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ECO 214: HISTORY OF ECONOMIC THOUGHT

CLASSICAL SCHOOL I

Winford Masanjala

Presentation Outline

1. General Classical Thinking

2. Main Ideas of Classical School

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General Classical Thinking

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CLASSICAL ECONOMICS (CLASSICALIST)

 Classical economics developed in the 18th and 19th centuries

 It included a value theory and distribution theory.

 The value of a product was thought to depend on the costs involved in

producing that product.
 The explanation of costs in Classical economics was simultaneously an
explanation of distribution.
A landlord received rent, workers received wages, and a capitalist tenant
farmer received profits on their investment.

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Evolution of Classical Economics

Initial Steps
 The fundamental principle of the classical theory is that the
economy is self‐regulating.
 Classical economists maintain that the economy is always capable
of achieving the natural level of real GDP or output,
 The Natural level of GDP is the level of real GDP that is
obtained when the economy's resources are fully employed.

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Evolution of Classical Economics

Step 2: Introduction of utility as an objective

 Overtime, some economists gradually began emphasizing the
perceived value of a good to the consumer.
 They proposed a theory that the value of a product was to be
explained with differences in utility (usefulness) to the consumer.
 Classical economists tended to conceptualize utility in keeping with
the Utilitarian School of Jeremy Bentham and John Stuart Mill.

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Evolution of Classical Economics

Step 3: Inclusion of Marginalism

 Marginalism: the proposition that economic actors make decisions
based on margins.
 The marginalists claim that agents weigh how marginal benefit
compares with marginal cost
 This differs from the aggregate decision making of classical political
economy.

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Main Ideas of Classical School

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1. The Economy is subject to laws

Classicals argued that the economy obeys its own laws—laws that can be
researched, understood, and used to improve the conditions of life
Some of the initial political economists were from natural sciences they
saw their new science as quantitative and empirical
 William Petty in Political Arithmetick , adopted the perspective of a
physician who wished “to express my self in Terms of Number, Weight,
or Measure;
 The surgeon, Francois Quesnay, argued that economics “must make use
of mathematics and statistics.”
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2. Existence of Social Division of Labour

Classicalists saw society as stratified in social classes, whose members

perform different roles in the economic process
They viewed the economy as characterized by
a growing division of labor
 private ownership of natural resources and the means of production
 activities
of its numerous economic agents being coordinated via
interconnected markets;
 exchange of goods and services facilitated by money as a means of
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2. Existence of Social Division of Labour

 Landlords who drew rent for leasing their land;

 “they love to reap where they never sowed.” - Adam Smith in The Wealth of Nations,
 Workers who owned almost nothing apart from their labor power.
 They had to find employment at high enough wages to support their families.
 Spent their wages on food, clothes, and housing – had little to no savings at all
 Capitalists or “masters” or “entrepreneurs” were society’s aspiring class.
 They had money, commercial capital and means of production at their disposal
 Their income was profit and interest in the case of money capital.
 Capital owners were able to save and to invest
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3. The Economy is self-regulating

 Classical economists repudiated the Hobbesian conviction that if the system were
left to itself it would inevitably sink into civil war.
In Leviathan (1651), Thomas Hobbes had argued as follows
 In the state of nature man has a natural right to everything

 in light of his unbridled desires man become a rapacious wolf: homo homini lupus est.
 The state of nature leads to a war of all against all (bellum omnium contra omnes).

 Leviathan - the absolutist state furnished with absolute power, ends the state of
nature and brings about a condition of social equilibrium by keeping the “children
of pride” in check.
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3. The Economy is self-regulating

 Classical Claim: A society in which economic activity is coordinated via interdependent

markets based on free trade is a self-regulating, homeostatic system.
 i.e. the system has natural tendency to revert to equilibrium
 A market economy not only works better but can be expected to out-perform a
centrally planned/command economy or an economy with substantial government
interference
 Market system facilitates a faster increase in the wealth than all other economic
orders, because it stimulates hard work, business acumen, and inventiveness.
 Classicals recommended liberalism: Laissez faire, laissez passer, le monde va de lui-meme (Let
it be, let it alone, the world goes on by itself )
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4. Individual Action has unintended consequences

 Humans are not isolated individuals like Robinson Crusoe on his island.

 Self-regarding actions of individuals typically lead to consequences neither

intended nor planned nor foreseeable by the individual.
 “History is the result of human action, but not the execution of any human design.”
Adam Ferguson (1723–1816)
 A classical goal was to figure out
 Which actions had not just private but socially beneficial results
 which actions, while privately beneficial, were socially harmful
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5. Labour is the main source of riches

 Classicals repudiated the mercantilist position on sources of wealth

 The main source of a large and growing wealth of most nations was neither
the colonization of other countries and exploitation of their resources nor
favorable overseas trade.
 The main lever of national riches is labor - the skills, dexterity, and
ingeniousness of the population
 increases in labor productivity are due to deepening social divisions of labor
The wealth of a nation is expressed in terms of the size of its social net product
per capita
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5. Labour is the main source of riches

 The classical authors no longer measured wealth in terms of a given

stock of gold and silver in the king’s coffers at a given moment of time
but in terms of the net flow of commodities produced during a year.
 Quesnay called it the “produit net,”
 Adam Smith and David Ricardo called it “surplus product” or “neat
produce.”
 Correspondingly, the wealth of a nation is expressed in terms of the size
of its social net product per capita
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5. Labour as source of wealth

 Classicals claimed that prices reflect the difficulty of producing the

various commodities.
 Therefore, the amount of labor needed to produce a product, both
directly and indirectly (in producing intermediate products) was
considered a good measure of this difficulty.
 Most classical economists advocated some sort of labor theory of
value
 The total amount of labor “embodied” in a commodity was the key to
its value or price
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6. Competition is driver of progress

 Classicals attributed importance to competition as a force that renders

order and coherence to the economic system and fosters industry and
technical progress
 Market-based economic coordination in competitive conditions leads to
prices determined by cost of production;
 At the heart of classical economics, therefore, was an explanation of
market-mediated coordination, price formation, and the resultant income
distribution.

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6. Competition as a Driver of Progress

 Free competition, works like an “invisible hand,” and takes the place of
the visible hand of the state.
 As a social institution, free competition would reward and punish without
requiring a Leviathan.

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7. There is tendency towards uniform rate of profit

In a freely competitive environment

 There is a tendency toward a uniform rate of profits resulting from
the profit-seeking behavior of capital owners
 Owners of factors of production are also in search of their
resources most advantageous employments
 Therefore there is also a tendency toward uniform rates of
remuneration for the services of various qualities of land and labor

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7. There is tendency towards uniform rate of profit

In a freely competitive environment

 If there is a shortage of supply of a good in a market, competition
among demanders forces up the market price.
 This increases profit margins, attracting capital and labor from other
branches, leading to an increase in the output and supply of the good
under consideration.
 High supply, in turn, causes the market price to fall again and so too
profit margins
 The converse would apply in the case of an excess supply of a good.
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7. There is tendency towards uniform rate of profit

Conclusion
 The restless search of capital owners for the highest possible profits per
unit of capital invested; and
 The restless search of workers for the highest possible wages

 leads to a general rate of profits or rate of return on capital that tends to

be uniform across all branches of the economy and to equal wages for
equal work.

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8. Market prices gravitate toward their natural rate

 Classical distinguished between natural prices and markets prices

 “natural” or “production” prices reflect systematic and permanent forces at

work (i.e. economic fundamentals)
 “market” prices reflected a multitude of incidental and temporary factors (e.g.,
the weather) on top of that.
 Competition causes market prices to gravitate toward or oscillate around
production (natural) prices, so the former never stray too far from the latter.
 This reflect the general rate of profits and uniform wage rates and rent rates
of the different kinds of work and qualities of land.
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