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Understanding the Three Main Schools of Economic Thought
Dive into Classical, Keynesian, and Monetarist economic theories. Explore their unique perspectives on free markets, government intervention, and money supply. Gain insights into modern economic policies and debates.

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Intros
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  1. The 3 School of Thoughts
    • Classical School of Thought
    • Keynesian School of Thought
    • Monetarist School of Thought
  2. Classical School of Thought
    • Self-regulated economy
    • Goes back to Full Employment
    • Money Wage is flexible
    • Little to no government intervention
Aggregate supply
Jump to:NotesConceptFAQsPrerequisites
Notes

The 3 School of Thoughts

Macroeconomists have different views about how the market operates.

School of Thought: a particular idea or way of thinking that a group strongly believes in, and takes it into their practices.

We are going to investigate three different macroeconomic school of thoughts and see how each macroeconomist views them.

The three school of thoughts are:
  1. Classical School of Thought
  2. Keynesian School of Thought
  3. Monetarist School of Thought


Classical School of Thought

The word “classical” comes from a group of economists who produced this theory, whose names were Adam Smith, John Stuart Mill, and David Ricardo.

For the classical school of thought, the idea is that the economy will always goes back to full employment (real GDP = potential GDP) because of an automatic self-regulated mechanism.

In other words, we always have

School of Thought


But if real GDP = potential GDP, then why does real GDP fluctuate around potential GDP, creating this business cycle, rather than being equal to it all the time?

It is due to disturbances from an uneven pace in technological advances.

In fact, technological changes play a big role in the aggregate demand and aggregate supply.

Aggregate Demand: The following types of technological changes can shift aggregate demand.

  1. Productivity of capital: when productivity increases, firms increase their expenditures on equipment and tools, so increases aggregate demand.

  2. Lengthening lifespan of capital: when equipment or tools last longer, there is a low demand for new capital. Therefore, this decreases aggregate demand.


Short-run Aggregate Supply: The short-run aggregate supply is very flexible. Whether the money wage rate is too low or too high, it will eventually adjust back to equilibrium so that real GDP = potential GDP.

School of Thought


Long-Run Aggregate Supply: This supply curve can change depending on what happens to potential GDP, which is also influenced by technological change.

Technological change can grow at a rapid or slow pace.

  1. Rapid Pace: a rapid pace of technological change increases potential GDP quickly, causing real GDP to also increase.

  2. Slow Pace: a slow pace of technological change slows the growth rate of potential GDP, causing real GDP to increase slowly as well.

Policy: The policy for the classical school of thought says that the market works mostly efficiently when it is left alone with little to no government intervention. Therefore, we need to minimize the effects of taxes, employment, investments, and make sure that technological changes are at an efficient level.

This lets the economy to grow at a rapid pace.

Keynesian School of Thought

The word “Keynesian” comes from a macroeconomist named John Maynard Keynes.

He believes that if the economy were to be left alone, then the economy would rarely be at full employment. There needs to be active fiscal and monetary policy keep it at full employment.

In this school of thought, future expectations impact aggregate demand.

Aggregate Demand: depending on future expectations, it can increase or decrease aggregate demand

  1. When there are future expectations of high profit, people/firms tend to spend more today, causing an increase in aggregate demand

  2. When there are future expectations of low profit, people/firms tend to spend less today, causing a decrease in aggregate demand and causes a recession.


Short-Run Aggregate Supply: Money wage rate is very sticky in the short-run, causing aggregate supply curve to be really flat or even horizontal.

School of Thought


Due to it being horizontal, the money wage rate does not fall.

Normally in a recession, the economy would shift the upward sloping supply curve to the right so that there is no recessionary gap.

School of Thought


However, we cannot shift the supply curve right with a horizontal line. So, the recessionary gap remains, and we stay in recession until the government intervenes to change the aggregate demand.

School of Thought


Policy: the policy for Keynesian school of thought says that the government needs to use monetary or fiscal policies to actively offset changes in the aggregate demand that causes recession.

Monetarist School of Thought

The word “monetarist” comes from economists named Karl Brunner and Milton Friedman.

From the monetarist school of thought, they believe that the economy goes back to full employment (real GDP = potential GDP) from an automatic self-regulated system. However, this is only applicable if the monetary policy is consistent, and the growth of money is steady.

The quantity of money plays a big role in aggregate supply.

Aggregate Demand: Depending on the quantity of money, aggregate demand can shift.

  1. If the quantity of money grows at a rapid pace, then the aggregate demand increases.

  2. If the quantity of money grows at a steady pace, then aggregate demand fluctuations are minimized.

  3. If the quantity of money is decreased or grows at a slow pace, the aggregate demand decreases, and the economy goes to recession.


Short-run Aggregate Supply: the idea for the short-run aggregate supply works the same as the Keynesian school of thought.

Money wage rate is very sticky, so if a recession happens, then it will take a long time to reach full employment without the help of the government.

Policy: the policy is the same as the classical school of thought. As long as the quantity of money is steady, and there is little to no government intervention (taxes, etc.), then the economy will grow at a steady pace.
Concept

Introduction to Schools of Economic Thought

Welcome to our exploration of the three main schools of economic thought! As your friendly math tutor, I'm excited to guide you through this fascinating topic. Let's start with the introduction video, which is crucial for grasping these concepts. Now, let's dive into the three primary schools of thought that macroeconomists often discuss. First, we have the Classical school, which emphasizes free markets and minimal government intervention. Next, there's the Keynesian school, which advocates for active government involvement to stabilize the economy. Lastly, we'll explore the Monetarist school, focusing on the importance of money supply in economic stability. Each of these economic theories offers unique perspectives on how economies function and how to address economic challenges. Understanding these schools of thought is essential for anyone interested in economics, as they form the foundation for many modern economic policies and debates. So, let's embark on this journey together and unravel the complexities of these influential economic theories!

FAQs

  1. What are the main differences between Classical, Keynesian, and Monetarist schools of thought?

    The Classical school emphasizes free markets and minimal government intervention, believing in self-regulating markets. The Keynesian school advocates for active government involvement to stabilize the economy, especially during downturns. The Monetarist school focuses on the importance of money supply in economic stability, arguing for controlled monetary growth to manage inflation and promote economic stability.

  2. How do these schools of thought approach unemployment?

    Classical economists believe unemployment is temporary and will resolve through wage adjustments. Keynesians view unemployment as a serious issue requiring government intervention through fiscal policies. Monetarists focus on maintaining stable monetary growth to support long-term employment, believing that short-term interventions can be counterproductive.

  3. What role does government play in each school of thought?

    In Classical economics, government should have minimal involvement. Keynesian economics advocates for active government intervention through fiscal and monetary policies. Monetarists prefer limited government involvement, primarily focused on controlling the money supply through central bank policies.

  4. How do these schools view inflation?

    Classical economists see inflation as a result of changes in the money supply relative to output. Keynesians view inflation as potentially caused by excessive demand or cost pressures. Monetarists consider inflation primarily a monetary phenomenon, directly linked to excessive growth in the money supply.

  5. Which school of thought is most relevant in modern economics?

    Modern economics incorporates elements from all three schools. New Keynesian and New Classical models have evolved, integrating insights from each perspective. The relevance of each school depends on the specific economic situation and challenges. Current economic policy often blends aspects of all three, adapting to complex global economic conditions.

Prerequisites

Understanding the foundations of economic thought is crucial when delving into the concept of "School of thought" in economics. One of the key prerequisite topics that plays a significant role in this understanding is the theory of comparative advantage. This fundamental principle, developed by David Ricardo in the early 19th century, forms the bedrock of many economic schools of thought and continues to influence modern economic theories and policies.

The concept of comparative advantage is essential to grasp before exploring various schools of economic thought because it provides insights into how nations, firms, and individuals can benefit from specialization and trade. This theory explains why countries engage in international trade even when one country can produce all goods more efficiently than another. By understanding comparative advantage theory, students can better comprehend the arguments and perspectives of different economic schools of thought regarding trade policies, economic growth, and resource allocation.

Many schools of economic thought, from classical and neoclassical economics to more modern approaches, incorporate or respond to the principles of comparative advantage in their frameworks. For instance, the Austrian School of economics builds upon this concept to advocate for free markets and minimal government intervention. In contrast, other schools might use comparative advantage as a starting point to argue for strategic trade policies or to analyze the complexities of global economic relationships.

Furthermore, the theory of comparative advantage serves as a foundation for understanding more advanced economic concepts that are central to various schools of thought. These include opportunity cost, production possibilities frontiers, and the gains from trade. By mastering this prerequisite topic, students will be better equipped to critically analyze and compare different economic ideologies and their policy implications.

As students explore different schools of economic thought, they will encounter debates and discussions that often circle back to the principles of comparative advantage. Whether examining the merits of free trade agreements, analyzing the effects of globalization, or considering the role of government in the economy, a solid understanding of this theory is invaluable. It provides a common language and framework for evaluating the strengths and weaknesses of various economic perspectives.

In conclusion, the theory of comparative advantage is a crucial prerequisite for studying schools of economic thought. It not only lays the groundwork for understanding complex economic relationships but also helps students appreciate the nuances and debates within the field of economics. By mastering this fundamental concept, students will be better prepared to engage with and critically evaluate the diverse range of economic theories and their real-world applications.