Classical economics is the economic school of thinking that emerged in the late 18th and early 19th centuries.
Who is the father of classical economics?
The Classical school of economics originated in 1776 with the publication of Adam Smith’s (1723-1790) “The Wealth of Nations.” Contemporaries including David Ricardo (1772-1823), Jean Baptise Say (1767-1832), and Robert Malthus (1766-1834) expanded on Smith’s views. Adam Smith and his following contributions are collectively known as the “Classical School” of economics. This school of thought developed in the late eighteenth century and ruled until the first half of the nineteenth century. The classical school was known as the “Classical School of Political Economy” at the time.
Some argue that classical school as a result of the Mercantilists and Physiocrats’ thoughts prevailed from the sixteenth to the first half of the eighteenth century. And Adam Smith collected and organized these ideas and started to look at them in a systematic manner.
What did Classical economics teach?
The proponents of the Classical school did not develop any clear macroeconomic theory or model, but nevertheless, their ideas were in the form of hypotheses. They mainly focused on economic growth, output, and employment, and these ideas were influenced by the industrial revolution and the capitalist transformation in Europe. Classical economists viewed economics as a multi-disciplinary matter, and they did their analysis of economics by taking historical, social, and institutional dimensions into consideration. However, these ideas are considered as the beginning of the formal economic study. There are several important conclusions from the classical school.
One of the most used terms in classical economics school is Adam Smith’s idea of the “invisible hand”. According to this idea, individual economic agents act in their own self-interest and rational manner. And they are continuously aiming to maximize their self-interests, and competitive markets ensure that their actions collectively generate a socially optimal outcome. This is possible due to perfectly competitive markets where producers produce goods and services at minimum possible costs to maximize their profits.
Flexible prices and markets
Under the classical assumptions, prices and markets are flexible. Flexibility means that prices and wages can adjust quickly and efficiently to eliminate shortages or surpluses. Therefore, when the economy is in a disequilibrium position, prices increase or decrease accordingly, restoring the economy back to equilibrium. As a result, any imbalance in the economy is a short-run phenomenon.
Say’s law (attributed to Jean-Baptiste Say) is considered as one of the cornerstones of classical economic thought. This law is most commonly summarized by the phrase “supply creates its own demand.” Simply put, that means total output determines aggregate demand. Production of goods and services (supply) generates income equivalent to the value of its output and then this income is used for the purchase (demand) of goods and services. To illustrate, consider two sector-economy where only firms and households exist. Firms produce goods and services and households supply factors of production (land, labor, capital, and entrepreneurship) to be used in the production process. Households receive factor income and use it to buy goods and services. Hence, production generates income, and then income creates demand.
In this kind of economy, there can not be overproduction or underproduction because households spend their entire income on buying goods and services. So, the entire output is sold. Hence, demand is equal to the supply at the aggregate level. Consequently, the economy will always be in a state of equilibrium in the long run. Therefore, markets are incapable of naturally generating a recession. Even if there is a recession, that is due to an exogenous incident.
Economy operates at full employment in the long run
In addition, Classical economists believe that in the long run economy will always be in a full-employment position. That means all available resources are fully employed and no involuntary unemployment exists. However, voluntary unemployment or frictional unemployment can occur. The classical labor supply curve is vertical at full employment. However, involuntary unemployment is possible in the short run. It occurs when the quantity of labor supplied exceeds the quantity of labor demanded at the existing wage rate. In this kind of situation, wages will fall and unemployed workers will start to work at lower wage rates and the surplus will eliminate. Hence, involuntary unemployment is only a short-run phenomenon. However, this is possible only under the flexible prices and wages assumption.
Savings – investment equality
People do not consume all their income and they save part of it. Classical economists stress that any saving is replaced by an equal amount of investment because saving is solely utilized for investment purposes. Hence, savings and investment are equal and are interchangeable concepts. Moreover, the interest rate depends on the supply of savings and demand for investments.
Laissez – Faire policy
Classical school advocates the Laissez-faire policy or else minimum government intervention to the market and strongly rejects the protectionism or regulations by the government. This was in opposition to the mercantilist policies which were dominated at that time. The classical school argues that due to the flexible prices and invisible hand market forces can adjust automatically, so whenever there is a deviation from equilibrium, the economy automatically moves back to the equilibrium, so no need for government intervention.
Classical economics vs Keynesian
Classical economic theories often contracted with Neoclassical and Keynesian economics views. To know more about these differences, read our articles about Neoclassical economics school and Keynesian economics school.