concerning their inaction:

The Austrian School of economics is a school of economic thought positing that the only appropriate means to understand economic events is by logically studyingthe intentions of individual economic decision-makers, based on certain fundamental truths. Austrian School theory is outside mainstream economic theory and mainstream economists are generally critical of its methodology. Austrian economists are, in turn, critical of mainstream economic methodology.

The theory that economic events are best explained by a deductive study of human action. The theory that the use of economic models and statistical methods to model economic behavior are a flawed, unreliable, and insufficient means of analyzing economic behavior and evaluating economic theories. The theory that testability in economics and consistently accurate mathematical modeling of an economic market are impossible because mathematical modeling of any real market affects the decision-makers in that market and "testing" relies on real human actors who cannot be placed in a lab setting without altering their wouldbe actions. The theory that the way in which money is produced has real and not only nominal economic effects. The theory that the cost of any activity should be measured by reference to the next best alternative. The theory that, in a free market, interest rates, and profits are determined by three factors: monetary gains or losses from a change in the consumption of a good or service, additional output that can be produced by additional inputs, and the valuation of consumption nearer in time versus more remote consumption.

The theory that markets clear if prices are allowed to adjust freely. The theory that inflation (when properly defined) relates to an increase in the supply of money (including credit) which causes prices to rise. The theory that capital goods and labor are highly heterogeneous (dissimilar), that money allows different goods to be analyzed in terms of their cost effectively, that economic calculation requires a common basis for comparison for all forms of capital and labor, that this process is the signaling function of prices, and that it is also a rationing function which prevents over-use of inherently limited resources. The theory that the capital structure of economies consists of heterogeneous goods that have multispecific uses which must be aligned to be effectively allocated, that the economic "boom-bust cycle" is caused by an artificial and unsustainable expansion of the money supply, and that this expansion causes businesses to make bad investment decisions that, in turn, inevitably and necessarily cause major economic dislocation.

Some theories developed by early Austrian economists have been absorbed into mainstream economics. Austrian theories have also significantly influenced other theories in mainstream economic thought, including the subjective theory of value, marginalism, and the economic calculation debate.[17] From the mid-20th century onwards, the Austrian school has been considered heterodox. Its reputation rose in the mid-1970s, after Austrian economist Friedrich Hayek shared the 1974 Nobel Prize in Economics. Opportunity cost The opportunity cost doctrine was first explicitly formulated by the Austrian economist Friedrich von Wieser in the late 19th century. Opportunity cost is the cost of any activity measured in terms of the value of the next best alternative foregone (that is not chosen). It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the cost of the foregone products after making a choice. Opportunity cost is a key concept ineconomics, and has been described as expressing "the basic relationship between scarcity and choice".[36] The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output foregone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs. Capital and interest

The Austrian theory of capital and interest holds that interest rates and profits are determined solely by the interaction of diminishing gains or losses from a change in the consumption of a good or service with diminishing extra output that can be produced by using one more unit of the input, and the valuation consumers place on consumption nearer in time versus more remote consumption. The Austrian theory of capital and interest was created by Bhm-Bawerk. He created the theory as a response to Marx's theories on capital. Bhm-Bawerk's theory centered on the un tenability of the labor theory of value in the light of the transformation problem. He also argued that capitalists do not exploit workers; they accommodate workers by providing them with income well in advance of the revenue from the output they helped to produce. Bhm-Bawerk's theory equates capital intensity with the degree of roundaboutness of production processes. Bhm-Bawerk also argued that the law of marginal utility necessarily implies the classical law of costs. Austrians therefore reject the notion that interest rates are determined by liquidity preference. In his book America's Great Depression, Rothbard argued that interest rates are instead determined by time preference. Says Rothbard, "Increased hoarding can either come from funds formerly consumed, from funds formerly invested, or from a mixture of both that leaves the old consumption-investment proportion unchanged. Unless time preferences change, the last alternative will be the one adopted. Thus, the rate of interest depends solely on time preference, and not at all on "liquidity preference." In fact, if the increased hoards come mainly out of consumption, an increased demand for money will cause interest rates to fallbecause time preferences have fallen." Inflation Mises argues that inflation only results when the supply of money outpaces demand for money given that all major economies currently have a central bank supporting the private banking system, money can be supplied into these economies by way of bankcreated credit or debt. The Austrian School also views the "contemporary" definition of inflation as inherently misleading in that it draws attention only to the effect of inflation (rising prices) and does not address the "true" phenomenon of inflation, which they believe simply involves an increase in the money supply (or the debasement of the means of exchange). They argue that this semantic difference is important in defining inflation and finding a cure for inflation. Austrians maintain the most effective cure is the strict maintenance of a stable money supply. Austrians hold that states use monetary inflation as one of the three means by which it can fund its activities, the other two being taxing and borrowing. Therefore, Austrians often seek to identify reasons why the state resorts to allowing the creation new money (whether fiat paper or electronic money) and what the new money is used for. Various forms of spending are often cited as reasons for resorting to inflation and borrowing. In other cases, the central bank may try avoid or defer the widespread bankruptcies and insolvencies which cause economic recessions

by artificially trying to "stimulate" the economy through money supply growth and further borrowing via artificially low interest rates. The role of central banks Austrians generally argue that inherently damaging and ineffective central bank policies, including unsustainable expansion of bank credit through fractional reserve banking, are the predominant cause of most business cycles, as they tend to set artificial interest rates too low for too long, resulting in excessive credit creation, speculative "bubbles", and artificially low savings. Under fiat monetary systems, a central bank creates new money when it lends to member banks, and this money is multiplied many times over through the money creation process of the private banks. This new bank-created money enters the loan market and provides a lower rate of interest than that which would prevail if the money supply were stable. However, Murray Rothbard paid particular attention to the role of central banks in creating an environment of loose credit prior to the onset of the Great Depression, and the subsequent ineffectiveness of central bank policies, which simply delayed necessary price adjustments and prolonged market dysfunction. Rothbard begins with the premise that in a market with no centralized monetary authority, there would be no simultaneous cluster of malinvestments or entrepreneurial errors, since astute entrepreneurs would not all make errors at the same time and would quickly take advantage of any temporary, isolated mispricing. In addition, in an open, non-centralized (uninsured) capital market, astute bankers would shy away from speculative lending and uninsured depositors would carefully monitor the balance sheets of risky financial institutions, tempering any speculative excesses that arose sporadically in the finance markets. In Rothbard's view, the cycle of generalized malinvestment is greatly exacerbated by centralized monetary intervention in the money markets by the central bank. Such propositions from Rothbard prompted criticism from Bryan Caplan, who questions "Why does Rothbard think businessmen are so incompetent at forecasting government policy? He credits them with entrepreneurial foresight about all market-generated conditions, but curiously finds them unable to forecast government policy, or even to avoid falling prey to simple accounting illusions generated by inflation and deflation... Particularly in interventionist economies, it would seem that natural selection would weed out businesspeople with such a gigantic blind spot." Rothbard argues that an over-encouragement to borrow and lend is initiated by the mispricing of credit via the central bank's centralized control over interest rates and its need to protect banks from periodic bank runs (which Austrians believe then causes interest rates to be set too low for too long when compared to the rates that would prevail in a genuine noncentralbank dominated freemarket).

Ludwig von Mises

Early life Ludwig von Mises was born to wealthy Jewish parents in the city of Lemberg, in Galicia, Austria-Hungary (now Lviv in Ukraine). The family of his father Arthur Edler von Mises had been elevated to the Austrian nobility in the 19th century, and was involved in building and financing railroads. Ludwig's mother, Adele (ne Landau), was a niece of Dr. Joachim Landau, a Liberal Party deputy to the Austrian Parliament. Arthur was stationed there as a construction engineer with Czernowitz railway company. At the age of twelve Ludwig spoke fluent Yiddish, German, Polish, and French, read Latin, and could understand Ukrainian. Mises was the older brother of the famous applied physicist Richard von Mises, a member of the Vienna Circle. Another brother, Karl von Mises, died as a child from scarlet fever. When Ludwig and Richard were children, his family moved back to their ancestral home of Vienna. In 1900, he attended the University of Vienna, becoming influenced by the works of Carl Menger. Mises' father died in 1903, and in 1906 Mises was awarded hisdoctorate from the school of law. Professional and Personal life In the years from 1904 to 1914, Mises attended lectures given by the prominent Austrian economist Eugen von Bhm-Bawerk. There, he developed friendships not only with Menger and Bhm-Bawerk, but also prominent sociologist Max Weber. Mises taught as a Privatdozent at the Vienna University in the years from 1913 to 1934 while formally serving as secretary at the Vienna Chamber of Commerce from 1909 to 1934. In these roles, he became one of the closest economic advisers of Engelbert Dollfuss, the austrofascist but strongly anti-Nazi Austrian Chancellor, and later to Otto von Habsburg, the Christian democratic politician and claimant to the throne of Austria (which had been legally abolished in 1918). In 1934, Mises left Austria for Geneva, Switzerland, where he was a professor at the Graduate Institute of International Studies until 1940. While in Switzerland, Mises married Margit Herzfeld

Serny, a former actress and the widow of the Hungarian aristocrat Ferdinand Serny. In 1940, fearing the prospect of Germany taking control over Switzerland, Mises left Europe and emigrated to New York City. There he became a visiting professor at New York University. He held this position from 1945 until his retirement in 1969, though he was not salaried by the university. In 1947, Mises became one of the founding members of the Mont Pelerin Society. Despite fleeing Europe, Mises is credited for having an influential role in the economic reconstruction of Europe after World War II through his professional relationships with Ludwig Erhard, Charles de Gaulle and Luigi Einaudi. Contributions
Mises wrote and lectured extensively on behalf of classical liberalism and is seen as one of the leaders of the Austrian School of economics. In his treatise on economics, Human Action, Mises introduced praxeology as a more general conceptual foundation of the social sciences and established that economic laws were only arrived at through the means of methodological individualism firmly rejecting positivism and materialism as a foundation for the social sciences. Many of his works, including Human Action, were on two related economic themes: 1. monetary economics and inflation; 2. the differences between government controlled economies and free markets. Mises argued that money is demanded for its usefulness in purchasing other goods, rather than for its own sake and that any unsound credit expansion causes business cycles. His other notable contribution was his argument that socialism must fail economically because of the economic calculation problem the impossibility of a socialist government being able to make the economic calculations required to organize a complex economy. Mises projected that without a market economy there would be no functional price system, which he held essential for achieving rational and efficient allocation of capital goods to their most productive uses. If capital goods are the subject of neither rent nor exchange, as per private ownership of those means of production, then no barter terms or money prices can arise for them. Without the common nominal index of money pricing that allows comparison of costs of production to likely revenues, there can be no rational allocation of diverse capital goods in the production of diverse consumer goods whose production requires some use of scarce capital. In a socialist society, capital is not distributed according to the more efficientthus profitablecapital structures, but rather to any use a theoretical socialist planner sees fit without the aid of monetary price signals to compare the profitability in a given use of capital. According to Mises, socialism must fail, as demand cannot be known without prices. Therefore, socialist waste of capital goods is as chronic as the incentives for production and retention of capital are low, while capital goods are coercively monopolised by a dysfunctional State operating with only the data pertaining to interpersonal comparisons of utility, as per democratic production. Capital's place in a free market is ordained by the prices set by private owners of the means of production, who keep capital where its production is remunerated best by consumers, and who liquidate it and pass it to other uses if production is bankrupt. In socialism, such means for liquidation of capital goods, and the passage or maintenance of the means of production across extremely diverse applications throughout the divisions of labour according to the expense or cheapness of bidding capital away from vital production, is simply not present.

Friedrich August Hayek

Life Hayek was born in Vienna (then the capital of Austria-Hungary), and was the son of August von Hayek, a doctor in the municipal health service. Hayek's grandfathers were prominent academics working in the fields of statistics and biology. His paternal line had been raised to the ranks of the Bohemian nobility for its services to the state. Similarly, a generation before his maternal forebears had also been raised to the lower noble rank. However, after 1919 titles of nobility were banned by law in Austria, and the "von Hayek" family became simply the Hayek family. Hence, after 1919, Hayek's legal name became "Friedrich Hayek", not "Friedrich von Hayek". Hayek's father turned his work on regional botany into a highly esteemed botanical treatise, continuing the family's scholarly traditions. At the University of Vienna, he earned doctorates in law and political science in 1921 and 1923 respectively, and he also studied philosophy, psychology, and economics. For a short time, when the University of Vienna closed, Hayek studied in Constantin von Monakow's Institute of Brain Anatomy, where Hayek spent much of his time staining brain cells. Hayek's time in Monakow's lab, and his deep interest in the work of Ernst Mach, inspired Hayek's first intellectual project, eventually published as The Sensory Order (1952). It located connective learning at the physical and neurological levels, rejecting the "sense data" associationism[clarification needed] of the empiricists and logical positivists. Hayek presented his work to the private seminar he had created with Herbert Furth called the Geistkreis.

The Road to Serfdom Hayek was concerned about the general view in Britain's academia that fascism was a capitalist reaction to socialism and The Road to Serfdom arose from those concerns. It was written between 1940 and 1943. The title was inspired by the French classical

liberal thinker Alexis de Tocqueville's writings on the "road to servitude". It was first published in Britain by Routledge in March 1944 and was quite popular, leading Hayek to call it "that unobtainable book," also due in part to wartime paper rationing. When it was published in the United States by the University of Chicago in September of that year, it achieved greater popularity than in Britain. At the arrangement of editor Max Eastman, the American magazine Reader's Digest also published an abridged version in April 1945, enabling The Road to Serfdom to reach a far wider audience than academics. The economist Walter Block observed critically that while The Road to Serfdom is "a war cry against central planning," it does show some reservations with a free market system and laissez-faire capitalism, with Hayek even going so far as to say that "probably nothing has done so much harm to the liberal cause as the wooden insistence of some liberals on certain rules of thumb, above all the principle of laissezfaire." In the book, Hayek writes that the government has a role to play in the economy through the monetary system, work-hours regulation, institutions for the flow of proper information, and other principles on which most members of a free society will tend to agree. These are contentions associated with the point of view of ordoliberalism. However, when central planning reaches into areas on which people will probably not agree, the tendency is created for dictatorship and totalitarianism (i.e. "serfdom"), as a means of coercing implementation of one's plan. Through analysis of this and other of Hayek's works, Block purports, "in making the case against socialism, Hayek was led into making all sort of compromises with what otherwise appeared to be his own philosophical perspective so much so, that if a system was erected on the basis of them, it would not differ too sharply from what this author explicitly opposed." Notwithstanding such criticisms, the book is still widely popular and is prominent among works advocatingindividualism and classical liberalism.

KEYNESIAN SCHOOL OF ECONOMICS

Keynesian Economics Keynesian economics are the group of macroeconomic schools of thought based on the ideas of 20th-century economist John Maynard Keynes. Keynesian economists believe that aggregate demand (total spending capacity in the economy) does not necessarily equal aggregate supply (the total productive capacity of the economy). Instead it is influenced by a host of factors and sometimes behaves erratically, affecting production, employment and inflation. Advocates of Keynesian economics argue that private sector decisions sometimes lead to inefficient macroeconomic outcomes which require active policy responses by the public sector, particularly monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over thebusiness cycle. The theories forming the basis of Keynesian economics were first presented by Keynes in his book, The General Theory of Employment, Interest and Money, published in 1936. The interpretations of Keynes are contentious and several schools of thought claim his legacy. Keynesian economics advocates a mixed economy predominantly private sector, but with a significant role of government and public sector and served as the economic model during the later part of the Great Depression, World War II, and the postwar economic expansion (19451973), though it lost some influence following the tax surcharge in 1968 and the stagflation of the 1970s. The advent of the global financial crisis in 2008 has caused a resurgence in Keynesian thought. Keynesian theory was much denigrated in academic circles from the mid-1970s until the mid-1980s. It has staged a strong comeback since then, however. The main reason appears to be that Keynesian economics was better able to explain the economic events of the 1970s and 1980s than its principal intellectual competitor, new classical economics. True to its classical roots, new classical theory emphasizes the ability of a market economy to cure recessions by downward adjustments in wages and prices. The new classical economists of the mid-1970s attributed economic downturns to peoples misperceptions about what was happening to relative prices (such as real wages). Misperceptions would arise, they argued, if people did not know the current price level or inflation rate. But such misperceptions should be fleeting and surely cannot be large in societies in which price indexes are published monthly and the typical monthly inflation rate is less than 1 percent. Therefore, economic downturns, by the early new classical view, should be mild and brief. Yet, during the 1980s most of the worlds industrial economies endured deep and long recessions. Keynesian economics may be theoretically untidy, but it certainly predicts periods of persistent, involuntary unemployment.

According to the early new classical theorists of the 1970s and 1980s, a correctly perceived decrease in the growth of the money supply should have only small effects, if any, on real output. Yet, when the Federal Reserve and the Bank of England announced that monetary policy would be tightened to fight inflation, and then made good on their promises, severe recessions followed in each country. New classicals might claim that the tightening was unanticipated (because people did not believe what the monetary authorities said). Perhaps it was, in part. But surely the broad contours of the restrictive policies were anticipated, or at least correctly perceived as they unfolded. Old-fashioned Keynesian theory, which says that any monetary restriction is contractionary because firms and individuals are locked into fixed-price contracts, not inflation-adjusted ones, seems more consistent with actual events. Theory In Keynes' theory, one person's spending goes towards another person's earnings, and when that person spends his or her earnings, he or she is, in effect, supporting another person's earnings. This cycle continues on and helps support a normal, functioning economy. When the Great Depression hit, people's natural reaction was to hoard their money. Under Keynes' theory, this stopped the circular flow of money, keeping the economy at a standstill. Keynes' solution to this poor economic state was to "prime the pump." He argued that the government should step in to increase spending, either by increasing the money supply or by actually buying things itself. During the Great Depression, however, this was not a popular solution. It is said, however, that the massive defense spending that United States president Franklin Delano Roosevelt initiated helped revive the U.S. economy. Keynesian economics advocates for the public sector to step in to assist the economy generally, which is a significant departure from popular economic thought that preceded it laissez-faire capitalism. Laissez-faire capitalism supported the exclusion of the public sector in the market. The belief was that an unfettered market would achieve balance on its own. The proponents of free-market capitalism include the Austrian School of economic thought. One of its founders, Friedrich von Hayek, lived in England at the same time as Keynes. The two men had a public rivalry for many years because of their opposing thoughts on the role of the state in the economic lives of individuals. Keynesian economics warns against the practice of too much saving and not enough consumption, or spending, in an economy. It also supports considerable redistribution of wealth, when needed. Keynesian economics further concludes that there is a pragmatic reason for the massive redistribution of wealth: if the poorer segments of society are given sums of money, they will likely spend it, rather than save it, thus promoting economic growth. Another central idea of Keynesian economics is that trends in the macroeconomic level can disproportionately influence consumer behavior at the micro-level.

John Maynard Keynes

Keynes was a British economist and one of the most influential of the 20th century. John Maynard Keynes was born on 5 June 1883 in Cambridge into a well-to-do academic family. His father was an economist and a philosopher, his mother became the town's first female mayor. He excelled academically at Eton as well as Cambridge University, where he studied mathematics. He also became friends with members of the Bloomsbury group of intellectuals and artists. After graduating, Keynes went to work in the India Office, and simultaneously managed to work on a dissertation - often during office hours - which earned him a fellowship at King's College. In 1908, he quit the civil service and returned to Cambridge. Following the outbreak of World War One, Keynes joined the treasury, and in the wake of the Versailles peace treaty, he published 'The Economic Consequences of the Peace' in which he criticised the exorbitant war reparations demanded from a defeated Germany and prophetically predicted that it would foster a desire for revenge among Germans. This best-selling book made him world famous. During the inter-war years, Keynes amassed a considerable personal fortune from the financial markets and, as bursar of King's College, greatly improved the college's financial position. He became a prominent arts patron and board member of a number of companies. In 1926, he married Lydia Lopokova, a Russian ballerina. Keynes' bestknown work, 'The General Theory of Employment, Interest and Money', was published in 1936, and became a benchmark for future economic thought. It also secured his position as Britain's most influential economist, and with the advent of World War Two, he again worked for the treasury. In 1942, he was made a member of the house of lords. During the war years, Keynes played a decisive role in the negotiations that were to shape the post-war international economic order. In 1944, he led the British delegation to the Bretton Woods conference in the United States. At the conference he played a significant part in the planning of the World Bank and the International Monetary Fund. He died on 21 April 1946.

SALAMANCA SCHOOL OF ECONOMICS

Salamanca Economics Origin Much attention has been drawn to the economic thought of the School of Salamanca by Joseph Schumpeter's History of Economic Analysis (1954). It did not coin, but certainly consolidated, the use of the term School of Salamanca in economics. Schumpeter studied scholastic doctrine in general and Spanish scholastic doctrine in particular, and praised the high level of economic science in Spain in the 16th century. He argued that the School of Salamanca most deserve to be considered the founders of economics as a science. The School did not elaborate a complete doctrine of economics, but they established the first modern economic theories to address the new economic problems that had arisen with the end of the medieval order. Unfortunately, there was no continuation of their work until the end of the 17th century and many of their contributions were forgotten, only to be rediscovered later by others. Antecedents In 1517, de Vitoria, then at the Sorbonne, was consulted by Spanish merchants based in Antwerp about the moral legitimacy of engaging in commerce to increase one's personal wealth. From today's point of view, one would say they were asking for a consultation about the entrepreneurial spirit. Beginning at that time, Vitoria and other theologians looked at economic matters. They moved away from views that they found to be obsolete, adopting instead new ideas based on principles of natural law. According to these views, the natural order is based in the "freedom of circulation" of people, goods, and ideas, allowing people to know one another and increase their sentiments of brotherhood. Private property The adherents of the School of Valencia all agreed that property has the beneficial effect of stimulating economic activity, which, in turn, contributed to the general well being. Diego de Covarubias y Leyva(15121577) considered that people had not only the right to own property but again, a specifically modern idea they had the exclusive right to the benefit from that property, although the community might also benefit. Nonetheless, in times of great necessity, there all goods become a commons. Luis de Molina argued that individual owners take better care of their goods than is taken of common property, a form of the tragedy of the commons.

Money, value, and price The most complete and methodical developments of a Salamancan theory of value were by Martn de Azpilcueta (14931586) and Luis de Molina. Interested in the effect of precious metals arriving from the Americas, de Azpilcueta proved that in the countries where precious metals were scarce, prices for them were higher than in those where they were abundant. Precious metals, like any other mercantile good, gained at least some of their value from their scarcity. This scarcity theory of value was a precursor of the quantitative theory of money put forward slightly later by Jean Bodin (15301596). Up until that time, the predominant theory of value had been the medieval theory based on the cost of production as the sole determinant of a just price (a variant of the cost-ofproduction theory of value, most recently manifested in the labor theory of value). Diego de Covarrubias and Luis de Molina developed a subjective theory of value and prices, which asserted that the usefulness of a good varied from person to person, so just prices would arise from mutual decisions in free commerce, barring the distorting effects of monopoly, fraud, or government intervention. Expressing this in today's terms, the adherents of the School defended the free market, where the fair price of a good would be determined by supply and demand. Interest on money Usury (which in that period meant any charging of interest on a loan) has always been viewed negatively by the Catholic Church. The Second Lateran Council condemned any repayment of a debt with more money than was originally loaned; the Council of Vienne explicitly prohibited usury and declared any legislation tolerant of usury to be heretical; the first scholastics reproved the charging of interest. In themedieval economy, loans were entirely a consequence of necessity (bad harvests, fire in a workplace) and, under those conditions, it was considered morally reproachable to charge interest. In the Renaissance era, greater mobility of people facilitated an increase in commerce and the appearance of appropriate conditions for entrepreneurs to start new, lucrative businesses. Given that borrowed money was no longer strictly for consumption but for production as well, it could not be viewed in the same manner. The School of Salamanca elaborated various reasons that justified the charging of interest. The person who received a loan benefited; one could consider interest as a premium paid for the risk taken by the loaning party. There was also the question of opportunity cost, in that the loaning party lost other possibilities of utilizing the loaned money. Finally, and perhaps most originally, was the consideration of money itself as a merchandise, and the use of one's money as something for which one should receive a benefit in the form of interest. Martn de Azpilcueta also considered the effect of time, formulating the time value of money. All things being equal, one would prefer to receive a given good now rather than in the future. This preferenceindicates greater value. Interest, under this theory, is the payment for the time the loaning individual is deprived of the money.

PUBLIC CHOICE SCHOOL OF ECONOMICS

Public Choice Economics Public choice theory is the use of modern economic tools to study problems that traditionally are in the province of political science. From the perspective of political science, it is the subset of positive political theory that models voters, politicians, and bureaucrats as mainly self-interested. In particular, it studies such agents and their interactions in the social system either as such or under alternative constitutional rules. These can be represented in a number of ways, including standard constrained utility maximization, game theory, or decision theory. Public choice analysis has roots in positive analysis("what is") but is often used for normative purposes ("what ought to be"), to identify a problem or suggest how a system could be improved by changes in constitutional rules, the subject of constitutional economics. Prior to the emergence of public choice theory, many economists tended to consider the state as an agent outside the scope of economic theory, whose actions depend on different considerations than those driving economic agents. (The many other economists who did place the state and its agents within such theory include Vilfredo Pareto.) Public choice theory attempts to look at governments from the perspective of the bureaucrats and politicians who compose them, and makes the assumption that they act based on Budget-maximizing modelin a self-interested way for the purpose of maximizing their own economic benefits (e.g. their personal wealth). The theory aims to apply economic analysis (usually decision theory and game theory) to the political decision-making process in order to reveal certain systematic trends towards inefficient government policies. There are also Austrian variants of public choice theory (suggested by von Mises, Hayek,Kirzner, Lopez, and Boettke) in which it is assumed that bureaucrats and politicians may be benevolent but have access to limited information. The assumption that such benevolent political agents possess limited information for making decisions often results in conclusions similar to those generated separately by means of the rational self-interest assumptions. Randall Holcombe and Richard E. Wagner have also developed the notion of "Political Entrepreneurship". Special interests Public choice theory is often used to explain how political decision-making results in outcomes that conflict with the preferences of the general public. For example, many advocacy group and pork barrelprojects are not the desire of the overall democracy. However, it makes sense for politicians to support these projects. It may make them feel powerful and important. It can also benefit them financially by opening the door to future wealth as lobbyists. The project may be of interest to the politician's local constituency, increasing district votes or campaign contributions. The politician pays little or no cost to gain these benefits, as he is spending public money.

Special-interest lobbyists are also behaving rationally. They can gain government favors worth millions or billions for relatively small investments. They face a risk of losing out to their competitors if they don't seek these favors. The taxpayer is also behaving rationally. The cost of defeating any one government give-away is very high, while the benefits to the individual taxpayer are very small. Each citizen pays only a few pennies or a few dollars for any given government favor, while the costs of ending that favor would be many times higher. Everyone involved has rational incentives to do exactly what they're doing, even though the desire of the general constituency is opposite. Costs are diffused, while benefits are concentrated. The voices of vocal minorities with much to gain are heard over those of indifferent majorities with little to individually lose. Decision making processes and the state One way to organize the subject matter studied by public choice theorists is to begin with the foundations of the state itself. According to this procedure, the most fundamental subject is the origin ofgovernment. Although some work has been done on anarchy, autocracy, revolution, and even war, the bulk of the study in this area has concerned the fundamental problem of collectively choosingconstitutional rules. This work assumes a group of individuals who aim to form a government, then it focuses on the problem of hiring the agents required to carry out government functions agreed upon by the members. Rent-seeking A field that is closely related to public choice is "rent-seeking". This field combines the study of a market economy with that of government. Thus, one might regard it as a "new political economy." Its basic thesis is that when both a market economy and government are present, government agents provide numerous special market privileges. Both the government agents and self-interested market participants seek these privileges in order to partake in the resulting monopoly rent. When such privileges are granted, they reduce the efficiency of the economic system. In addition, the rent-seekers use resources that could otherwise be used to produce goods that are valued by consumers. Rent-seeking is broader than Public Choice in that it applies to autocracies as well as democracies and, therefore, is not directly concerned with collective decision-making. However, the obvious pressures it exerts on legislators, executives, bureaucrats, and even judges are factors that public choice theory must account for in its analysis of collective decision-making rules and institutions. Moreover, the members of a collective who are planning a government would be wise to take prospective rent-seeking into account.

Theory Democracy One of the basic claims that results from public choice theory is that good government policies in a democracy are an underprovided public good, because of the rational ignorance of the voters. Each voter is faced with a tiny probability that his vote will change the result of the elections, while gathering the relevant information necessary for a well-informed voting decision requires substantial time and effort. Therefore, the rational decision for each voter is to be generally ignorant of politics and perhaps even abstain from voting. Rational choice theorists claim that this explains the gross ignorance of most citizens in modern democracies as well as low voter turnout. Rational abstention creates the so-called "Paradox of voting" in which a strict cost-benefit analysis implies that no one should vote. Special interests While good government tends to be a pure public good for the mass of voters, there may be many advocacy groups that have strong incentives for lobbying the government to implement specific policies that would benefit them, potentially at the expense of the general public. For example, lobbying by the sugar manufacturers might result in an inefficient subsidy for the production of sugar, either direct by protectionist measures. The costs of such inefficient policies are dispersed over all citizens, and therefore unnoticeable to each individual. On the other hand, the benefits are shared by a small special-interest group with a strong incentive to perpetuate the policy by further lobbying. Due to rational ignorance, the vast majority of voters will be unaware of the effort; in fact, although voters may be aware of special-interest lobbying efforts, this may merely select for policies which are even harder to evaluate by the general public, rather than improving their overall efficiency. Even if the public were able to evaluate policy proposals effectively, they would find it infeasible to engage in collective action in order to defend their diffuse interest. Therefore, theorists expect that numerous special interests will be able to successfully lobby for various inefficient policies. In public choice theory, such scenarios of inefficient government policies are referred to as government failure a term akin to market failure from earlier theoretical welfare economics. Political stance From such results it is sometimes asserted that public choice theory has an anti-state tilt. But there is ideological diversity among public choice theorists. Mancur Olson for example was an advocate of a strong state and instead opposed political interest group lobbying. James Buchanan has suggested that public choice theory be interpreted as "politics without romance," a critical approach to a pervasive earlier notion of idealized politics set against market failure. As such it is more a correction of the earlier scientific record, almost requiring certain pragmatism in comparing alternative politicized institutional structures.

MAINSTREAM SCHOOL OF ECONOMICS

Mainstream economics History Economics has, in modern times, always featured multiple schools of economic thought, with different schools having different prominence across countries and over time; the current use of the term "mainstream economics" is specific to the postWorld War II era, particularly in the Anglosphere, and to a lesser extent globally. Prior to the development of modern academic economics, the dominant school in Europe was mercantilism, which was rather a loose set of related ideas than an institutionalized school. With the development of modern economics, conventionally given as the late 18th-century The Wealth of Nations by Adam Smith, British economics developed and became dominated by what is now called the classical school. From The Wealth of Nations until the Great Depression, the dominant school within the Anglosphere was classical economics, and its successor, neoclassical economics. In continental Europe, the earlier work of the physiocrats in France formed a distinct tradition, as did the later work of the historical school of economics in Germany, and throughout the 19th century there were debates in British economics, most notably the oppositionunderconsumptionist school. During the Great Depression and the following Second World War, the school of Keynesian economics gained prominence, which built on the work of the underconsumptionist school, and present-day mainstream economics stems from the neoclassical synthesis, which was the postWorld War II merger of Keynesian macroeconomics and neoclassical microeconomics. In continental Europe, by contrast, Keynesian economics was rejected, with German thought dominated by the Freiburg school, whose political philosophy of ordoliberalism formed the intellectual basis of Germany's post-war social market economy. Within developing economies, which formed the majority of the world's population, various schools of development economics have been influential. Since 2007, the financial crisis of 20072010 and the ensuing global economic crisis has publicly exposed divisions within mainstream economics and significantly intensified controversy about its status, with some arguing for radical overhaul or rejection of mainstream economics, others arguing for evolutionary change, and others still arguing that mainstream economics explains the crisis. The term "mainstream economics" came into common use in the late 20th century. It appears in 2001 edition of the seminal textbook Economics by Samuelson and Nordhaus on the inside back cover in the "Family Tree of Economics," which depicts arrows into "Modern Mainstream Economics" from J.M. Keynes (1936) and neoclassical economics (18601910). The term "neoclassical synthesis" itself also first appears in the 1955 edition of Samuelson's textbook.

Assumptions A number of assumptions may underpin many mainstream economic models, while being rejected by some heterodox schools. These include the neoclassical assumptions of rational choice theory, arepresentative agent, and, often, rational expectations. Much of modern economic modelling consists of exploring the effects that complicating factors have on models, such as imperfect and asymmetric information, incomplete markets, imperfect competition and transaction costs. Methods Mainstream economics has also been defined methodologically as work which mainstream economists are willing to engage, which requires conforming to the mainstream language of mathematical models, featuring calculus, optimization, and comparative statics. Under this definition, areas of thought which are typically thought of as heterodox because they do not work under the typical neoclassicalassumptions, such as econophysics, behavioral economics, and evolutionary economics, can be considered mainstream when they are engaged in the mainstream, using mainstream methods. Geoffrey Hodgson has considered the possibility that evolutionary economics and institutional economics may eventually become a new mainstream. Additionally, some economic fields include elements of both mainstream economics and heterodox economics: for example, the Austrian economics, institutional economics, neuroeconomics and non-linear complexity theory.[12] They may use neoclassical economics as a point of departure. At least one institutionalist has argued that "neoclassical economics no longer dominates a mainstream economics." A countervailing trend is the expansion of mainstream methods to such seemingly distant fields as crime the family, law, politics, and religion. The latter phenomenon is sometimes referred to aseconomic imperialism. Topics Mainstream economics includes theories of market and government failure and private and public goods. These developments suggest a range of views on the desirability or otherwise of government intervention.