Classical Economics

Definition

Classical economics is a school of thought that emerged in the late 18th and early 19th centuries, emphasizing free markets, the self-regulating nature of economies, and the idea that supply creates its own demand. This perspective is critical for understanding how economies operate over time, particularly regarding production, labor, and the long-term growth of national income.

5 Must Know Facts For Your Next Test

1. Classical economists believe that markets are efficient and that prices will adjust to reflect supply and demand.
2. The focus on long-term growth leads classical economists to emphasize the importance of savings and investment in driving economic expansion.
3. Labor market flexibility is crucial in classical economics, as it is believed that wages adjust to ensure full employment over time.
4. Classical economics advocates for limited government intervention, arguing that it can disrupt the natural balance of supply and demand.
5. Prominent figures in classical economics include Adam Smith, David Ricardo, and John Stuart Mill, each contributing significantly to economic theory.

Review Questions

• How does the concept of Say's Law connect to the views classical economists have on production and employment?
  • Say's Law posits that supply creates its own demand, which aligns with classical economists' belief that production is inherently linked to economic growth. This view suggests that as businesses produce goods, they also generate income for workers, enabling them to purchase those goods. Consequently, classical economists argue that an economy naturally tends toward full employment as long as markets operate freely without government interference.
• Discuss the implications of classical economics on government fiscal policy and its approach to budget deficits.
  • Classical economics advocates for minimal government intervention in the economy, which extends to fiscal policy. Classical economists argue that budget deficits can disrupt market equilibrium and lead to inefficiencies. They typically support balanced budgets over time, believing that excessive borrowing by governments can crowd out private investment and hinder economic growth by reducing available capital for businesses.
• Evaluate how classical economics contrasts with Keynesian economics regarding aggregate demand and government intervention during economic downturns.
  • Classical economics asserts that economies are self-regulating and capable of achieving full employment without government intervention, based on the belief that any decrease in aggregate demand will naturally be countered by price adjustments. In contrast, Keynesian economics argues that insufficient aggregate demand can lead to prolonged periods of unemployment and economic stagnation. Keynesians advocate for active government intervention through fiscal policies to stimulate demand during downturns, demonstrating a fundamental divergence in approaches to economic management.

Related terms

Invisible Hand: A concept introduced by Adam Smith, suggesting that individuals pursuing their own self-interest inadvertently contribute to the overall economic well-being of society.

Say's Law:

A principle stating that supply creates its own demand, implying that production will always generate enough income to purchase the goods produced.

Long-Run Aggregate Supply (LRAS):

The total supply of goods and services that an economy can produce when both labor and capital are fully employed, representing potential output at full capacity.