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'''Economics''' is the social science that studies the production, distribution, and consumption of goods and services. The word 'economics' is from the Greek for οἶκος (oikos: house) and νόμος (nomos: custom or law), hence "rules of the house(hold)."
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Modern economic thought is generally considered to have originated in the late eighteenth century with the work of [[David Hume]] and [[Adam Smith]], the founders of classical economics. The nineteenth and twentieth centuries saw major developments in the methodology and scope of economic theory; and the early twenty-first century has seen a rethinking of some previously accepted tenets.


Origin of Economics takes its roots in the natural propensity of human beings to barter, to exchange or trade goods. Whilst there are no records of dogs ever having bartered bones, men has been bartering all sorts of goods since pre-history.
Nineteenth- and early twentieth-century economists applied deductive reasoning to axioms considered to be self-evident and simplified assumptions which were thought to capture the essential features of economic activity.  That methodology yielded concepts such as [[elasticity]] and [[utility]], tools such as marginal analysis, and theorems such as the law of [[comparative advantage]]. An understanding of the relationships governing transactions between consumers and producers was considered to provide all that was necessary to explain the behaviour of the [[economic system]].  


Economics as an independent science, and as we understand the word today, begins with the work of Adam Smith, ''The Wealth of the Nations''. <ref name=WEALTH> SIMTH, Adam. ''Wealth of the Nations, The''. Modern Library, 1ª edition, 2000, ISBN 0679783369</ref>.
The development, in the latter half of the 20th century, of systems of [[economic statistics]] enabled economists to use [[induction (philosophy)|inductive reasoning]] to test theoretical findings against observed economic behaviour, and to develop new theories. By that time, the concept had emerged of the national economy as a [[complex  interactive system]], and analysis of that concept provided explanations of [[recession|recessions]], [[unemployment]] and [[inflation]] that were not previously available. The application of empirical data and inductive reasoning enabled those theories to be refined, and led to the development of forecasting models that could be used as tools of economic management.  


Before Smith, Economics was a chapter in political science, the art of managing a State. The list of acceptable definitions for Economics is enourmous. Economics is the study of those activities which, with or without money, involve exchange transactions among people. Economics is also the study of wealth. Several other definitions are acceptable <ref name=ECONOMICS> SAMUELSON, Paul Anthony e NORDHAUS, William D.''Economics''. McGraw Hill Professional, 18ª edition, 2004, ISBN 0072872055</ref>
The  development of economic thought in the early 21st century has been stimulated by the [[crash of 2008| financial crisis]] and [[Great Recession]], and the  questions that these events raised concerning  the functioning of the global [[financial system]] and the part that it plays in the functioning of the [[economic system]] generally.   


Paul Samuelson, in his famous book ''Economics - An Introductory Analysis'', defines Economics as:''"the study of how men and society 'choose', with or without the use of money, to employ 'scarce' productive resources to produce various commodities over time and distribute them for consumption, now an in the future, among various people and groups in society"'' <ref name=ECONOMICS> SAMUELSON, Paul Anthony e  NORDHAUS, William D.''Economics''. McGraw Hill Professional, 18ª edição, 2004, ISBN 0072872055</ref>
The search for understanding continues.


==Introduction==
==Overview: categories of economic thought==
Historians categorise economic thought into “periods” and “schools”, and tend to attribute each  innovation to one individual.  This categorisation is helpful for the purpose of exposition, but the reality has been a story of interwoven intellectual threads in which advances attributed to particular individuals or schools have often prompted the work of others.  For example, the quantity theory of money, which achieved prominence in the twentieth century and is associated with [[Milton Friedman]], was first formulated at least three centuries earlier.  Many of those threads, that have  permeated  the categories referred to as "Classical economics" and "Neoclassical economics", had  earlier origins.  "Classical", in economics, denotes the adoption in the late eighteenth century of an approach that was inspired by the enlightenment and the methodology of the physical sciences, and that had abandoned previous examinations of economics in terms of ethics, religion and politics.  Preoccupation with those threads was overshadowed in the twentieth century by the responses of [[Keynesianism]] and [[monetarism]] to the problems of unemployment and [[inflation]], but the development of neoclassical economics started before that time, and has continued thereafter. The introduction of new tools of exploration has since led to the vigorous development of that, and other, threads, and an expansion in the scope of economics into many new directions.


In antiquity various philosophers have studied Economics, the most famous of which being [[Aristotle]], who created some important economic concepts in his books ''[[Politics]]'' <ref name=ARISTOTLE>[http://classics.mit.edu/Aristotle/politics.html ARISTOTLE. ''Politics''. Translated by Benjamin Jowett, in: The Internet Classics Archive]</ref> and ''[[Nicomachean Ethics]]'' <ref name=ARISTOTLE3>[http://classics.mit.edu/Aristotle/nicomachaen.html ARISTOTLE. ''Nicomachean Ethics''. translated by W. D. Ross in: The Internet Classics Archive.]</ref>, both written around 350 B.C.
==Classical Economics==
===David Hume===
The Scottish philosopher [[David Hume]] was an early exponent of what was later known as [[monetary economics]], and was an opponent of "[[mercantilism]]". Mercanilist policy at the time, regulated trade in ways that subsidised exports so as to promote inflows of gold and silver, and restricted imports in order to discourage outflows.  Hume contested the mercantilist thesis, partly on the grounds that an inflow of money would cause [[inflation]], and partly on the grounds that nations would benefit from the international specialisation that would result from the introduction of free trade.  More generally, Hume argued that all government intervention in commerce tended to obstruct economic progress.<ref>David Hume [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/hume/trade.txt David Hume Essays, Moral and Political, 1742, Vol 2 "Of the Balance of Trade"] (published by Liberty Fund, 1985).</ref>.


Aristotle analysed the economic processes around him and was able to define the place of economy within a society that included commercial buying and selling. His economic thought (especially his value theory) is inspiring but sometimes contradictory and inconsistent.
===Adam Smith===
A major advance in the development of economics occurred with the publication in 1776 of [[Adam Smith]]'s ''An Inquiry into the Nature and Causes of The Wealth of Nations''.<ref name=WEALTH>Adam Smith, [http://www.econlib.org/library/Smith/smWN.html ''The Wealth of the Nations''] (Modern Library, 2000).</ref>.  Smith wrote a comprehensive treatment of the subject,  using deductive logic in a  manner similar to its use in the physical sciences.  His main purpose was to recommend changes of economic policy in the interests of economic growth.  He argued that the division of labour was the main cause of economic growth.  His famous maxim was that the extent of the market is determined by the division of labour.  To thus expand markets, required that they should not be impeded by governmental policies.  He therefore opposed government intervention in commerce (as in mercantilist trade regulation).  But he did not oppose all governmental intervention into the economy.  He advocated government spending upon what are now termed [[public goods]] such as defence, law enforcement, infrastructure, and education of the children of people who could not afford it. He identified what he considered to be the economic drawbacks of all forms of [[taxation]] (except the [[taxation of land values]]) and of  [[public expenditure]].  He examined the relation of price to value and concluded that the  price of a product tends to equality with its cost of production, which he termed its "natural price". He reasoned that "when the quantity brought to market is just sufficient to supply the effectual demand and no more, the market price naturally comes to be either exactly, or as nearly as can be judged of, the same with the natural price"  - an outcome which he took to be the normal result of  market bargaining.


In Book I of the ''Politics'', Aristotle distinguishes between use value and exchange value, defines value as the ability to satisfy wants and demand as being governed by the desirability of a good (i.e., its use value). According to Aristotle, exchange value is derived from use value as communicated through market demand.<ref name=ARISTOTLE2>[http://www.quebecoislibre.org/05/050915-11.htm YOUNKINS, Edward W. ''Aristotle and Economics'', Capitalism and Commerce. Montreal: Le Québécois Libre, nº 158, 15/9/2005.]</ref>
===Jean-Baptiste Say===
Jean-Baptiste Say<ref name=SAY2>[http://www.econlib.org/library/Enc/bios/Say.html Jean-Baptiste Say]</ref> was an influential advocate of Adam Smith's teaching in French government circles, but his best-known contribution was what came to be known as "Say's Law of Markets."  Later paraphrased as "supply creates its own demand," Say's law stated that, although there could be an imbalance between the supply and the demand for particular products, no such imbalance could exist in the economy as a whole.  It was based upon the postulate that money plays no part in the functioning of the economy beyond its role as a medium of exchange. (The claim that money is nothing but a medium of exchange, is another way of saying  that people use money only for buying things (including stocks and bonds). Say  justified that postulate by arguing that it would be foolish to hold money out of circulation because that would mean needlessly going without things (or without dividends or interest). Say's Law remained part of mainstream classical economics until [[John Maynard Keynes]] drew attention to the [[speculative motive|speculative]] and [[precautionary motive]]s for holding money.


[[Xenophon]] (420?-355? BC) wrote a book called ''Economics'' in which he analyses [[Socrates]]' positions on the subject.
===Thomas Malthus===
In his influential ''Essay on the Principle of Population'', [[Thomas Malthus]] postulated that the population would grow at a geometric rate (2, 4, 8, 16...) while food production could only increase arithmetically (1, 2, 3, 4 ....) and concluded that the food supply would eventually be insufficient to support the population.<ref>Thomas Malthus, ''[http://www.econlib.org/Library/Malthus/malPlong.html Essay on the Principle of Population]''.</ref>  This theory led him to oppose the introduction of the UK's [[Poor Law]], and to advocate the protection of agriculture. In other respects, he followed Adam Smith in opposing government intervention in commerce. Evidence in support of his postulates was lacking at the time, and they have since been found to be mistaken<ref>[http://www.nytimes.com/1999/09/19/weekinreview/why-malthus-was-mistaken.html, Nicolas Wade ''Why Malthus Was Mistaken'', New York Times, September 19, 1999]</ref>, mainly  because they took no account of the benefits of technical change.


[[Ibn Khaldun]] (1332- 1406)<ref name=ALARAKI>[http://home.online.no/~al-araki/index.html AL-ARAKI, Abdel Magid. ''Ibn Khaldun: A Forerunner for Modern Sociology. Discourse of the Method and Concepts of Economic Sociology''. © 1983-2006 A. M. Al-Araki ISBN 82-570-0743-9]</ref> was a famous Muslim historiographer and historian born in present-day [[Tunisia]] and is  viewed as one of the forerunners of modern historiography, sociology and economics. His best known book is ''Muqaddimah "Prolegomenon" ''<Ref name=Muqaddimah> [http://www.muslimphilosophy.com/ik/Muqaddimah/TransIntro/TheMuqaddimah.htm. KHALDUN, Ibn. ''The Muqaddimah''.]</ref> Khaldun was the first to understand the important interaction of forces between [[Sociology]] and Economics. Some researchers have compared Ibn Khaldun to [[Marx]], based on economic theories in section 1, chapter V of the Muqaddimah about ''"The real meaning and explanation of sustenance and profit or profit is the value realized from human labour"''.
===David Ricardo===
With minor reservations, [[David Ricardo]] accepted and extended Adam Smith’s economics. In his major work,''The Principles of Political Economy and Taxation'', he accepted the concept of a value-determined “natural price”, although he considered value to be determined by labour value added, rather than cost.<ref>David Ricardo, ''[http://www.econlib.org/library/Ricardo/ricP.html The Principles of Political Economy and Taxation]'' (John Murray, 1821).</ref> Following Adam Smith’s lead, he also developed the [[Wage-fund theory|wage fund]] concept that the amount available for the payment of wages is fixed at any particular level of capital investment, so that an increase in the supply of labour would lead to a reduction in wage rates. He pioneered a definition of [[rent]] as the difference between the produce of a unit of labour on the land in question, and its produce on the least productive land in use. In a further extension to Adam Smith’s work, he explored the incidence of taxation on wages, profits, houses, and rent, identifying in each case (but with the exception of rent) its harm to the economy.  Probably his most influential contribution, however, was his development of his "Law of [[Comparative advantage]]" that challenged the belief that the trading of a product is possible only with those with a lesser ability to produce it.  Ricardo produced a logical demonstration that there can be mutually  beneficial trade between two countries, one of which is better able than the other to produce all of the commodities that are traded.


In the middle ages the economic thought was dominated by the teachings of [[Roman Catholic Church]], with the ''[[Scholastics]]'', divided in two main and fiercily opposing schools, the Dominicans (St. Thomas Aquinas (1225-1274) and the School of Salamanca <ref name=SALAMANCA>[http://cepa.newschool.edu/het/ ''The School of Salamanca'' in: The History of Economic Thought.]</ref> - which was initiated by Francisco de Vitoria around 1536 and counted Navarrus and de Soto as its most prominent theoreticians; its influence lasted until circa 1624), and the Franciscans (aproximately 1295-1495). <ref name=SCHOLASTICS>[http://cepa.newschool.edu/het/schools/ancients.htm ''The Ancients and the Scholastics'']</ref>
===Karl Marx===
[[Karl Marx]]<ref name=MARXHET>[http://www.econlib.org/library/Enc/bios/Marx.html Karl Marx]</ref> adapted Ricardo's concept of labour value and put it to an entirely different use. In his analysis, as in Ricardo's, labour consumption determines value. This, Marx termed ''exchange value''. But Marx regarded each labourer as a product, whose exchange value is determined by the labour inputs required to feed, clothe, and train him. He reasoned that what the employer receives is the labourer's ''use value'', which is determined by the utility of his products. Marx noted that a labourer's use value normally exceeds his exchange value, and he termed the difference ''surplus value'', which was the employer's profit.  Like Adam Smith and his classical predecessors, Marx was preoccupied with the subject of economic growth but, unlike them, he saw technical progress as a major contributor. 


After the ''Scholastics'' era, we had, in that order, ''Sir William Petty'', the ''Mercantilists'', ''Richard Cantillon'', ''Jacques Turgot'' and ''Enlightenment Economics'', ''François Quesnay'' and the ''Physiocrats'', ''David Hume'' and the ''Scottish Enlightenment'', ''Ferdinando Galiani'' and the ''Italian Tradition'' and the ''Social Philosophers and Commentators''
Marx was probably the first economist to make a systematic attempt to explain the fluctuations in economic activity known as the [[business cycle]].  He considered that if technical progress were to slow down, the only way to maintain growth would be to invest more and more in machinery and buildings, as a result of which the rate of profit on new investment would fall, leading to a further reduction in growth.  Also, in his view, any departure from the conditions necessary for steady growth would lead to the accumulation of unwanted stocks of goods, producing a downturn in economic activity - until price-cutting, in order to get rid of surpluses, put the process into reverse.


The period that runs from early antiquity until past the ''Physiocrats'' and ends before [[Adam Smith]] is called the  ''"Pre-Classical"'' period of economic thought.
In his major work, ''Das Kapital''<ref>Karl Marx, ''[http://archive.workersliberty.org/wlmags/capital/ruhle2.htm Das Kapital]'' (abridged).</ref> Marx puts his findings in an historical, concludes that economic conditions shape history, and forecasts a breakdown of the capitalist system and its replacement by [[socialism]].


==History==
===Other contributors===
Among the many lesser contributors to classical economic theory, the best-known was [[John Stuart Mill]].  His ''Principles of Political Economy''<ref>John Stuart Mill, ''[http://www.econlib.org/library/Mill/mlP.html Principles of Political Economy]'', (Longmans Green, 1926.</ref>, although intended by the author merely to bring together the works of others, offered some fresh insights into [[scale economies|increasing returns to scale]] and their consequences for the development of monopolies, and anticipated (though not in these terms) the neoclassical concepts of [[elasticity]] and the determination of price by the interaction of [[supply and demand]].


===Pre-Classical Period===
Written during the classical period, but without recognition at the time, was the [[Theory of the Firm]] by the French economist and mathematician Antoine Augustin Cournot.  Cournot used differential calculus to demonstrate the profit-maximising requirement of equality between marginal cost and marginal revenue, thus anticipating some of the more important developments of neoclassical economics.


====The Ancients and the Scholastics====
==Neoclassical Economics==
===The neoclassical approach===
The term "neoclassical" is commonly applied to all of  the  continuing developments in economic thinking that followed the replacement of value-based concepts by the concept of [[market (economics)|market]]s that are  governed by the interaction of [[supply and demand]]. In that sense, the term denotes a period rather than a consistent approach - although it is a period that overlaps the competing approaches of [[Keynesianism]] and [[monetarism]]. It is nevertheless a period in which most economists have deduced their findings from  the same hypothetical postulates - including the assumption of competitive markets in which consumers  maximise [[utility]] and producers maximise profits. Within that framework of postulates, neoclassical economists have explored a variety of aspects of economic activity in a variety of different ways.


=====Aristotle=====
===Marginal analysis===
The neoclassical period is also marked by an expansion in the number of people applying their minds to the problems of economics, as a result of which there have frequently been similar contributions from a number of different thinkers. That was true of the innovative concepts of marginal analysis, that are attributable to the contributions of  William Stanley Jevons <ref name=JEVONSHET>[http://www.econlib.org/library/Enc/bios/Jevons.html William Stanley Jevons, 1835-1882]</ref> , Carl Menger <ref name=MENGERHET>[http://www.econlib.org/library/Enc/bios/Menger.html Carl Menger, 1841-1921]</ref> and Léon Walras <ref name=WALRASHET>[http://www.econlib.org/library/Enc/bios/Walras.html Marie Esprit Léon Walras (1834-1910)]</ref>. Their contributions have been brought together by Alfred Marshall in his ''Principles of Economics'' <ref> Alfred Marshall ''Principles of Economics'' Macmillan 1890</ref>, which provides the reader with an accessible and  readable (and non-mathematical) account of those and other contributions. The concept of [[utility]],  was given more prominence, and it was demonstrated logically (and mathematically) that a rational consumer would continue to buy additional units of a product until its  marginal utility (the increase in utility obtainable from one additional unit of the product) became level with to its price; and that a rational supplier would continue to offer additional units of a product until its [[marginal cost]] became level with the  [[marginal revenue]] that he would get from selling it. The American economist, John Bates Clark,  subsequently applied the concept to a market in which a rational employer would continue to hire labour until its [[marginal product]] became level with the prevailing wage rate.


{{main|Aristotle}}
===Equilibrium and the Price Mechanism===
The concept of "market equilibrium" is central to the neoclassical model. Léon Walras<ref>[http://www.cooperativeindividualism.org/walrasbio.html Léon Walras]</ref> thought of it as the achievement of an imaginary auctioneer who adjusts a notional opening price in response to a succession of bids by buyers and sellers, and permits transactions to take place  only when a price is reached at which buyers are willing to buy all that is offered for sale. That is the process of price determination by [[supply and demand]] which marks the abandonment of the concept of value-determined price, and which is examined in detail in [[Alfred Marshall]]'s ''Economics'' and in [[Milton Friedman]]'s ''Price Theory''<ref>Milton Friedman: ''Price Theory'', Transaction Publishers, 2007 </ref>. Walras, and subsequently the Italian economist [[Vilfredo Pareto]] <ref>[http://www.econlib.org/library/Enc/bios/Pareto.html Vilfredo Pareto]</ref>, later developed the concept of a [[general equilibrium]] in which supply is equal to demand in every market in a closed economy. The normal assumption of neoclassical economics is that of a stable equilibrium to which the economy will automatically return after a disturbance. In such an economy, [[unemployment]] does not persist  because any excess in the supply of labour, relative to its demand, is corrected by a reduction in wages.


In the ''Topics'' <ref name=TOPICS>[http://etext.library.adelaide.edu.au/mirror/classics.mit.edu/Aristotle/topics.html ARISTOTLE, ''Topics'', Translated by W. A. Pickard-Cambridge, in: The Internet Classics Archive]</ref> Aristotle made a philosophical analysis of human ends and means. He explains that the value of means, or instruments of production, are a function of the end products's utility to people.  
===Welfare and Efficiency===
The most politically influential of the contributions of the neoclassical economists was probably their development of the concept of [[welfare (economics)|welfare]]. In accordance with the precepts of [[representative government]],  they assumed the criterion for the success of an economic system to be the welfare of the individual, and they introduced the concept of [[economic efficiency]] as a measure of that success. Vilfredo Pareto took the lead in defining efficiency as a state in which no-one could be made better off without making someone worse off. The three types of efficiency were identified as [[Economics#Productive efficiency|productive efficiency]] (the production of good at minimum cost), [[Economics#Allocative efficiency|allocative efficiency]] (the provision of the mix of goods that consumers want) and [[Economics#Distributive efficiency|distributive efficiency]] (the distribution of the goods in such a way as to maximise individual welfare). That work laid the foundations for the subsequent development of the theory of [[welfare economics]] by Sir John Hicks  and others. (The subject of economic welfare is discussed extensively in Arthur Pigou's ''Economics of Welfare'' <ref>[http://www.econlib.org/Library/NPDBooks/Pigou/pgEW.html Arthur C Pigou ''The Economics of Welfare'' Macmillan 1920],</ref>, and the theorems of [[welfare economics]] are summarised in
William Baumol's ''Economic Theory and Operations Analysis'' <ref>[http://www.questia.com/PM.qst?a=o&d=59217071 William Baumol ''Economic Theory and Operations Analysis'' Chapter 13, Prentice-Hall 1961]</ref>)


For Aristotle, the ''economic dimension'' is the individual human action of using wealth.
===Competition===
         
The theorems of welfare economics establish a presumption that allocative [[efficiency]] - that is to say that resources will be optimally allocated as between the production of  alternative products - will be achieved  under the hypothetical conditions of perfect [[competition]]. (Those conditions include the requirement that for each product there is no supplier large enough to influence prices, that all producers supply identical products, and that all consumers are well informed and behave rationally.) Despite the unreasonableness of those requirements, most  economists advocate a presumption that restrictions upon competition will result in a reduction in efficiency . Those theoretical developments were the foundation for [[antitrust]] and other forms of [[competition policy]], the economics and politics of which have been developed by George Stigler .
According to Aristotle, human nature has a dual material and spiritual character. For him economics is an expression of that dual character and the ''economic sphere'' is the intersection between the corporeal and mental aspects of men.


Aristotle classifies economics as a practical science, as opposed to speculative sciences, such as mathematics and metaphysics.  
===The theory of the firm===
The tools of welfare economics were also used to develop the [[theory of the firm]] by Nicholas Kaldor of the London School of Economics  in his ''Equilibrium of the Firm'' <ref> Nicholas Kaldor ''The Equilibrium of the Firm'' the Economic Journal 1934 </ref> and Ronald Coase  in his "The Nature of the Firm <ref>[http://courses.essex.ac.uk/ec/ec262/lecture_notes/CoaseNatureofthefirmj.1468-0335.1937.tb00002.x.pdf Ronald Coase: ''The Nature of the Firm'', Economica, November 1937 ]</ref>. (Those theoretical developments have been summarised in William Baumol's ''Economic Theory and Operations Analysis'' <ref> William Baumol ''Economic Theory and Operations Analysis'' Chapters 9 and 10, Prentice-Hall 1961</ref>. An empirical study of the way firms actually behave is provided by Cyert and March's ''Behavioral Theory of the Firm'' <ref>[http://www.questia.com/read/89106593 Richard Cyert and James G March ''The Behavioral Theory of the Firm'' Prentice-Hall 1963]</ref>)


For Aristotle economics is concerned with both the household and the polis, relating to the use of things required for the good (or "virtuous") life. Economics is aimed at the good and is fundamentally moral. For him Economics was embedded in politics, so it can be said that the study of ''political economy'' began with Aristotle.
===Economic growth===
There has been succession of attempts to create [[model (theory)| models]] of economic growth that identify the contributions of such factors as investment, productivity, innovation and institutional environment; and that explain the differences in growth experienced by different regions of the world. In the simple model proposed by Malthus in 1850, growth could not exceed population growth, but it was not long before it became evident that it was doing so. The ''Harrod-Domar  model'' <ref>  Roy Harrod ''An essay in dynamic theory'' Economic Journal March 1939</ref>, and its successors, assume that there would be sufficient economic growth to enable some to go into growth-enhancing  investments. In a later development, the 1956 ''Solow model'' <ref> Robert Solow ''A Contribution to the Theory of Economic Growth''  Quarterly Journal of Economics 70 1956</ref> introduced the influence of the substitution of [[capital (economics)|capital]] for labour that results from  investment in improved capital equipment. Solow also pioneered the technique of ''growth accounting'' , which he used to estimate relative  contributions to historical growth in the United States; and he identified an unexplained residual which he termed ''total factor productivity'', the growth of which he attributed to technological change.  Technological change was [[exogenous]] to the Solow model, in that it was not the consequence of factors that were represented in the model. As a result of subsequent research, notably that  of Paul Romer <ref> Paul Romer ''Endogenous Technological Change'' Journal of Political Economy October 1986</ref> and Robert Lucas <ref> Robert Lucas Jr  ''On the Mechanics of Economic Development''  Journal of Monetary Economics July 1988</ref>,  some of the factors believed to influence technological change, such as expenditure on R&D and training, have since been  embodied in the growth models,  which are termed ''[[endogenous growth]] models''. The most recent work on the subject has sought to identify the contributions to economic growth of institutional factors such as quality of governance, trust, and ethic diversity; and to explore its links with geographical factors and globalisation.


'''Theory of Value'''
==Keynesian macroeconomics==
===The contribution of John Maynard Keynes===
The most important contribution to economic thought by [[John Maynard Keynes]] was his examination of the factors determining the levels of national income and employment, and the causes of economic fluctuations. His major (and hard to read) work, the ''General Theory of Employment, Interest and Money'', contains a sustained attack on much of the thinking of classical economics - mainly on the grounds that their postulates were unrealistic. His first target was Say's law of markets with its denial of the possibility of a general deficiency of demand. He challenged its implicit assumption that  money is no more than a medium of exchange by drawing  attention to the [[speculative motive]]  for holding money. Secondly, he attacked the classical economists' contention that it was the [[interest rate]] that reconciled savings plans with investment plans, claiming that the level of savings was largely determined by the level of national income. Thirdly, he rejected the classical economists' assumption that any tendency for unemployment to rise would be corrected by a reduction in the general level of wages, substituting the contention that "wages are sticky downward". Having substituted his assumptions for those of his predecessors, he advanced the thesis that a deficiency of demand could occur if there was an excess of planned savings over planned investment, because such an  excess could be removed only by a reduction in national income. The implication of that thesis was that the economy could settle down into a condition of high unemployment, lacking the self-righting mechanism envisaged by the classical economists.


In the ''Politics'' <ref name=ARISTOTLE>[http://classics.mit.edu/Aristotle/politics.html ARISTOTLE. ''Politics''. Translated by Benjamin Jowett, in: The Internet Classics Archive]</ref>, Aristotle views labor as a "commodity" that has value but does not give value. He did not see labor as a source of wealth. Aristotle formulated a "theory of the value of labor". Observing that labor skill is not a determinant of exchange value, he maintains that, in the end, the basic requirement of value is utility, which is related to a person's desires. Value is the ability to satisfy wants. Demand is governed by the desirability of a good (i.e., its use value). According to Aristotle, exchange value is derived from use value as communicated through market demand.
===Neo-Keynesianism===
Shortly after the publication of Keynes' ''General Theory'',  John Hicks published an article entitled "''Mr Keynes and the Classics''"<ref>[https://webspace.utexas.edu/hcleaver/www/368/368hicksonkeynes.html John Hicks ''Mr Keynes and the Classics''(Econometrica, April 1937)]</ref>,   in which he  produced a synthesis between the Keynesian and neoclassical models. Its main feature is  the ''[[IS/LM]] diagram'' with its intersecting curves, one of which (Investment/Savings) relates the demand for savings to the interest rate,  and the other (Liquidity/Money Supply) relates the demand for money to the interest rate - and in which the  point of intersection of the two curves represents an equilibrium level of demand.   (The IS/LM diagram subsequently  came to be known as the ''Hicks-Hansen diagram'' in recognition of prior work by the American economist Alvin Hansen . The important feature of the synthesised model is that it can be made to depict behaviour in accordance with either the Keynesian model or the neoclassical model, depending upon what is assumed concerning the slopes of the two curves.  In doing so it introduced a fundamental departure in the methodology of economics - a change from an exclusive reliance upon logical deduction from ''a priori'' postulates, to the increasing use of the [[induction (philosophy|inductive]] process of testing hypotheses against empirical evidence, that was made possible at the time by the comparatively recent practice of systematically collecting [[economic statistics]]. The work of a large body of economists was subsequently devoted to testing such hypotheses, using the mathematical technique known as "''[[econometrics]]''". That work does not appear to have resolved the controversy concerning the usefulness of the two models (except that some economists now acknowledge that one or the other seems to have worked better from time to time and in some countries' economies)


In Book I of the ''Politics'', Aristotle distinguishes between "use value" and "exchange value". It was Aristotle who created the concept of ''"value in use"''. In addition, Aristotle distinguished between final goods and factors of production.  
===Policy Implications===
A Keynesian consensus dominated the economic policies of the developed countries for two or three decades following the second world war. Keynesian stabilisation policy required governments to counter downturns in demand by cutting taxes or increasing [[public expenditure]]. Since it takes some years for such actions to take effect, their timing had to be based upon forecasts using computerised [[economic forecasting models]], but  forecasting errors and misguided attempts to stimulate growth often had destabilising consequences. Measures that unwittingly stimulated demand at a time when an economy was operating at its full capacity, frequently gave rise to rising inflation - for which the only remedy appeared to be wage restraint - and the situation was sometimes exacerbated by the operation of [[Foreign Exchange|foreign exchange]] policies. Opposition to those policy actions came from economists of the [[Austrian School]],  and from economists of the [[Chicago School]] whose thinking is described below.


Aristotle antecipated the role of diminishing marginal utility in price formation.  According to Aristotle, the quantity of a good reaches its saturation point when the use value plunges and becomes immaterial.  
==Monetarism and the Chicago School==
===The Chicago School===
The University of Chicago School of Economics
<ref>[http://economics.uchicago.edu/ The University of Chicago Department of Economics]</ref> has enjoyed a reputation for economic excellence since its foundation in 1892  However, the term ''Chicago School'' is usually taken to refer to the outlook and methodology of its economists during the period that started in the 1960s - including  Milton Friedman, George Stigler, Ronald Coase, Robert Lucas, Cary Becker, Harry Johnson and Merton Miller, and to some like-minded economists in other universities. It is best known for its advocacy of [[monetarism]] but its economists have also made contributions on a wide range of other topics, including international trade, rational expectations and institutional economics. Their methodology embodies an approach, which philosophers term [[instrumentalism|instrumentalist]], that gives the predictive value of a theory priority over the representativeness of its assumptions <ref>Milton Friedman ''The Methodology of Positive Economics''</ref>


'''The Problem of Commensurability'''
===Monetarism===
The [[Monetarism#The monetary equation|quantity theory]] of money, which is often attributed to the economist [[Irving  Fisher]], but which  undoubtedly had earlier origins,  equated  the volume of money in circulation multiplied by a notional "velocity of circulation". to the volume of physical output multiplied by its unit price (usually written as MV = PT). If the velocity of circulation were roughly constant, that would imply an association between [[inflation]] and growth in the [[money supply]]. Milton Friedman found that to have been the case during various periods in United States history <ref> Friedman and Meiselman The relative stability of monetary velocity and the Investment Multiplier in the United States 1897-1958 in ''Stabilisation Policies, CMC Research Papers'' p165  Prentice-Hall 1964</ref>, and that periods of monetary expansion had been followed by periods of inflation, although with long and variable time-lags. That led him to argue that Keynesian demand management would be ineffective in the long run because it would be accompanied by a damaging rise in the money supply; and that stability of demand and prices could better be achieved by control of the money supply. The controversy that followed  was mainly concerned with the nature of the [[Monetarism#The transmission mechanism|transmission mechanism]] (the question whether an excess of money would bid up the prices of goods, or whether it would be invested in interest-bearing [[bond]]s without affecting the prices of goods).


Aristotle discovered, formulated, and analyzed the problem of commensurability. He wondered how ratios for the exchange of heterogeneous things could be set. Aristotle says that money, as a common measure of everything, makes things commensurable and makes it possible to equalize them. For Aristotle, money is a medium of exchange that makes exchange easier by translating subjective qualitative phenomena into objective quantitative phenomena.  
A theory connecting the [[money supply]] and the [[balance of payments]] had previously been put forward  by Harry Johnson when he was a professor of economics at Manchester University. The conventional view had been that the [[exchange rate]] is determined by the balance between the supply and demand  of exports and imports, but  Harry Johnson treated it as the relative price of the moneys in circulation in the two countries <ref>[http://www.questia.com/library/book/international-trade-and-economic-growth-studies-in-pure-theory-by-harry-g-johnson.jsp Harry G Johnson ''International Trade and Economic Growth'' Chapter 6 Harvard UP 1958]</ref>. One of the implications of his theory  is that if the [[exchange rate]] is fixed, the money supply cannot be controlled - which was a consideration that influenced the Chicago School's campaign to put an end to the system of fixed exchange rates then in operation. Another is that if the money supply is held constant, the [[balance of payments]] is self-correcting.


The lending of money at interest is condemned as the most unnatural mode of acquisition. Aristotle insisted that money was barren.
===Expectations===
Milton Friedman also attacked the thinking behind the [[Phillips curve]]  (which had reflected the observation that [[inflation]] tended to fall when there was a rise in [[unemployment]]) on the grounds that it failed to take account of expectations. He proposed its replacement by the [[expectations-augmented Phillips curve]] <ref> Edmund  Phelps ''Money wage dynamics and labor market equilibrium''. Journal of Political Economy 1968</ref>,  and used that construction to  counter fears that a reduction in growth of the money supply would lead to a sustained increase in unemployment. To do so, he introduced the concept  of the [[non-accelerating-inflation rate of unemployment]] (NAIRU), which is usually referred to as its [[natural rate of unemployment|natural rate]], and which is the unemployment rate at which the expected inflation rate is the same as its actual rate. He argued that if a reduction in money supply growth caused unemployment to rise above its natural rate, the expected inflation rate would fall, setting in motion a sequence of events that would cause unemployment to revert to its natural rate. Conversely, a reduction in unemployment accompanying an increase in the money supply would cause an increase in expected inflation, prompting wage demands which would lead to an increase in actual inflation - a process which could continue indefinitely.


=====Xenophon=====
Applying the concept of "rational expectations"<ref> John Muth "Rational Expectations and the Theory of Price Movements" Econometrica, Vol. 29, No. 3, July 961)</ref>
formulated by his former colleague, John Muth, to the operation of economic policy, Robert Lucas  of the Chicago School put forward what has become known as the ''Lucas Critique''<ref> Robert Lucas ''Econometric Policy Evaluation: A Critique.'' Carnegie-Rochester Conference Series on Public Policy 1: 19–46 1976</ref> . He argued that policy actions tend to change people's expectations so that the same policy action could have future consequences that differ from the consequences that it had in the past. That possibility has fundamental implications for the construction of forecasting models, and the Lucas critique  also raises the possibility that public reactions could frustrate the achievement of policy objectives.


Xenophon, was a soldier, philosopher and mercenary from ancient [[Greece]] who lived between 425 and 355 BC. He wrote a book called '' Economics'', in which the cynic Kritoboulos and the sympathetic Isomachos engage in a philosophical exchange mediated by the figure of [[Socrates]]. The title is badly translated and misrepresents the book's subject. In Greek, the work ''"oikonomikon"'' signifies ''"household management"''. Xenophon's ''Economics'' verses instead about the management of agricultural endeavours focusing on the manner in which a good citizen ensures his own subsistence, along with a surplus for the state.  
===Policy implications and outcomes===
The Chicago School's prescription for stabilisation problem was confined  to the control the [[money supply]], and its prescription for the reduction of unemployment was to take measures to improve wage - and [[price flexibility]]. Concern for rising [[inflation]], and the failure of attempts to control it by wage restraint, led to the widespread adoption of the first of those prescriptions in the late 1970s. In the United States, the Congress passed The Full Employment and Balanced Growth Act  (known as the Humphrey-Hawkins Act) which required the [[Federal Reserve System|Federal Reserve Bank]] to set one-year target ranges for money supply growth twice a year and to report the targets to Congress. In the United Kingdom, the Callaghan administration adopted a specific money supply objective: a practice that was enthusiastically adopted by its successor Thatcher administration. In both countries, attempts to keep the growth of the money supply within pre-set limits were generally unsuccessful (and in the United Kingdom,  money supply growth actually increased <ref> Nick Gardner ''Decade of Discontent'' p207 Basil Blackwell 1987 </ref>) and were eventually abandoned. Some central bankers have said that they take account of long-term money supply trends, but none consider control of the money supply to be a practicable instrument of stabilisation policy. Consensus monetary policy since the late 1980s  uses interest rates as a means of stabilising both prices and output<ref> [http://www.bankofengland.co.uk/publications/other/monetary/bean070413.pdf Charles Bean ''Is There a Consensus in Monetary Policy?'']</ref>, and the median inflation rate in 13 industrialised countries has fallen from around 15 per cent in the mid 1970s and early 1980s to around 2 per cent in 2005<ref> Kenneth Kuttner and Adam Posen ''Do Markets Care Who Chairs the Central Bank'' NBER Working Paper 13101 02007</ref>.


Xenophon, using Socrates's speaches, emphasizes the moral virtues of citizens and their freedom.
==Institutional Economics==
===The Institutionalist School===
The term ''Institutionalist'' refers to economists who argue that economic activity cannot properly be understood except in the context of the public and social structure in which it takes place.  That approach to the can be traced back to the ''German Historical School'', which included Friedrich List and Max Weber, who is best known for his ''The Protestant Ethic and the Spirit of Capitalism''. But the term is more commonly applied to the views of a pre-war group of American economists whose leading member was [[Thorstein Veblen]] - the man who coined the term ''conspicuous consumption'' - and whose lasting contributions were the collection of economic statistics and the study  of business cycles.


=====Ibn Khaldun=====
===Modern institutional economics===
A major contributor to the theory of institutional economics has been Ronald Coase, who  summarised his approach in his 1991 Nobel Prize lecture <ref>[http://nobelprize.org/nobel_prizes/economics/laureates/1991/coase-lecture.html Ronald Coase ''The Institutional Structure of Production'' The Nobel Prizes 1991,  Nobel Foundation 1992]</ref>. Early in his career as an economist he had formulated what came to be known as the ''[[Coase Theorem]]'' which was the proposition  that economic efficiency will be achieved provided that property rights are fully allocated and can freely be traded; a proposition which he developed further in his 1960 paper ''The Problem of Social Cost'' <ref>[http://www.cerna.ensmp.fr/Enseignement/CoursEcoIndus/SupportsdeCours/COASE.pdf Ronald Coase The Problem of Social Cost ''Journal of Law and Economics'' October 1960]</ref>. The development of institutional economics by economists at the University of Chicago has taken them across the conventional borders of economics into the disciplines of law, sociology and politics. (An extreme example has been the publication of the best-selling ''Freakonomics'' that was jointly authored by the Chicago economist Steven Levitt and the New York journalist Stephen Dubner, and which applies economic thinking to such questions as cheating,  drug dealing and the connection between crime and abortion.)


{{main|Ibn Khaldun}}
===Mechanism design theory===
A recent extension to institutional economics is concerned with how well  different institutions and allocation mechanisms achieve goals  such as  welfare and  private profit. Contributions to that subject by Leonid Hurwicz of the University of Minnesota, Eric Maskin of Princeton and Roger Myerson of Chicago earned them the 2007 Nobel Prize in Economics.


In his ''Prolegomena'' (''The Muqaddimah''), 'Abd al-Rahman Ibn Muhammad Ibn Khaldun al-Hadrami (A.D. 1332-1406), commonly known as [[Ibn Khaldun]], a fourteenth century Muslim thinker, laid down the foundations of different fields of knowledge, in particular the science of civilization (al-'umran).
===Public choice theory===
A different approach to the same questions <ref>[http://www.econlib.org/LIBRARY/Enc/PublicChoiceTheory.html Public Choice]</ref> had previously been put forward under the heading of [[public choice theory]], the principle contribution to which had been James Buchanan and Gordon Tullock's major  treatise, ''The Calculus of Choice'' <ref>[http://www.econlib.org/LIBRARY/Buchanan/buchCv3Contents.html James Buchanan and Gordon Tullock ''The Calculus of Consent'']</ref>. However, Buchanan and Tullock are best known for their analysis of the behaviour of politicians, civil servants and voters on the assumption that they are mainly motivated by personal gain, rather than a desire to serve the public interest.


His contributions to economics place him in the history of economic thought as a forerunner, if not the ''"father"'', of economics. Ibn Khaldun planted the germinating seeds of classical economics analysing production, supply, or cost and pioneered in consumption, demand, and utility, the cornerstones of modern economic theory.<ref name=FATHER>[http://www.islamic-world.net/economics/father_of_economics.htm OWEISS, Dr. Ibrahim M. ''Ibn Khaldun, Father of Economics''. Islamic-World.Net, Ramadhan 1424 H/2003.]</ref>
==International economics==


Ibn Khaldun was the first to systematically analyze the functioning of an economy, the importance of technology, specialization and foreign trade in economic surplus and the role of government and its stabilization policies to increase output and employment. <ref name=FIRST>[http://www.muslimheritage.com/topics/default.cfm?ArticleID=600 KARATAS, Dr. Selim Cafer. ''The Economic Theory of Ibn Khaldun and the Rise and Fall of Nations''. Political Science. MuslimHeritage.com, 18 May, 2006.]</ref>
===The gains from trade===
David Ricardo's law of [[comparative advantage]] - and its implication that trade restrictions are damaging to the interests of the country that imposes them - was the starting-point of the historical  development  of trade theory <ref>Douglas  Irwin Against the Tide: ''An Intellectual History of Free Trade'' Princeton University Press 1997</ref>. The subsequent theoretical developments of "classical" trade theory have mainly been  attempts to create mathematical models of inter-country trade. The best-known of those was the Heckscher-Ohlin Theory <ref>
[http://mitpress.mit.edu/catalog/item/default.asp?tid=4723&ttype=2  Eli  Heckscher and Bertil Ohlin ''Heckscher-Ohlin'' Trade Theory (Ed Harry Flam and . June Flanders) MIT Press]</ref>, which deduced from a range of highly restrictive assumptions that a country will export those commodities that are intensive in the factor of production in which it is most well-endowed. That theory was extended by Paul Samuelson to conclude that, in the absence of  productivity differences, trading between two countries would tend to equalise wages and capital costs in those countries. However, doubt was cast upon the relevance of the Heckscher-Ohlin theory by Wassily Leontief's discovery that the United States, which is the world's most capital-intensive country, had been exporting labour-intensive commodities and importing capital-intensive commodities. The general conclusion has been that international trade is mainly driven by factors other than labour-intensity and capital-intensity. "Modern" trade theory depends mainly upon the econometric analysis of international trade statistics,and has produced a range of findings concerning the influence of factors such as innovation and training.


Ibn Khaldun, moreover, dealt with the problem of optimum taxation, minimum government services, incentives, institutional framework, law and order, expectations, production, and the theory of value.  
===Infant industries===
There was  opposition in the early nineteenth century to the proposition that trade restrictions reduce welfare  from a small group of economists, including Friedrich List of the German Historical School, who argued that free trade should not be permitted until the government had taken the measures necessary to establish the country's "productive powers". That was the precursor of  the argument for ''infant-industry protection'' that was politically influential in  the early twentieth century and which led to the introduction of the ''Smoot-Hartley'' system of industrial [[tariff]]s in the United States. It has been given recent expression in Ha-Joon Chang's book  ''Kicking Away the Ladder'' <ref>[http://www.paecon.net/PAEtexts/Chang1.htm Ha-Joon Chang ''Kicking Away the Ladder'']</ref> which suggests that industrial successes in Britain and the United States (and later in  creating an automobile industry in South Korea) were attributable to the fact that they were protected from overseas competition until they were large enough to benefit from [[economies of scale]]. The mainstream reaction among economists concedes that the case for free trade does not take account of the benefits of scale economies, and that welfare gains from temporary trade restrictions might in principle be possible if a government were sufficiently successful in "picking winners" but that tax incentives and [[subsidy|subsidies]] are more effective than tariffs <ref>Bhagwati  and Ramaswami. ''Domestic Distortions, Tariffs and the Theory of Optimum Subsidy  - Some Further Results''  Journal of Political Economy, 1969, vol. 77, issue 6, pages 1005-10' (1963)</ref> .


For Ibn Khaldun, the role of the State is to establish law and order conducive for economic activities. The enforcement of property rights, the protection of trade routes and the security of peace are necessary for a civilized society to engage in trade and production.
===Globalisation===
[[Globalization|Globalisation]] is seen by most economists as contributing to economic welfare by promoting competition and the division of labour. But there are exceptions. Professor Joseph Stiglitz <ref>[http://www2.gsb.columbia.edu/faculty/jstiglitz/ Joseph Stiglitz website]</ref> <ref>[http://www.cceia.org/resources/transcripts/101.html Interview with Joseph Stiglitz]</ref> of the Columbia Business School has advanced the infant industry case for [[protection]] in developing countries and criticised the conditions imposed for help by the International Monetary Fund <ref>Joseph Stiglitz ''Globalization and its Discontents" Norton 2002</ref>. And Professor Dani Rodrik of Harvard<ref>[http://rodrik.typepad.com Dani Rodrik's website]</ref> has noted that the benefits of globalisation are unevenly spread, leading to income inequalities that, in his view, lead to damaging losses of [[social capital]], and to the migration of labour causing social stresses in receiving countries <ref>Dani Rodrik ''Has Globalization Gone Too Far?.'' Institute for International Economics 1997.  
</ref>


For him "over-taxation" would occur when the demands bureaucracy and mercenary armies would expand beyond "normal" ''economic surplus''.
==Financial economics==
===Overview===
Economists and professional investors gave little attention to [[financial economics]] until the adoption in the 1970s of [[model (theory)|models]] based upon the [[financial economics#The efficient markets hypothesis|efficient markets hypothesis]]. That hypothesis was the basis of risk analysis using the assumption that price variations on the markets for financial [[asset (finance)|assets]] could be treated as random variations, which could be represented by established [[probability distribution]]s. The international financial industry made use of the models to select investments that were predicted to give the best return for a stipulated level of risk. It was not until the  [[crash of 2008| 2008 financial crisis]] that it was widely recognised that the efficient market hypothesis was no more than a statement of a general tendency, and that additional risks could  arise from statistically unpredictable patterns of investor conduct.


For Ibn Khaldun, it is clear that ''"the profit human beings make is the value realized from their labor,"'' but this value, ''the price of labor'', is determined by the law of supply and demand, a point later missed by [[Karl Marx]].  
===The finance market===
The study of [[financial economics]] had its origin in a 1900 thesis entitled ''Theorie  de la Speculation'' by the French mathematician Louis Bachelier <ref> Jean-Michel Courtault, Yuri Kabarov And Bernard Bru: "Louis Bachelier and the Centenary of the Theorie de la Speculation", ''Mathematical Finance'' Vol10 No3 July 2000</ref>, according to which price fluctuations in a speculative market are analogous to the Brownian Movement of physics (the [[random walk]] of statistics theory), such that there is no combination of prices that offer the prospect of a certain gain.  In 1933, the American economist Alfred Cowles<ref>[http://cowles.econ.yale.edu/archive/people/directors/cowles.htm Alfred Cowles]</ref>  developed a similar thesis, which he published in a  paper entitled ''Can Stock Market Forecasters Forecast?''.  According to Cowles' [[efficient market hypothesis]], all of the available information  that was relevant to an asset's prospects would already be embodied in its price (so that the answer to his question was "no"). The hypothesis depended upon the assumptions that most traders behave rationally, and that the activities of the others are mutually cancelling. Those assumptions were widely accepted, and on their basis, financial markets were taken to be essentially stable. Hyman Minsky's 
1986 [[Financial economics#The financial instability hypothesis|financial instability hypothesis]], which suggested that financial markets are apt to become unstable after a period of sustained economic growth, received little attention at the time.
A number of [[Financial economics/Tutorials|mathematical models of finance markets]] based upon the efficient markets hypothesis were developed in the course of the 20th century and were widely applied as guides to investment, but financial economics was then considered by most of the economics profession to be a specialised subject of little general interest, regarding the financial system as a collection of secondary markets whose internal characteristics do not affect the rest of the economy.


Khaldun recognized the advantages of specialization. For him, specialization meant the coordination of different functions of factors of production where, ''"what is obtained through the cooperation of a group, of human beings satisfies the need of a number many times greater (than themselves)."''
===Portfolio and asset price theory===
A sequence of Nobel Prize-winning  advances concerning the problem of getting the best return from an investment without exceeding a chosen level of risk, occurred during the period from the 1950s to the 1970s. The sequence started in the late 1950s, when James Tobin <ref>[http://nobelprize.org/nobel_prizes/economics/laureates/1981/tobin-autobio.html James Tobin]</ref> and Harry Markowitz laid the foundations of modern portfolio management. In his  "Separation Theorem",  Tobin proposed a two-stage process in which the required risk ceiling could be maintained by mixing risky and riskless assets, and Markowitz demonstrated the benefits of a diversified portfolio in which the prices of it assets would not rise and fall together, using the statistical concept of [[covariance]]. In 1970, William Sharpe<ref>[http://nobelprize.org/nobel_prizes/economics/laureates/1990/sharpe-autobio.html William Sharpe]</ref> applied that concept to the tendency of the price of an asset to rise and fall in concert with the all-share index, assigning the title "Beta" to its mathematical definition, and used it to derive a pricing method know as the [[Capital Asset Pricing Model]], and in 1973, Fischer Black <ref>[http://www.mayin.org/ajayshah/MEDIA/1995/black.html Fischer Black]</ref> and Myron Scholes <ref>[http://nobelprize.org/nobel_prizes/economics/laureates/1997/scholes-autobio.html Myron Scholes]</ref> developed the Black-Scholes model which made use of the fact that the expected volatility of an asset is reflected in its price in the options market, which led to the development by Robert Merton <ref>[http://nobelprize.org/nobel_prizes/economics/laureates/1997/merton-autobio.html Robert Merton]</ref> of the "Contingency Claims Analysis" method of pricing assets.


There is a striking similarity in the economic thought of Ibn Khaldun and those of [[Adam Smith]] <ref name=WEALTH> SIMTH, Adam. ''Wealth of the Nations, The''. Modern Library, 1ª edition, 2000, ISBN 0679783369</ref>, writting four centuries apart. This leaves the question to ascertain direct or indirect links between these two great thinkers open to the economic historian. In thesis Adam Smith could have been exposed to Ibn Khaldun's contributions, even without having been aware of the author's name, during his six years research at Oxford University's library. <ref name=FATHER>[http://www.islamic-world.net/economics/father_of_economics.htm OWEISS, Dr. Ibrahim M. ''Ibn Khaldun, Father of Economics''. Islamic-World.Net, Ramadhan 1424 H/2003.]</ref>
===Corporate finance===
During the same period there was a sequence of advances in the economics of corporate finance. It started with the demonstration by Franco Modigliani <ref>[http://nobelprize.org/nobel_prizes/economics/laureates/1997/merton-autobio.html Franco Modigliani]</ref> and Merton Miller <ref>[http://nobelprize.org/nobel_prizes/economics/laureates/1990/miller-autobio.html Merton Miller]</ref> that shareholders should be indifferent to the level of a corporation's debts provided that it was possible to repay them costlessly with money available at a riskless rate of interest. Other economists subsequently augmented the ''Modigliani-Miller'' theory with allowances for the effects of taxation and of [[information asymmetry]].


=====The early Scholastics=====
==Recent developments ==
===The Greenspan era===
Divergences of view about economic management persisted into the early 21st century, but a consensus developed among those responsible for the management of the major economies, along the lines of a speech by the then United States [[Federal reserve system|Federal Reserve Board]] Chairman, [[Alan Greenspan]]<ref>[http://www.federalreserve.gov/boarddocs/speeches/1996/19961205.htm  Alan Greenspan: ''The Challenge of Central Banking in a Democratic Society'', (lecture to The American Enterprise Institute for Public Policy Research, December 5, 1996, Federal Reserve Board 1996]</ref>. The use of [[Keynesian theory|Keynesian]] [[fiscal policy]] to regulate output was considered to have proved ineffective and inflationary, and [[Monetarism|monetarist]] attempts to control the [[money supply]] were seen to have been unsuccessful. The new rôle of fiscal policy was the  maintenance of [[fiscal stability]], responsibility for the management of the economy had become the exclusive function of [[monetary policy]], and monetary policy was confidently expected  to prevent serious interruption to economic growth  (the President of the American Economic Association had declared that "The central problem of depression-prevention [has] been solved, for all practical purposes"<ref>[http://home.uchicago.edu/~sogrodow/homepage/paddress03.pdf Robert E. Lucas, Jr:  Presidential Address to the American Economic Association, January 10, 2003]</ref>). The [[financial system]] was considered to be essentially stable, making [[financial regulation]] unnecessary.


The "Scholastics" <ref name=SCHOLASTICS>[http://cepa.newschool.edu/het/schools/ancients.htm ''The Ancients and the Scholastics'']</ref> refer to the group of 13th and 14th Century theologians, notably the Dominican St. Thomas Aquinas <ref name=SUMMA>[http://www.ccel.org/a/aquinas/summa/home.html THOMAS AQUINAS, Saint (1225?-1274).''The Summa Theologica''. Benziger Bros. edition, 1947. Translated by Fathers of the English Dominican Province.<small>Acknowledgement: This digital file was produced through the kindness of Sandra K. Perry, Perrysburg, Ohio.</small>]</ref>
The conclusion of the era was marked by Alan Greenspan's 2008 congressional testimony:
, that set down the dogma of the Catholic Church in light of the resurrection of the Greek philosophy. In  economics  there were four themes the Scholastics were particularly concerned with: property, justice in economic exchange, money, and usury.
<blockquote>
:"In recent decades, a vast risk management and pricing system has evolved combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel prize was awarded for the discovery of the pricing model that underpins much of the advance in the derivatives markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year."<ref>[http://clipsandcomment.com/wp-content/uploads/2008/10/greenspan-testimony-20081023.pdf Testimony of Dr. Alan Greenspan before the Committee of Government Oversight and Reform October 23, 2008]</ref>
</blockquote>


Private property and Christian teachings have been always at odds. In the 5th Century, the early Church fathers (the "Patricians", e.g. St. Augustine) had struck down ''"communistic"'' Christian movements and the Church itself went on to accumulate enormous amounts of property.  In the 12th Century, St. Francis of Assisi began a movement (the "Franciscans"), which insisted on vows of poverty, "brotherhood" and deplored the accumulative tendencies of the Church.
The shortcomings of economic theory in that respect have been held
<ref>for example by Professor Shin of Princeton University [http://www.voxeu.eu/index.php?q=node/3948 Hyun Song Shin: Interview with Ramesh Vatilingam, 4 September 2009]</ref> to have played a major role in the [[crash of 2008|the financial crisis of 2008]].


Against the Franciscans were arrayed St. Thomas and the Dominicans, who dug out of Aristotle and the Bible the necessary arguments to put down their challenge.  The Thomists took a practical stance.
===Post-Great Recession thinking===
The [[crash of 2008|financial crisis of 2008]] and the resulting [[Great Recession]] prompted much  re-thinking of economic theory.
Professor Shin of Princeton University  reported  that the "race is on" to  add a new perspective to [[macroeconomics]] by the incorporation into it of a new theory of  financial economics<ref>[http://www.voxeu.eu/index.php?q=node/3948 Hyun Song Shin: Interview with Ramesh Vatilingam, 4 September 2009]</ref>, and there was new thinking about the use of [[financial regulation]] to reduce the risk of fresh financial [[shock (economics)|shocks]]. A re-examination of the rôle of [[fiscal policy]] had been triggered  among economists and politicians by a 2008 proposal by Britain's  [[Gordon Brown]] for a coordinated [[fiscal stimulus]] to counter the expected recessionary effects of the financial crisis. The idea was dismissed as ineffective by some economists<ref>[http://www.dimensional.com/famafrench/2009/01/bailouts-and-stimulus-plans.html Eugene Fama: ''Bailouts and Stimulus Plans'' January 2009]</ref><ref>[http://www.iea.org.uk/record.jsp?type=pressArticle&ID=376 ''Keynesian over-spending won't rescue the economy'', Letter by IEA economists in the Sunday Telegraph, 26 October 2008]</ref>, and as inflationary by others
<ref>[http://www.nytimes.com/2009/05/04/opinion/04meltzer.html Allan Meltzer: ''Inflation Nation'', New York Times op-ed, 3rd May 2009]</ref>, and it  was rejected by Germany's [[Angela Merkel]]<ref>[http://www.time.com/time/world/article/0,8599,1865273,00.html Catherine Mayer: ''Behind a Merkel Snub, Euro Economic Discord'', Time, 9 December 2008]</ref>  and ridiculed by her finance minister as "crass Keynesianism"<ref>[http://news.bbc.co.uk/1/hi/business/7780160.stm Tristana Moore: ''Steinbrueck 'shouldn't scare UK'''BBC News 12 December 2008]</ref>
Although fiscal stimulus packages were implemented during the [[recession of 2009]], they were not sustained by European governments to support the faltering recovery in  2010, and programmes of [[fiscal contraction]] were widely introduced in 2011. The main reason that was given for that reversal of fiscal policy was the fear that operators in the [[bond]] market would lose confidence in governments' ability to service the levels of [[public debt]] that their continuation would involve. The European Union's [[European Union/Addendum|Fiscal Compact]] (which  places mandatory restrictions upon the use of fiscal policy  by its signatories) may gain political approval, but its economic consequences are likely to remain a matter of controversy. Unlike the European governments, the United States government has not introduced a major programme of fiscal contraction, and the  Congress  has not been able to agree on a plan for the reduction of the government's budget deficit<ref>[http://topics.nytimes.com/top/reference/timestopics/organizations/c/congress/joint_congressional_committee_on_deficit_reduction/index.html  ''Joint Select Committee on Deficit Reduction (Deficit "Super Committee")'', New York Times, 22 March, 2012]</ref>.  A controversy also remains unresolved concerning the merit of techniques known as [[quantitative easing]] by which [[central bank]]s seek to increase the [[money supply]] in order to relieve  [[credit crunch]]es and stimulate economic activity<ref>[http://www.cnbc.com/id/39775319/CEOs_Debate_the_Merits_of_QE2_%E2%80%A8%E2%80%A8 Lori Ann LaRocco: ''CEOs Debate the Merits of QE2'', CNBC News, 21 Oct 2010]</ref><ref>[http://economics21.org/commentary/e21s-open-letter-ben-bernanke ''Open Letter to Ben Bernanke'', 15 November 2010]</ref>.  


Another question that arose was that of entrepreneurship.  Should a merchant be allowed to profit from differentials in prices?  The Scholastics replied with a qualified yes, provided the merchant is not motivated by pure gain and profit be only just enough to cover the "sacrifices" of the merchant.  They argued that the trader is performing a valuable service and increasing general welfare by meeting different needs.
The history of economic thought has taken an unexpected turn, and a new consensus on economic management has not yet emerged.
 
The charging of interest on money lent (usury), came quickly under scrutiny.  There is no clear basis for a ban on usury in Christian scriptures. To early Church fathers, like St. Jerome, the Christian notion that "all men are brothers" necessarily implied that usury must be banned outright.  Another patrician, St. Ambrose, decided that lending with interest to enemies in the course of a just war was permissible. 
 
Clerics had been prohibited from lending at interest at least since the 4th Century.This ban was extended to laymen much later. In 1139, the Second Lateran Council denied all sacraments to unrepentant usurers and, in an 1142 decree, condemned any payment greater than the capital that was lent.  Jews and Moors ("strangers" in Christian lands) were initially exempt, but the Fourth Lateran Council (1215) issued an admonition prohibiting non-Christians from charging ''"excessive usury"'' . In 1311, Pope Clement V at the Council of Vienna prohibited usury outright and condemned as ''"heretical"'' any secular legislation that tolerated it.
 
The issue of "justice in exchange" was a more complicated issue.  Even if we hang the intrinsic value of a good on its "usefulness", how does one estimate what the "just price" (justum pretium) should be?. Following the Golden Rule  ("Do unto others as you would have them do unto you"), the Scholastics decided that a person should not charge more for a good than what he would be willing to pay for it himself.
 
====The Salamanca School====
 
 
The University of Salamanca, founded 1218, is  one of the oldest universities in the world. It was a prominent [[Dominican]] bastion in the late [[Scholastic]] period. Home of the [[Thomistic theology]], it maintained its full strenght even after the doctrines of [[St. Thomas Aquinas]] became under attack elsewhere in Europe, first under the [[Scotist]] and [[Nominalist]] onslaughts, and then from the [[Reformation]]. <ref name=SALAMANCA>[http://cepa.newschool.edu/het/schools/salamanca.htm ''The School of Salamanca''. The History of Economic Thought Website.]</ref>
 
The ''"School of Salamanca"'' begins with Francisco de Vitoria around 1536 and counted Navarrus and de Soto as its theoreticians.  The Jesuit trio, Lessius, de Lugo and Luis Molina adhered to and further developed the Salamanca position.
 
During the confusing economic times of the inflationary 16th century, there was reversal of centuries of Scholastic thinking on economic matters.  It was the Salamanca school that defined the just price as no more and no less than the naturally exchange-established price. Theologians moved away from past dogma and approached their questions in the spirit of natural law philosophy. Their analysis led them to trace a scarcity ''theory of value'' and employed ''supply-and-demand'' with dexterity. They rejected Duns Scotus's '''"cost of production"'' conception of the just price, arguing that there was no objective way of determining price. <ref name=SALAMANCA>[http://cepa.newschool.edu/het/schools/salamanca.htm ''The School of Salamanca''. The History of Economic Thought Website.]</ref>
 
The Salamanca School discovered the essential properties of the ''"Quantity Theory of Money"'' <ref name=QUANTITY>[http://cepa.newschool.edu/het/essays/money/quantity.htm ''The Quantity Theory of Money'', in: The History of Economic Thought Website.]</ref>, using it to explain the inflation of the 1500s arising from the influx of precious metals from Spanish America. They also provided a resounding defense of usury.
 
The ideas of the ''Salamanca School'' were fierciely opposed by the ''Franciscans Scholastics''. Among them, [[John Duns Scotus]], (1265-1308) an Oxford Franciscan theologian author of the ''Sententiae'', 1295?, was the Thomists' most formidable opponent.  Influenced by Neoplatonic mysticism, Scotus was the progenitor of the ''"[[Nominalist]]"'' movement that unravelled Thomism in the 16th Century. <ref name=SCHOLASTICS>[http://cepa.newschool.edu/het/schools/ancients.htm ''The Ancients and the Scholastics'']</ref>
 
In economic affairs he refused the "practical" Aristotlean resolutions of the Thomists, demanding proper explanations.  In the process, he created a ''"cost theory of value"'' and formulated some interesting  arguments about the nature of pure and monopolistic competition.
 
Jean Buridan, (c.1295 - 1358), was a French secular scholastic philosopher, a member of Ockham's ''"Nomalist School"'' who rose to become rector of the [[University of Paris]], was a renowned critic of Aristotlean "just exchange" and was the originator of the ''"metallic theory of money"''.
 
Nicole de Oresme, (c.1320-1382) was a French theologian, student of Buridan, mathematician and originator of the "clockwork" theory of the universe.  Oresme produced a succint analysis of currency debasement.
 
Gabriel Biel, (1425-1495), the ''"Last of the Scholastics"'' was one of the founders of the [[University of Tübingen]]. A late ''Nominalist'', Biel is renowned for his defense of  entrepreneurship and free contract. He undermined the concept of ''"just price"'' by noting that trade would actually not occur without advantages to the parties.
 
====Sir William Petty and the Mercantilists====
 
'''Sir William Petty'''
 
When British forces invaded Ireland in the 1650s, a problem emerged: how to partition the spoils among the victors or, more precisely, what were the spoils? The task of surveying Ireland and assessing its riches was given to a physician which had accompanied the British army, [[Sir William Petty]]. Thus, the first ''"econometrician"'' was born.
 
Petty's ''Political Anatomy'' (1672) is a work on Ireland. Petty was disciple of Hobbes and a Mercantilist in his policies.On his works one can find rudiments of the ''"labor theory of value"''. His writings were influential upon [[Davenant]] and [[Locke]]. <ref name=PETTY>[http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/petty/hull.html HULL, Charles H. ''Petty's Place In The History Of Economic Theory''. In: Quarterly Journal of Economics, 1900.]</ref>
 
'''Mercantilists'''
 
Mercantilism <ref name=MERCANTILISM>[http://www.econlib.org/library/Enc/Mercantilism.html LAHAYE, Laura. ''Mercantilism''. in: The Library of Economics and Liberty]</ref> is economic nationalism for the purpose of building a wealthy and powerful nation-state. Adam Smith <ref name=WEALTH> SIMTH, Adam. ''Wealth of the Nations, The''. Modern Library, 1ª edition, 2000, ISBN 0679783369</ref> coined the term ''"mercantile system"'' to describe it.
 
''' ''Bullionism'' ''' was an early and primitive form of mercantilism and is most closely associated with 16th- and 17th-century Spain, which was thought to owe its prosperity and military might to the gold and silver of its New World colonies.
 
'' '''Colbertism'' ''' was the mercantilism as idealized by the French statesman [[Jean-Baptiste Colbert]], one of the most successful practitioners of mercantilism. He encouraged the growth of industry through subsidies and tariff protection, regulated the qualities and prices of manufactured and agricultural products, worked to break down trade barriers within France, initiated a vigorous road-building program, and restricted the use of natural resources.
 
Mercantilism was adopted as an economic philosophy by merchants and statesmen during the 16th and 17th centuries. Mercantilists believed that a nation-sate's wealth came primarily from the accumulation of gold and silver. Nation-sates without mines should obtain gold and silver by  trade, selling more goods than they bought from abroad. For this purpose nation-sates intervened extensively in the free market, imposing tariffs on foreign goods to restrict imports and granting subsidies to incentivate exports of domestic goods. Mercantilism put commercial interests to the level of national states' policy.
 
The economic rationale for mercantilism during the sixteenth century was the consolidation of the regional power centers of the feudal era by large competitive nation-states. Contributing factors were the establishment of colonies outside Europe, the growth of European commerce and industry relative to agriculture, the increase in the volume and breadth of trade, and the increase in the use of metallic monetary systems, particularly gold and silver, as opposed to barter transactions.
 
During this period, military conflict between nation-states was more frequent than at any time in history.  Each government's economic objective was to command a sufficient quantity of hard currency to support a military that would deter attacks by other countries and help its own territorial expansion.
 
Most of the mercantilist policies were the result of an interaction between the governments of the nation-states and their mercantile classes. In return for paying levies and taxes, the mercantile classes convinced governments to enact policies that would protect their business against competition.
 
Shipping became important during the mercantile period. With the growth of colonies and the shipment of gold from the New World into Spain and Portugal, control of the oceans was considered vitally important to national power. Navigation policies by France, England, and other powers were directed primarily against the Dutch, who dominated commercial marine activity in the sixteenth and seventeenth centuries.
 
During the mercantilist era it was believed that the principal benefit of foreign trade was the importation of gold and silver.
 
Adam Smith <ref name=WEALTH> SIMTH, Adam. ''Wealth of the Nations, The''. Modern Library, 1ª edition, 2000, ISBN 0679783369</ref> refuted the idea that the wealth of a nation is measured by the size of the treasury in his famous treatise, ''The Wealth of Nations''.
 
The last vestiges of the mercantile era were removed in England by 1860.
 
====Richard Cantillon, Jacques Turgot and Enlightenment Economics====
 
'''Richard Cantillon (1680?-1734)'''
 
Richard Cantillon, considered by many historians to be the first great economic ''"theorist"'', was an obscure character. An Irishman with a Spanish name who lived in France, reputedly made a fortune of some twenty million livres under John Law's schemes before moving to England. Not much more is known about his life. <ref name=CANTILLON>[http://cepa.newschool.edu/het/profiles/cantillon.htm ''Richard Cantillon, 1680?-1734''. The History of Economic Thought Website.]</ref>
 
Cantillon's wrote one remarkable treatise, ''Essai Sur la Nature du Commerce en Général'' <ref name=ESSAY>[http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/cantillon/index.html CANTILLON, Richard. '' An Essay on Commerce in General''.Hamilton, Ontario: McMaster University]</ref>  , written in French (circa 1732) which was published anonymously in England some twenty years after his death.
 
His work was well-known to the [[Physiocrats]] and the [[French school]], but fell into obscurity in the English-speaking world until he became popularized by [[William Stanley Jevons]] in the 1880s.
 
Cantillon decribed the ''supply-and-demand'' mechanism for the determination of short-run market price (but not long-run natural price). This work placed him as a progenitor of the [[Marginalist Revolution]].  His notes on ''entrepreneurship'' (as a type of arbitrage) have made him an icon of the modern [[Austrian School]]. Cantillon was also one of the first to articulate a ''Quantity Theory of Money'' and its reasonings.
 
As a consequence of his theory, he defended a ''quasi-Mercantilist'' policy for a favorable balance of trade but with a twist: Cantillon recommended the importation of ''"land-based products"'' and the exporting of ''"non-land-based"'' products as a way of increasing a nation-state wealth.
 
 
'''Jacques Turgot (1727-1781)'''
 
'''Anne-Robert-Jacques Turgot, (Baron de l'Aulne)'''<ref name=TURGORTPAGE>[http://www.taieb.net/auteurs/Turgot/Turgot00.html ''Anne-Robert-Jacques Turgot, Baron de l'Aulne, (1727-1781)''. <small> Courtesy of Mme Paulette Taieb, Université de Paris</small>]</ref> was a leading economist of  18th Century France. His contributions were quite distinct and advanced considerably upon Physiocratic theories.  Turgot have formed a distinct school of his own, counting the Abbé Morellet and the Marquis de Condorcet as close friends and disciples. Turgot exercised a deep influence upon [[Adam Smith]], who was living in France in the 1760s and was on intimate terms with Turgot.  Many of the concepts and ideas in Smith's ''Wealth of Nations'' are drawn directly from Turgot. <ref name=TURGOT2>[http://cepa.newschool.edu/het/profiles/turgot.htm ''Anne-Robert-Jacques Turgot, 1727-1781''. in: The History of Economic Thought Website]</ref>
 
His major work was ''Reflections on the Formation and Distribution of Riches (1766)'' in which Turgot introduced the concept of capital into the Physiocratic system. He clarified the meaning of ''"surplus"'' and made the connection between the ''"surplus"'' and ''"growth"'' and related profit rate to the rate of interest. He made clear the distinction between ''"market"'' price and ''"natural"'' price. Turgot differed from original  Physiocrats on the nature of the ''"produit net"'', defending that ''surplus'' could be generated by industry as well as agriculture.  His ideas were to be taken up by Adam Smith and the [[Classical School]]. 
 
Turgot was also onde of the a forerunners of the [[Marginalist Revolution]]. On his book  ''Valeurs et Monnaies'' (1769) he developed a  demand-based theory of price.  In that same work, he presents an account of how a large number of traders reduce the degree of indeterminacy of exchange, a topic later studied by [[Edgeworth]]. In his 1768 ''Observations'' he introduced the concept of ''variable input proportions'' in production.  Turgot was also  the first to conceive of the notion of ''diminishing marginal productivity'' to factor inputs. Finally, his 1766 discussion on money included the distinction (not made hitherto) between the ''"real"'' and ''"nominal"'' rates of interest.
 
'''Enlightenment Economics'''
 
Led by progresses in the science of  astronomy during the 16th Century - specially after Galileo Galilei's discoveries, which marked a sort of ''"turning point"'' in the scientific thought - there were various changes in the philosophy of science and the induction/deduction methods. The creation of classical physics and the new medical theories contributed to launch the western civilizations through a deep tranformation which gave birth to the new ''"The Scientific Attitude"''. This paved the way to the birth of a period which became kown as ''"The Enlightenment Period"'', when profound changes took place in all of the  social sciences, including Economics.
 
Several important authors published a sequence of books on Economics during the ''Enlightenment Period''. Among them: Charles de Secondat, Baron de Montesquieu (''The Spirit of the Laws''); Jean Jacques Rousseau (''A Discourse on Political Economy''), 1755; Caesar Beccaria (''A Discourse on Public Economy and Commerce''); Adam Ferguson (''An Essay on the History of Civil Society''), 1767; David Hume (1711-1776) (''Of the Original Contract'', 1748; (''On Money''), 1752; (''On Interest'');(''Idea of a Perfect Commonwealth''), 1754; (''On the Balance of Trade''); (''Selected Essays''); Jeremy Bentham (''Defence of Usury''), 1787; St. George Tucker (''Blackstone's Commentaries'' with notes (...)'', 1803; David Ricardo (1772-1823) (''The principles of political economy and taxation''), 1815; James Kent (''Commentaries on American Law''), 1826.
 
On 1776 Adam Smith (1723-90) published his masterpiece ''An Inquiry into the Nature and Causes of the Wealth of Nations'', which marked the begining of [[Classical Economics]] and will be subject of a separate chapter in this article.
 
====François Quesnay and the Physiocrats====
 
'''François Quesnay, 1694-1774.'''
 
François Quesnay is considered to be the father of the Physiocrats.
 
Quesnay opposed the mercantilist doctrines of [[Colbert]] believing that they concentrated too much on propping up industry and commerce rather than agriculture. <ref name=QUESNAY>[http://cepa.newschool.edu/het/profiles/quesnay.htm ''François Quesnay, 1694-1774''. The History Of Economic Thought Website]</ref>
 
Quesnay theory began with the axiom that "agriculture is the only source of ''produit net''" (''net product'', or ''surplus'' of output above cost).  He believed that manufacturing and commerce were ''"sterile"'' as the value of their output was equal to the value of their inputs.  Only ''land'', he said, produced more than went into it. Quesnay observed that the wealth of a nation lies in the size of its ''net product''. 
 
Influenced by the advocates of ''laissez-faire'', Quesnay wished to see many of the Medieval rules governing agricultural production lifted for  the economy to find its ''"natural state"''.  The ''natural state'' of the economy was the balanced circular flow of income between economic sectors. Quesnay, a physician in Louis XV's court, saw analogies to the circulation of human blood and the homeostasis of a body.
 
Quesnay emphazised the distinction between the ''ordre naturel'' (''nature's order'') and the ''ordre positif'' (''positive'', i.e. human-idealized, order).  A good government, Quesnay argued, should follow a  ''laissez-faire'' policy so that the ''ordre naturel'' could emerge.
 
[[Mirabeau]] (1760, 1763),  [[Mercier de la Riviere]][[ (1767) and DuPont de Nemours]] (1767) commentaries of Quenay's articles gave Quesnay's ideas a more systematic feel.
 
'''The Physiocrats'''
 
The Physiocrats <ref name= PHYSIOCRATS>[http://cepa.newschool.edu/het/schools/physioc.htm ''The Physiocrats''. in: The History of Economic Thought Website]</ref> were a group of ''French Enlightenment'' thinkers of  the 1760s that followed François Quesnay's ideas.  The founding document of ''"Physiocratic doctrine"'' was Quesnay's ''Tableau Économique'' (1759) <ref name=TABLEAU>[http://cepa.newschool.edu/het/essays/youth/tableau.htm QUESNAY, François. ''Quesnay's Tableau Économique''. in: The History of Economic Thought Website]</ref>.
 
This circle included the Marquis de Mirabeau, Mercier de la Rivière, Dupont de Nemours, La Trosne, the Abbé Baudeau and a handful of others.  To their ''contemporaries, they were known simply as the ''économistes''. 
 
The cornerstone of the ''Physiocratic doctrine'' was François Quesnay's (1759, 1766) axiom that "only agriculture yielded a ''surplus''", called  ''produit net'' (''net product'').  Manufacturing, the Physiocrats argued, took up as much value as inputs into production as it created in output, and consequently created no ''net product''. 
 
The Physiocrats believed that the wealth of a nation lies not in its stocks of gold and silver, but rather in the size of its net product, going against the prevailing mercantilists' theories. 
 
Believing that industries cannot generate any ''produit net'', the Physiocrats argued that the old Colbertiste policies of encouraging commercial and industrial corporations was wrong-headed. Government policy, if any, should be geared to maximizing the value and output of the agricultural sector.
 
They defended a ''laissez-faire'' attitude. They called for the removal of restrictions on internal trade and labor migration, the abolition of the ''corvée'', the removal of state-sponsored monopolies and trading privileges, the dismantling of the guild system, etc. 
 
The Physiocrats defended their ''"single tax"'' on landed property -- ''l'impôt unique''.  [[Mirabeau]] (1760) laid out the logic of its defense arguing that if only ''land'' creates a ''surplus'', all taxes represent just a transfer of money form one sector to another.
 
====David Hume and the Scottish Enlightenment====
 
'''David Hume (1711-1776.)'''
 
David Hume <ref name=HUME'>[http://cepa.newschool.edu/het/profiles/hume.htm ''David Hume (1711-1776.). in: The History of Economic Thought Website.]</ref> was one of the most important figures of the ''Scottish Enlightenment'' and a friend of Adam Smith. Hume's contributions to economics are found mostly in his ''Political Discourses'' (1752), incorporated into his ''Essays'' (1758). 
 
Hume opposed Mercantilism. He defended that wealth of a was measured by the stock of commodities of a nation, not its stock of money. 
 
He was also one of the creators of the ''Quantity Theory'' and the neutrality of money ("It is none of the wheels of trade: it is the oil which renders the motion of the wheels more smooth and easy", ''Of Money'', 1752.
 
====Ferdinando Galiani and the Italian Tradition====
 
====Social Philosophers and Commentators====
 
===The Classicals===
 
====Adam Smith====
 
===Neoclassical Schools (1871-today)===
 
====Anglo-American Neoclassicism====
 
 
====Continental Neoclacissism====
 
===Alternative Schools===
 
====Heterodox Traditions====
 
====Keynesians====
 
===Thematic Schools===
 
====Themes====
 
====Other====


==References==
==References==
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==Bibliography==
 
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* [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/beccaria/pubecon BECCARIA, Marquis Caesar Beccaria Bonesaria. ''A Discourse on Public Economy and Commerce''. Hamilton, Ontario: McMaster University.]
 
*[http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/bentham/usury BENTHAM, Jeremy. ''Defence of Usury''(1787). Hamilton, Ontario: McMaster University.]
 
* [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/cantillon/index.html CANTILLON, Richard. '' An Essay on Commerce in General''. Hamilton, Ontario: McMaster University.]
 
* [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/ferguson/civil.html FERGUSON, Adam. ''An Essay on the History of Civil Society''. Hamilton, Ontario: McMaster University.]
 
* [http://www.questia.com/PM.qst?a=o&d=97704533 HANEY, Lewis H., Ph.D. ''History of economic thought: a critical account of the origin and development of the economic theories of the leading thinkers in the leading nations''. New York: The Macmillan Company, 1920.]
 
* [http://www.constitution.org/dh/origcont.htm HUME, David. Of The Original Contract (1748), Edited and rendered into HTML by Jon Roland, in: www.constitution.org.]
 
* [http://www.constitution.org/dh/hume.htm HUME, David. ''Selected Essays'' (1748).in: www.constitution.org.]
 
* [http://www.constitution.org/dh/perfcomw.htm HUME, David. Idea Of A Perfect Commonwealth'' (1754). Edited and rendered into HTML by Jon Roland. in: www.constitution.org.]
 
* [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/hume/interest.txt HUME, David. ''Of Interest''. Hamilton, Ontario: McMaster University.]
 
* [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/hume/trade.txt HUME, David. ''Of the Balance of Trade''. Hamilton, Ontario: McMaster University.]
 
* [http://www.constitution.org/jk/jk_000.htm KENT, James. ''Commentaries on American Law'' (in four volumes). New York: Published by O. Halstead, 15th edition, 1826. Edited by Jon Roland, 1997-2002. in: www.constitution.org.]
* [http://www.taieb.net/auteurs/Quesnay/tableau.html QUESNAY, François (1694-1774). ''Analyse de la formule arithmétique du TABLEAU ÉCONOMIQUE de la distribution des dépenses annuelles d'une Nation agricole''. <small> Courtesy of Mme Paulette Taieb, Université de Paris</small>]
 
* [http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/ricardo/prin/index.html RICARDO, David. ''The Principles of Political Economy and Taxation''. 1815 (third ed. 1821). Hamilton, Ontario: McMaster University.]
 
* [http://www.constitution.org/jjr/polecon.htm ROSSEAU, Jean Jacques. ''A Discourse On Political Economy''(1755). in: www.constitution.org.]
 
* [http://www.constitution.org/cm/sol.htm SECONDAT,Charles de, Baron de Montesquieu. ''The Spirit Of The Laws''. Translated by Thomas Nugent, revised by J. V. Prichard, Based on an public domain edition published in 1914 by G. Bell &  Sons, Ltd., London.]
 
* [http://www.econlib.org/library/Smith/smWN.html SMITH, Adam (1723-1790). ''An Inquiry into the Nature and Causes of the Wealth of Nations''. London: Methuen and Co., Ltd., ed. Edwin Cannan, 1904. Fifth edition. <small>(Downloadable)</small>]
 
* [http://www.ccel.org/a/aquinas/summa/home.html THOMAS AQUINAS, Saint (1225?-1274).''The Summa Theologica''. Benziger Bros. edition, 1947. Translated by Fathers of the English Dominican Province.<small>Acknowledgement: This digital file was produced through the kindness of Sandra K. Perry, Perrysburg, Ohio.</small>]
 
* [http://www.constitution.org/tb/tb-0000.htm TUCKER, St. George.''Blackstone's Commentaries: with notes of reference to the Constitution and Laws of the Federal Government of the United States; and of the Commonwealth of Virginia''. in: www.constitution.org.]
* [http://www.taieb.net/auteurs/Turgot/ref1788/r88_69.html TURGOT, Anne-Robert-Jacques Turgot, Baron de l'Aulne (1727-1781).''Réflexions sur la formation et la distribution des richesses'', Paris, 1788. <small> Courtesy of Mme Paulette Taieb, Université de Paris</small>]
 
* [http://www.econlib.org/Library/Essays/trgRfl1.html TURGOT, Anne-Robert-Jacques Turgot, Baron de l'Aulne (1727-1781).''Reflections on the Formation and Distribution of Wealth''. London: Printed by E. Spragg, 1793. Translated from the French. First published 1774.]
 
 
 
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[[Category:Economics Workgroup]]

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Modern economic thought is generally considered to have originated in the late eighteenth century with the work of David Hume and Adam Smith, the founders of classical economics. The nineteenth and twentieth centuries saw major developments in the methodology and scope of economic theory; and the early twenty-first century has seen a rethinking of some previously accepted tenets.

Nineteenth- and early twentieth-century economists applied deductive reasoning to axioms considered to be self-evident and simplified assumptions which were thought to capture the essential features of economic activity. That methodology yielded concepts such as elasticity and utility, tools such as marginal analysis, and theorems such as the law of comparative advantage. An understanding of the relationships governing transactions between consumers and producers was considered to provide all that was necessary to explain the behaviour of the economic system.

The development, in the latter half of the 20th century, of systems of economic statistics enabled economists to use inductive reasoning to test theoretical findings against observed economic behaviour, and to develop new theories. By that time, the concept had emerged of the national economy as a complex interactive system, and analysis of that concept provided explanations of recessions, unemployment and inflation that were not previously available. The application of empirical data and inductive reasoning enabled those theories to be refined, and led to the development of forecasting models that could be used as tools of economic management.

The development of economic thought in the early 21st century has been stimulated by the financial crisis and Great Recession, and the questions that these events raised concerning the functioning of the global financial system and the part that it plays in the functioning of the economic system generally.

The search for understanding continues.

Overview: categories of economic thought

Historians categorise economic thought into “periods” and “schools”, and tend to attribute each innovation to one individual. This categorisation is helpful for the purpose of exposition, but the reality has been a story of interwoven intellectual threads in which advances attributed to particular individuals or schools have often prompted the work of others. For example, the quantity theory of money, which achieved prominence in the twentieth century and is associated with Milton Friedman, was first formulated at least three centuries earlier. Many of those threads, that have permeated the categories referred to as "Classical economics" and "Neoclassical economics", had earlier origins. "Classical", in economics, denotes the adoption in the late eighteenth century of an approach that was inspired by the enlightenment and the methodology of the physical sciences, and that had abandoned previous examinations of economics in terms of ethics, religion and politics. Preoccupation with those threads was overshadowed in the twentieth century by the responses of Keynesianism and monetarism to the problems of unemployment and inflation, but the development of neoclassical economics started before that time, and has continued thereafter. The introduction of new tools of exploration has since led to the vigorous development of that, and other, threads, and an expansion in the scope of economics into many new directions.

Classical Economics

David Hume

The Scottish philosopher David Hume was an early exponent of what was later known as monetary economics, and was an opponent of "mercantilism". Mercanilist policy at the time, regulated trade in ways that subsidised exports so as to promote inflows of gold and silver, and restricted imports in order to discourage outflows. Hume contested the mercantilist thesis, partly on the grounds that an inflow of money would cause inflation, and partly on the grounds that nations would benefit from the international specialisation that would result from the introduction of free trade. More generally, Hume argued that all government intervention in commerce tended to obstruct economic progress.[1].

Adam Smith

A major advance in the development of economics occurred with the publication in 1776 of Adam Smith's An Inquiry into the Nature and Causes of The Wealth of Nations.[2]. Smith wrote a comprehensive treatment of the subject, using deductive logic in a manner similar to its use in the physical sciences. His main purpose was to recommend changes of economic policy in the interests of economic growth. He argued that the division of labour was the main cause of economic growth. His famous maxim was that the extent of the market is determined by the division of labour. To thus expand markets, required that they should not be impeded by governmental policies. He therefore opposed government intervention in commerce (as in mercantilist trade regulation). But he did not oppose all governmental intervention into the economy. He advocated government spending upon what are now termed public goods such as defence, law enforcement, infrastructure, and education of the children of people who could not afford it. He identified what he considered to be the economic drawbacks of all forms of taxation (except the taxation of land values) and of public expenditure. He examined the relation of price to value and concluded that the price of a product tends to equality with its cost of production, which he termed its "natural price". He reasoned that "when the quantity brought to market is just sufficient to supply the effectual demand and no more, the market price naturally comes to be either exactly, or as nearly as can be judged of, the same with the natural price" - an outcome which he took to be the normal result of market bargaining.

Jean-Baptiste Say

Jean-Baptiste Say[3] was an influential advocate of Adam Smith's teaching in French government circles, but his best-known contribution was what came to be known as "Say's Law of Markets." Later paraphrased as "supply creates its own demand," Say's law stated that, although there could be an imbalance between the supply and the demand for particular products, no such imbalance could exist in the economy as a whole. It was based upon the postulate that money plays no part in the functioning of the economy beyond its role as a medium of exchange. (The claim that money is nothing but a medium of exchange, is another way of saying that people use money only for buying things (including stocks and bonds). Say justified that postulate by arguing that it would be foolish to hold money out of circulation because that would mean needlessly going without things (or without dividends or interest). Say's Law remained part of mainstream classical economics until John Maynard Keynes drew attention to the speculative and precautionary motives for holding money.

Thomas Malthus

In his influential Essay on the Principle of Population, Thomas Malthus postulated that the population would grow at a geometric rate (2, 4, 8, 16...) while food production could only increase arithmetically (1, 2, 3, 4 ....) and concluded that the food supply would eventually be insufficient to support the population.[4] This theory led him to oppose the introduction of the UK's Poor Law, and to advocate the protection of agriculture. In other respects, he followed Adam Smith in opposing government intervention in commerce. Evidence in support of his postulates was lacking at the time, and they have since been found to be mistaken[5], mainly because they took no account of the benefits of technical change.

David Ricardo

With minor reservations, David Ricardo accepted and extended Adam Smith’s economics. In his major work,The Principles of Political Economy and Taxation, he accepted the concept of a value-determined “natural price”, although he considered value to be determined by labour value added, rather than cost.[6] Following Adam Smith’s lead, he also developed the wage fund concept that the amount available for the payment of wages is fixed at any particular level of capital investment, so that an increase in the supply of labour would lead to a reduction in wage rates. He pioneered a definition of rent as the difference between the produce of a unit of labour on the land in question, and its produce on the least productive land in use. In a further extension to Adam Smith’s work, he explored the incidence of taxation on wages, profits, houses, and rent, identifying in each case (but with the exception of rent) its harm to the economy. Probably his most influential contribution, however, was his development of his "Law of Comparative advantage" that challenged the belief that the trading of a product is possible only with those with a lesser ability to produce it. Ricardo produced a logical demonstration that there can be mutually beneficial trade between two countries, one of which is better able than the other to produce all of the commodities that are traded.

Karl Marx

Karl Marx[7] adapted Ricardo's concept of labour value and put it to an entirely different use. In his analysis, as in Ricardo's, labour consumption determines value. This, Marx termed exchange value. But Marx regarded each labourer as a product, whose exchange value is determined by the labour inputs required to feed, clothe, and train him. He reasoned that what the employer receives is the labourer's use value, which is determined by the utility of his products. Marx noted that a labourer's use value normally exceeds his exchange value, and he termed the difference surplus value, which was the employer's profit. Like Adam Smith and his classical predecessors, Marx was preoccupied with the subject of economic growth but, unlike them, he saw technical progress as a major contributor.

Marx was probably the first economist to make a systematic attempt to explain the fluctuations in economic activity known as the business cycle. He considered that if technical progress were to slow down, the only way to maintain growth would be to invest more and more in machinery and buildings, as a result of which the rate of profit on new investment would fall, leading to a further reduction in growth. Also, in his view, any departure from the conditions necessary for steady growth would lead to the accumulation of unwanted stocks of goods, producing a downturn in economic activity - until price-cutting, in order to get rid of surpluses, put the process into reverse.

In his major work, Das Kapital[8] Marx puts his findings in an historical, concludes that economic conditions shape history, and forecasts a breakdown of the capitalist system and its replacement by socialism.

Other contributors

Among the many lesser contributors to classical economic theory, the best-known was John Stuart Mill. His Principles of Political Economy[9], although intended by the author merely to bring together the works of others, offered some fresh insights into increasing returns to scale and their consequences for the development of monopolies, and anticipated (though not in these terms) the neoclassical concepts of elasticity and the determination of price by the interaction of supply and demand.

Written during the classical period, but without recognition at the time, was the Theory of the Firm by the French economist and mathematician Antoine Augustin Cournot. Cournot used differential calculus to demonstrate the profit-maximising requirement of equality between marginal cost and marginal revenue, thus anticipating some of the more important developments of neoclassical economics.

Neoclassical Economics

The neoclassical approach

The term "neoclassical" is commonly applied to all of the continuing developments in economic thinking that followed the replacement of value-based concepts by the concept of markets that are governed by the interaction of supply and demand. In that sense, the term denotes a period rather than a consistent approach - although it is a period that overlaps the competing approaches of Keynesianism and monetarism. It is nevertheless a period in which most economists have deduced their findings from the same hypothetical postulates - including the assumption of competitive markets in which consumers maximise utility and producers maximise profits. Within that framework of postulates, neoclassical economists have explored a variety of aspects of economic activity in a variety of different ways.

Marginal analysis

The neoclassical period is also marked by an expansion in the number of people applying their minds to the problems of economics, as a result of which there have frequently been similar contributions from a number of different thinkers. That was true of the innovative concepts of marginal analysis, that are attributable to the contributions of William Stanley Jevons [10] , Carl Menger [11] and Léon Walras [12]. Their contributions have been brought together by Alfred Marshall in his Principles of Economics [13], which provides the reader with an accessible and readable (and non-mathematical) account of those and other contributions. The concept of utility, was given more prominence, and it was demonstrated logically (and mathematically) that a rational consumer would continue to buy additional units of a product until its marginal utility (the increase in utility obtainable from one additional unit of the product) became level with to its price; and that a rational supplier would continue to offer additional units of a product until its marginal cost became level with the marginal revenue that he would get from selling it. The American economist, John Bates Clark, subsequently applied the concept to a market in which a rational employer would continue to hire labour until its marginal product became level with the prevailing wage rate.

Equilibrium and the Price Mechanism

The concept of "market equilibrium" is central to the neoclassical model. Léon Walras[14] thought of it as the achievement of an imaginary auctioneer who adjusts a notional opening price in response to a succession of bids by buyers and sellers, and permits transactions to take place only when a price is reached at which buyers are willing to buy all that is offered for sale. That is the process of price determination by supply and demand which marks the abandonment of the concept of value-determined price, and which is examined in detail in Alfred Marshall's Economics and in Milton Friedman's Price Theory[15]. Walras, and subsequently the Italian economist Vilfredo Pareto [16], later developed the concept of a general equilibrium in which supply is equal to demand in every market in a closed economy. The normal assumption of neoclassical economics is that of a stable equilibrium to which the economy will automatically return after a disturbance. In such an economy, unemployment does not persist because any excess in the supply of labour, relative to its demand, is corrected by a reduction in wages.

Welfare and Efficiency

The most politically influential of the contributions of the neoclassical economists was probably their development of the concept of welfare. In accordance with the precepts of representative government, they assumed the criterion for the success of an economic system to be the welfare of the individual, and they introduced the concept of economic efficiency as a measure of that success. Vilfredo Pareto took the lead in defining efficiency as a state in which no-one could be made better off without making someone worse off. The three types of efficiency were identified as productive efficiency (the production of good at minimum cost), allocative efficiency (the provision of the mix of goods that consumers want) and distributive efficiency (the distribution of the goods in such a way as to maximise individual welfare). That work laid the foundations for the subsequent development of the theory of welfare economics by Sir John Hicks and others. (The subject of economic welfare is discussed extensively in Arthur Pigou's Economics of Welfare [17], and the theorems of welfare economics are summarised in William Baumol's Economic Theory and Operations Analysis [18])

Competition

The theorems of welfare economics establish a presumption that allocative efficiency - that is to say that resources will be optimally allocated as between the production of alternative products - will be achieved under the hypothetical conditions of perfect competition. (Those conditions include the requirement that for each product there is no supplier large enough to influence prices, that all producers supply identical products, and that all consumers are well informed and behave rationally.) Despite the unreasonableness of those requirements, most economists advocate a presumption that restrictions upon competition will result in a reduction in efficiency . Those theoretical developments were the foundation for antitrust and other forms of competition policy, the economics and politics of which have been developed by George Stigler .

The theory of the firm

The tools of welfare economics were also used to develop the theory of the firm by Nicholas Kaldor of the London School of Economics in his Equilibrium of the Firm [19] and Ronald Coase in his "The Nature of the Firm [20]. (Those theoretical developments have been summarised in William Baumol's Economic Theory and Operations Analysis [21]. An empirical study of the way firms actually behave is provided by Cyert and March's Behavioral Theory of the Firm [22])

Economic growth

There has been succession of attempts to create models of economic growth that identify the contributions of such factors as investment, productivity, innovation and institutional environment; and that explain the differences in growth experienced by different regions of the world. In the simple model proposed by Malthus in 1850, growth could not exceed population growth, but it was not long before it became evident that it was doing so. The Harrod-Domar model [23], and its successors, assume that there would be sufficient economic growth to enable some to go into growth-enhancing investments. In a later development, the 1956 Solow model [24] introduced the influence of the substitution of capital for labour that results from investment in improved capital equipment. Solow also pioneered the technique of growth accounting , which he used to estimate relative contributions to historical growth in the United States; and he identified an unexplained residual which he termed total factor productivity, the growth of which he attributed to technological change. Technological change was exogenous to the Solow model, in that it was not the consequence of factors that were represented in the model. As a result of subsequent research, notably that of Paul Romer [25] and Robert Lucas [26], some of the factors believed to influence technological change, such as expenditure on R&D and training, have since been embodied in the growth models, which are termed endogenous growth models. The most recent work on the subject has sought to identify the contributions to economic growth of institutional factors such as quality of governance, trust, and ethic diversity; and to explore its links with geographical factors and globalisation.

Keynesian macroeconomics

The contribution of John Maynard Keynes

The most important contribution to economic thought by John Maynard Keynes was his examination of the factors determining the levels of national income and employment, and the causes of economic fluctuations. His major (and hard to read) work, the General Theory of Employment, Interest and Money, contains a sustained attack on much of the thinking of classical economics - mainly on the grounds that their postulates were unrealistic. His first target was Say's law of markets with its denial of the possibility of a general deficiency of demand. He challenged its implicit assumption that money is no more than a medium of exchange by drawing attention to the speculative motive for holding money. Secondly, he attacked the classical economists' contention that it was the interest rate that reconciled savings plans with investment plans, claiming that the level of savings was largely determined by the level of national income. Thirdly, he rejected the classical economists' assumption that any tendency for unemployment to rise would be corrected by a reduction in the general level of wages, substituting the contention that "wages are sticky downward". Having substituted his assumptions for those of his predecessors, he advanced the thesis that a deficiency of demand could occur if there was an excess of planned savings over planned investment, because such an excess could be removed only by a reduction in national income. The implication of that thesis was that the economy could settle down into a condition of high unemployment, lacking the self-righting mechanism envisaged by the classical economists.

Neo-Keynesianism

Shortly after the publication of Keynes' General Theory, John Hicks published an article entitled "Mr Keynes and the Classics"[27], in which he produced a synthesis between the Keynesian and neoclassical models. Its main feature is the IS/LM diagram with its intersecting curves, one of which (Investment/Savings) relates the demand for savings to the interest rate, and the other (Liquidity/Money Supply) relates the demand for money to the interest rate - and in which the point of intersection of the two curves represents an equilibrium level of demand. (The IS/LM diagram subsequently came to be known as the Hicks-Hansen diagram in recognition of prior work by the American economist Alvin Hansen . The important feature of the synthesised model is that it can be made to depict behaviour in accordance with either the Keynesian model or the neoclassical model, depending upon what is assumed concerning the slopes of the two curves. In doing so it introduced a fundamental departure in the methodology of economics - a change from an exclusive reliance upon logical deduction from a priori postulates, to the increasing use of the inductive process of testing hypotheses against empirical evidence, that was made possible at the time by the comparatively recent practice of systematically collecting economic statistics. The work of a large body of economists was subsequently devoted to testing such hypotheses, using the mathematical technique known as "econometrics". That work does not appear to have resolved the controversy concerning the usefulness of the two models (except that some economists now acknowledge that one or the other seems to have worked better from time to time and in some countries' economies)

Policy Implications

A Keynesian consensus dominated the economic policies of the developed countries for two or three decades following the second world war. Keynesian stabilisation policy required governments to counter downturns in demand by cutting taxes or increasing public expenditure. Since it takes some years for such actions to take effect, their timing had to be based upon forecasts using computerised economic forecasting models, but forecasting errors and misguided attempts to stimulate growth often had destabilising consequences. Measures that unwittingly stimulated demand at a time when an economy was operating at its full capacity, frequently gave rise to rising inflation - for which the only remedy appeared to be wage restraint - and the situation was sometimes exacerbated by the operation of foreign exchange policies. Opposition to those policy actions came from economists of the Austrian School, and from economists of the Chicago School whose thinking is described below.

Monetarism and the Chicago School

The Chicago School

The University of Chicago School of Economics [28] has enjoyed a reputation for economic excellence since its foundation in 1892 However, the term Chicago School is usually taken to refer to the outlook and methodology of its economists during the period that started in the 1960s - including Milton Friedman, George Stigler, Ronald Coase, Robert Lucas, Cary Becker, Harry Johnson and Merton Miller, and to some like-minded economists in other universities. It is best known for its advocacy of monetarism but its economists have also made contributions on a wide range of other topics, including international trade, rational expectations and institutional economics. Their methodology embodies an approach, which philosophers term instrumentalist, that gives the predictive value of a theory priority over the representativeness of its assumptions [29]

Monetarism

The quantity theory of money, which is often attributed to the economist Irving Fisher, but which undoubtedly had earlier origins, equated the volume of money in circulation multiplied by a notional "velocity of circulation". to the volume of physical output multiplied by its unit price (usually written as MV = PT). If the velocity of circulation were roughly constant, that would imply an association between inflation and growth in the money supply. Milton Friedman found that to have been the case during various periods in United States history [30], and that periods of monetary expansion had been followed by periods of inflation, although with long and variable time-lags. That led him to argue that Keynesian demand management would be ineffective in the long run because it would be accompanied by a damaging rise in the money supply; and that stability of demand and prices could better be achieved by control of the money supply. The controversy that followed was mainly concerned with the nature of the transmission mechanism (the question whether an excess of money would bid up the prices of goods, or whether it would be invested in interest-bearing bonds without affecting the prices of goods).

A theory connecting the money supply and the balance of payments had previously been put forward by Harry Johnson when he was a professor of economics at Manchester University. The conventional view had been that the exchange rate is determined by the balance between the supply and demand of exports and imports, but Harry Johnson treated it as the relative price of the moneys in circulation in the two countries [31]. One of the implications of his theory is that if the exchange rate is fixed, the money supply cannot be controlled - which was a consideration that influenced the Chicago School's campaign to put an end to the system of fixed exchange rates then in operation. Another is that if the money supply is held constant, the balance of payments is self-correcting.

Expectations

Milton Friedman also attacked the thinking behind the Phillips curve (which had reflected the observation that inflation tended to fall when there was a rise in unemployment) on the grounds that it failed to take account of expectations. He proposed its replacement by the expectations-augmented Phillips curve [32], and used that construction to counter fears that a reduction in growth of the money supply would lead to a sustained increase in unemployment. To do so, he introduced the concept of the non-accelerating-inflation rate of unemployment (NAIRU), which is usually referred to as its natural rate, and which is the unemployment rate at which the expected inflation rate is the same as its actual rate. He argued that if a reduction in money supply growth caused unemployment to rise above its natural rate, the expected inflation rate would fall, setting in motion a sequence of events that would cause unemployment to revert to its natural rate. Conversely, a reduction in unemployment accompanying an increase in the money supply would cause an increase in expected inflation, prompting wage demands which would lead to an increase in actual inflation - a process which could continue indefinitely.

Applying the concept of "rational expectations"[33] formulated by his former colleague, John Muth, to the operation of economic policy, Robert Lucas of the Chicago School put forward what has become known as the Lucas Critique[34] . He argued that policy actions tend to change people's expectations so that the same policy action could have future consequences that differ from the consequences that it had in the past. That possibility has fundamental implications for the construction of forecasting models, and the Lucas critique also raises the possibility that public reactions could frustrate the achievement of policy objectives.

Policy implications and outcomes

The Chicago School's prescription for stabilisation problem was confined to the control the money supply, and its prescription for the reduction of unemployment was to take measures to improve wage - and price flexibility. Concern for rising inflation, and the failure of attempts to control it by wage restraint, led to the widespread adoption of the first of those prescriptions in the late 1970s. In the United States, the Congress passed The Full Employment and Balanced Growth Act (known as the Humphrey-Hawkins Act) which required the Federal Reserve Bank to set one-year target ranges for money supply growth twice a year and to report the targets to Congress. In the United Kingdom, the Callaghan administration adopted a specific money supply objective: a practice that was enthusiastically adopted by its successor Thatcher administration. In both countries, attempts to keep the growth of the money supply within pre-set limits were generally unsuccessful (and in the United Kingdom, money supply growth actually increased [35]) and were eventually abandoned. Some central bankers have said that they take account of long-term money supply trends, but none consider control of the money supply to be a practicable instrument of stabilisation policy. Consensus monetary policy since the late 1980s uses interest rates as a means of stabilising both prices and output[36], and the median inflation rate in 13 industrialised countries has fallen from around 15 per cent in the mid 1970s and early 1980s to around 2 per cent in 2005[37].

Institutional Economics

The Institutionalist School

The term Institutionalist refers to economists who argue that economic activity cannot properly be understood except in the context of the public and social structure in which it takes place. That approach to the can be traced back to the German Historical School, which included Friedrich List and Max Weber, who is best known for his The Protestant Ethic and the Spirit of Capitalism. But the term is more commonly applied to the views of a pre-war group of American economists whose leading member was Thorstein Veblen - the man who coined the term conspicuous consumption - and whose lasting contributions were the collection of economic statistics and the study of business cycles.

Modern institutional economics

A major contributor to the theory of institutional economics has been Ronald Coase, who summarised his approach in his 1991 Nobel Prize lecture [38]. Early in his career as an economist he had formulated what came to be known as the Coase Theorem which was the proposition that economic efficiency will be achieved provided that property rights are fully allocated and can freely be traded; a proposition which he developed further in his 1960 paper The Problem of Social Cost [39]. The development of institutional economics by economists at the University of Chicago has taken them across the conventional borders of economics into the disciplines of law, sociology and politics. (An extreme example has been the publication of the best-selling Freakonomics that was jointly authored by the Chicago economist Steven Levitt and the New York journalist Stephen Dubner, and which applies economic thinking to such questions as cheating, drug dealing and the connection between crime and abortion.)

Mechanism design theory

A recent extension to institutional economics is concerned with how well different institutions and allocation mechanisms achieve goals such as welfare and private profit. Contributions to that subject by Leonid Hurwicz of the University of Minnesota, Eric Maskin of Princeton and Roger Myerson of Chicago earned them the 2007 Nobel Prize in Economics.

Public choice theory

A different approach to the same questions [40] had previously been put forward under the heading of public choice theory, the principle contribution to which had been James Buchanan and Gordon Tullock's major treatise, The Calculus of Choice [41]. However, Buchanan and Tullock are best known for their analysis of the behaviour of politicians, civil servants and voters on the assumption that they are mainly motivated by personal gain, rather than a desire to serve the public interest.

International economics

The gains from trade

David Ricardo's law of comparative advantage - and its implication that trade restrictions are damaging to the interests of the country that imposes them - was the starting-point of the historical development of trade theory [42]. The subsequent theoretical developments of "classical" trade theory have mainly been attempts to create mathematical models of inter-country trade. The best-known of those was the Heckscher-Ohlin Theory [43], which deduced from a range of highly restrictive assumptions that a country will export those commodities that are intensive in the factor of production in which it is most well-endowed. That theory was extended by Paul Samuelson to conclude that, in the absence of productivity differences, trading between two countries would tend to equalise wages and capital costs in those countries. However, doubt was cast upon the relevance of the Heckscher-Ohlin theory by Wassily Leontief's discovery that the United States, which is the world's most capital-intensive country, had been exporting labour-intensive commodities and importing capital-intensive commodities. The general conclusion has been that international trade is mainly driven by factors other than labour-intensity and capital-intensity. "Modern" trade theory depends mainly upon the econometric analysis of international trade statistics,and has produced a range of findings concerning the influence of factors such as innovation and training.

Infant industries

There was opposition in the early nineteenth century to the proposition that trade restrictions reduce welfare from a small group of economists, including Friedrich List of the German Historical School, who argued that free trade should not be permitted until the government had taken the measures necessary to establish the country's "productive powers". That was the precursor of the argument for infant-industry protection that was politically influential in the early twentieth century and which led to the introduction of the Smoot-Hartley system of industrial tariffs in the United States. It has been given recent expression in Ha-Joon Chang's book Kicking Away the Ladder [44] which suggests that industrial successes in Britain and the United States (and later in creating an automobile industry in South Korea) were attributable to the fact that they were protected from overseas competition until they were large enough to benefit from economies of scale. The mainstream reaction among economists concedes that the case for free trade does not take account of the benefits of scale economies, and that welfare gains from temporary trade restrictions might in principle be possible if a government were sufficiently successful in "picking winners" but that tax incentives and subsidies are more effective than tariffs [45] .

Globalisation

Globalisation is seen by most economists as contributing to economic welfare by promoting competition and the division of labour. But there are exceptions. Professor Joseph Stiglitz [46] [47] of the Columbia Business School has advanced the infant industry case for protection in developing countries and criticised the conditions imposed for help by the International Monetary Fund [48]. And Professor Dani Rodrik of Harvard[49] has noted that the benefits of globalisation are unevenly spread, leading to income inequalities that, in his view, lead to damaging losses of social capital, and to the migration of labour causing social stresses in receiving countries [50]

Financial economics

Overview

Economists and professional investors gave little attention to financial economics until the adoption in the 1970s of models based upon the efficient markets hypothesis. That hypothesis was the basis of risk analysis using the assumption that price variations on the markets for financial assets could be treated as random variations, which could be represented by established probability distributions. The international financial industry made use of the models to select investments that were predicted to give the best return for a stipulated level of risk. It was not until the 2008 financial crisis that it was widely recognised that the efficient market hypothesis was no more than a statement of a general tendency, and that additional risks could arise from statistically unpredictable patterns of investor conduct.

The finance market

The study of financial economics had its origin in a 1900 thesis entitled Theorie de la Speculation by the French mathematician Louis Bachelier [51], according to which price fluctuations in a speculative market are analogous to the Brownian Movement of physics (the random walk of statistics theory), such that there is no combination of prices that offer the prospect of a certain gain. In 1933, the American economist Alfred Cowles[52] developed a similar thesis, which he published in a paper entitled Can Stock Market Forecasters Forecast?. According to Cowles' efficient market hypothesis, all of the available information that was relevant to an asset's prospects would already be embodied in its price (so that the answer to his question was "no"). The hypothesis depended upon the assumptions that most traders behave rationally, and that the activities of the others are mutually cancelling. Those assumptions were widely accepted, and on their basis, financial markets were taken to be essentially stable. Hyman Minsky's 1986 financial instability hypothesis, which suggested that financial markets are apt to become unstable after a period of sustained economic growth, received little attention at the time. A number of mathematical models of finance markets based upon the efficient markets hypothesis were developed in the course of the 20th century and were widely applied as guides to investment, but financial economics was then considered by most of the economics profession to be a specialised subject of little general interest, regarding the financial system as a collection of secondary markets whose internal characteristics do not affect the rest of the economy.

Portfolio and asset price theory

A sequence of Nobel Prize-winning advances concerning the problem of getting the best return from an investment without exceeding a chosen level of risk, occurred during the period from the 1950s to the 1970s. The sequence started in the late 1950s, when James Tobin [53] and Harry Markowitz laid the foundations of modern portfolio management. In his "Separation Theorem", Tobin proposed a two-stage process in which the required risk ceiling could be maintained by mixing risky and riskless assets, and Markowitz demonstrated the benefits of a diversified portfolio in which the prices of it assets would not rise and fall together, using the statistical concept of covariance. In 1970, William Sharpe[54] applied that concept to the tendency of the price of an asset to rise and fall in concert with the all-share index, assigning the title "Beta" to its mathematical definition, and used it to derive a pricing method know as the Capital Asset Pricing Model, and in 1973, Fischer Black [55] and Myron Scholes [56] developed the Black-Scholes model which made use of the fact that the expected volatility of an asset is reflected in its price in the options market, which led to the development by Robert Merton [57] of the "Contingency Claims Analysis" method of pricing assets.

Corporate finance

During the same period there was a sequence of advances in the economics of corporate finance. It started with the demonstration by Franco Modigliani [58] and Merton Miller [59] that shareholders should be indifferent to the level of a corporation's debts provided that it was possible to repay them costlessly with money available at a riskless rate of interest. Other economists subsequently augmented the Modigliani-Miller theory with allowances for the effects of taxation and of information asymmetry.

Recent developments

The Greenspan era

Divergences of view about economic management persisted into the early 21st century, but a consensus developed among those responsible for the management of the major economies, along the lines of a speech by the then United States Federal Reserve Board Chairman, Alan Greenspan[60]. The use of Keynesian fiscal policy to regulate output was considered to have proved ineffective and inflationary, and monetarist attempts to control the money supply were seen to have been unsuccessful. The new rôle of fiscal policy was the maintenance of fiscal stability, responsibility for the management of the economy had become the exclusive function of monetary policy, and monetary policy was confidently expected to prevent serious interruption to economic growth (the President of the American Economic Association had declared that "The central problem of depression-prevention [has] been solved, for all practical purposes"[61]). The financial system was considered to be essentially stable, making financial regulation unnecessary.

The conclusion of the era was marked by Alan Greenspan's 2008 congressional testimony:

"In recent decades, a vast risk management and pricing system has evolved combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel prize was awarded for the discovery of the pricing model that underpins much of the advance in the derivatives markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year."[62]

The shortcomings of economic theory in that respect have been held [63] to have played a major role in the the financial crisis of 2008.

Post-Great Recession thinking

The financial crisis of 2008 and the resulting Great Recession prompted much re-thinking of economic theory. Professor Shin of Princeton University reported that the "race is on" to add a new perspective to macroeconomics by the incorporation into it of a new theory of financial economics[64], and there was new thinking about the use of financial regulation to reduce the risk of fresh financial shocks. A re-examination of the rôle of fiscal policy had been triggered among economists and politicians by a 2008 proposal by Britain's Gordon Brown for a coordinated fiscal stimulus to counter the expected recessionary effects of the financial crisis. The idea was dismissed as ineffective by some economists[65][66], and as inflationary by others [67], and it was rejected by Germany's Angela Merkel[68] and ridiculed by her finance minister as "crass Keynesianism"[69] Although fiscal stimulus packages were implemented during the recession of 2009, they were not sustained by European governments to support the faltering recovery in 2010, and programmes of fiscal contraction were widely introduced in 2011. The main reason that was given for that reversal of fiscal policy was the fear that operators in the bond market would lose confidence in governments' ability to service the levels of public debt that their continuation would involve. The European Union's Fiscal Compact (which places mandatory restrictions upon the use of fiscal policy by its signatories) may gain political approval, but its economic consequences are likely to remain a matter of controversy. Unlike the European governments, the United States government has not introduced a major programme of fiscal contraction, and the Congress has not been able to agree on a plan for the reduction of the government's budget deficit[70]. A controversy also remains unresolved concerning the merit of techniques known as quantitative easing by which central banks seek to increase the money supply in order to relieve credit crunches and stimulate economic activity[71][72].

The history of economic thought has taken an unexpected turn, and a new consensus on economic management has not yet emerged.

References

  1. ↑ David Hume David Hume Essays, Moral and Political, 1742, Vol 2 "Of the Balance of Trade" (published by Liberty Fund, 1985).
  2. ↑ Adam Smith, The Wealth of the Nations (Modern Library, 2000).
  3. ↑ Jean-Baptiste Say
  4. ↑ Thomas Malthus, Essay on the Principle of Population.
  5. ↑ Nicolas Wade Why Malthus Was Mistaken, New York Times, September 19, 1999
  6. ↑ David Ricardo, The Principles of Political Economy and Taxation (John Murray, 1821).
  7. ↑ Karl Marx
  8. ↑ Karl Marx, Das Kapital (abridged).
  9. ↑ John Stuart Mill, Principles of Political Economy, (Longmans Green, 1926.
  10. ↑ William Stanley Jevons, 1835-1882
  11. ↑ Carl Menger, 1841-1921
  12. ↑ Marie Esprit Léon Walras (1834-1910)
  13. ↑ Alfred Marshall Principles of Economics Macmillan 1890
  14. ↑ Léon Walras
  15. ↑ Milton Friedman: Price Theory, Transaction Publishers, 2007
  16. ↑ Vilfredo Pareto
  17. ↑ Arthur C Pigou The Economics of Welfare Macmillan 1920,
  18. ↑ William Baumol Economic Theory and Operations Analysis Chapter 13, Prentice-Hall 1961
  19. ↑ Nicholas Kaldor The Equilibrium of the Firm the Economic Journal 1934
  20. ↑ Ronald Coase: The Nature of the Firm, Economica, November 1937
  21. ↑ William Baumol Economic Theory and Operations Analysis Chapters 9 and 10, Prentice-Hall 1961
  22. ↑ Richard Cyert and James G March The Behavioral Theory of the Firm Prentice-Hall 1963
  23. ↑ Roy Harrod An essay in dynamic theory Economic Journal March 1939
  24. ↑ Robert Solow A Contribution to the Theory of Economic Growth Quarterly Journal of Economics 70 1956
  25. ↑ Paul Romer Endogenous Technological Change Journal of Political Economy October 1986
  26. ↑ Robert Lucas Jr On the Mechanics of Economic Development Journal of Monetary Economics July 1988
  27. ↑ John Hicks Mr Keynes and the Classics(Econometrica, April 1937)
  28. ↑ The University of Chicago Department of Economics
  29. ↑ Milton Friedman The Methodology of Positive Economics
  30. ↑ Friedman and Meiselman The relative stability of monetary velocity and the Investment Multiplier in the United States 1897-1958 in Stabilisation Policies, CMC Research Papers p165 Prentice-Hall 1964
  31. ↑ Harry G Johnson International Trade and Economic Growth Chapter 6 Harvard UP 1958
  32. ↑ Edmund Phelps Money wage dynamics and labor market equilibrium. Journal of Political Economy 1968
  33. ↑ John Muth "Rational Expectations and the Theory of Price Movements" Econometrica, Vol. 29, No. 3, July 961)
  34. ↑ Robert Lucas Econometric Policy Evaluation: A Critique. Carnegie-Rochester Conference Series on Public Policy 1: 19–46 1976
  35. ↑ Nick Gardner Decade of Discontent p207 Basil Blackwell 1987
  36. ↑ Charles Bean Is There a Consensus in Monetary Policy?
  37. ↑ Kenneth Kuttner and Adam Posen Do Markets Care Who Chairs the Central Bank NBER Working Paper 13101 02007
  38. ↑ Ronald Coase The Institutional Structure of Production The Nobel Prizes 1991, Nobel Foundation 1992
  39. ↑ Ronald Coase The Problem of Social Cost Journal of Law and Economics October 1960
  40. ↑ Public Choice
  41. ↑ James Buchanan and Gordon Tullock The Calculus of Consent
  42. ↑ Douglas Irwin Against the Tide: An Intellectual History of Free Trade Princeton University Press 1997
  43. ↑ Eli Heckscher and Bertil Ohlin Heckscher-Ohlin Trade Theory (Ed Harry Flam and . June Flanders) MIT Press
  44. ↑ Ha-Joon Chang Kicking Away the Ladder
  45. ↑ Bhagwati and Ramaswami. Domestic Distortions, Tariffs and the Theory of Optimum Subsidy - Some Further Results Journal of Political Economy, 1969, vol. 77, issue 6, pages 1005-10' (1963)
  46. ↑ Joseph Stiglitz website
  47. ↑ Interview with Joseph Stiglitz
  48. ↑ Joseph Stiglitz Globalization and its Discontents" Norton 2002
  49. ↑ Dani Rodrik's website
  50. ↑ Dani Rodrik Has Globalization Gone Too Far?. Institute for International Economics 1997.
  51. ↑ Jean-Michel Courtault, Yuri Kabarov And Bernard Bru: "Louis Bachelier and the Centenary of the Theorie de la Speculation", Mathematical Finance Vol10 No3 July 2000
  52. ↑ Alfred Cowles
  53. ↑ James Tobin
  54. ↑ William Sharpe
  55. ↑ Fischer Black
  56. ↑ Myron Scholes
  57. ↑ Robert Merton
  58. ↑ Franco Modigliani
  59. ↑ Merton Miller
  60. ↑ Alan Greenspan: The Challenge of Central Banking in a Democratic Society, (lecture to The American Enterprise Institute for Public Policy Research, December 5, 1996, Federal Reserve Board 1996
  61. ↑ Robert E. Lucas, Jr: Presidential Address to the American Economic Association, January 10, 2003
  62. ↑ Testimony of Dr. Alan Greenspan before the Committee of Government Oversight and Reform October 23, 2008
  63. ↑ for example by Professor Shin of Princeton University Hyun Song Shin: Interview with Ramesh Vatilingam, 4 September 2009
  64. ↑ Hyun Song Shin: Interview with Ramesh Vatilingam, 4 September 2009
  65. ↑ Eugene Fama: Bailouts and Stimulus Plans January 2009
  66. ↑ Keynesian over-spending won't rescue the economy, Letter by IEA economists in the Sunday Telegraph, 26 October 2008
  67. ↑ Allan Meltzer: Inflation Nation, New York Times op-ed, 3rd May 2009
  68. ↑ Catherine Mayer: Behind a Merkel Snub, Euro Economic Discord, Time, 9 December 2008
  69. ↑ Tristana Moore: Steinbrueck 'shouldn't scare UK'BBC News 12 December 2008
  70. ↑ Joint Select Committee on Deficit Reduction (Deficit "Super Committee"), New York Times, 22 March, 2012
  71. ↑ Lori Ann LaRocco: CEOs Debate the Merits of QE2, CNBC News, 21 Oct 2010
  72. ↑ Open Letter to Ben Bernanke, 15 November 2010
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