Key Economic Ideologies

Why This Matters

Economic ideologies aren't just abstract theories—they're the intellectual frameworks that have shaped real-world policies, revolutions, and the global economy you live in today. When you're tested on the history of economic ideas, you're being asked to understand why different thinkers responded to the economic problems of their era and how their solutions reflect fundamentally different assumptions about human nature, markets, and the role of government. Think of each ideology as an answer to core questions: Who should control production? Can markets self-correct? What drives economic growth?

The exam will test your ability to connect ideologies to their historical contexts, compare their core assumptions, and trace their influence on later economic thought. You'll need to recognize how Classical Economics set the stage for both Neoclassical refinements and Marxist critiques, how Keynesianism emerged from the failures of classical assumptions during the Depression, and how Monetarism and Supply-side Economics pushed back against Keynesian dominance. Don't just memorize names and dates—know what fundamental problem each ideology was trying to solve and what mechanisms it proposed.

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Market-Centered Ideologies: Trust the System

These ideologies share a foundational belief that markets, when left relatively free, produce efficient outcomes. The core mechanism is price signals coordinating decentralized decisions without central planning.

Classical Economics

• Adam Smith's "invisible hand"—the metaphor that self-interested individuals unintentionally promote societal good through market exchange
• Labor theory of value held that a good's worth derives from the labor required to produce it—later adopted and transformed by Marx
• Comparative advantage (Ricardo) explains why nations benefit from trade even when one is more efficient at producing everything

Neoclassical Economics

• Marginalism replaced the labor theory of value with subjective utility—value depends on the satisfaction gained from one additional unit
• Rational actors assumption holds that individuals and firms maximize utility and profit, leading to market equilibrium
• Supply and demand curves became the central analytical tool, with prices adjusting until markets clear—a direct challenge to Keynesian disequilibrium

Austrian School

• Subjective value theory (Menger) emphasizes that value exists only in individual minds, not in objects themselves
• Spontaneous order describes how complex economic coordination emerges without central planning—Hayek's key contribution
• Critique of mathematical modeling—Austrians argue that economics involves too much uncertainty and human complexity for formal equations

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Critiques of Capitalism: Systemic Problems

These ideologies identify fundamental flaws in capitalist systems that cannot be resolved through market mechanisms alone. The core insight is that capitalism contains internal contradictions or power imbalances.

Marxism

• Class conflict between the bourgeoisie (owners of production) and proletariat (workers) drives historical change
• Exploitation occurs because workers produce more value than they receive in wages—surplus value is extracted as profit
• Historical materialism argues that economic systems (modes of production) determine social structures, politics, and ideas—not the reverse

Institutional Economics

• Institutions—the rules, norms, and organizations structuring society—shape economic outcomes more than individual choices
• Evolutionary approach views economies as constantly changing systems, not equilibrium-seeking machines
• Critique of abstraction—traditional economics ignores how property rights, legal systems, and cultural norms actually determine who wins and loses

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Demand-Side Management: Government as Stabilizer

These approaches argue that aggregate demand—total spending in the economy—is the key variable governments must manage. The mechanism is using fiscal or monetary policy to smooth economic cycles.

Keynesianism

• Aggregate demand drives output and employment—when demand falls, economies can get stuck in prolonged recessions
• Markets don't always clear—wages and prices can be "sticky," leaving economies in disequilibrium with persistent unemployment
• Fiscal policy (government spending and taxation) is the primary tool for stimulating demand during downturns—born from the Great Depression's failures

Behavioral Economics

• Cognitive biases like loss aversion, overconfidence, and anchoring cause systematic deviations from rational decision-making
• Nudges are policy interventions that steer choices without restricting options—redesigning default settings, for example
• Market inefficiencies result from predictable irrationality, justifying targeted government interventions to improve outcomes

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Supply-Side and Monetary Approaches: Counter-Revolution

These ideologies emerged as critiques of Keynesian demand management, arguing that long-run growth depends on production incentives and monetary stability. The core mechanism shifts focus from spending to investment, entrepreneurship, and controlling inflation.

Monetarism

• Money supply is the primary determinant of nominal GDP and inflation—Friedman's famous claim: "Inflation is always and everywhere a monetary phenomenon"
• Long-run neutrality of money means monetary expansion affects only prices, not real output, over time—challenging Keynesian stimulus
• Rules over discretion—Friedman advocated steady, predictable money supply growth rather than activist central bank policy

Supply-side Economics

• Tax cuts on income and capital gains incentivize work, saving, and investment—boosting the economy's productive capacity
• Laffer Curve illustrates that beyond a certain point, higher tax rates reduce revenue by discouraging economic activity
• Deregulation removes barriers to entrepreneurship and capital formation—associated with Reagan-era policies

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Institutional Analysis: Rules of the Game

These approaches emphasize that economic outcomes depend critically on the formal and informal rules structuring human interaction. The mechanism is transaction costs—the frictions that make exchange difficult without proper institutions.

Institutional Economics

• Thorstein Veblen and early institutionalists rejected abstract equilibrium models in favor of studying real economic organizations and habits
• Path dependence explains how historical choices constrain future options—institutions create lock-in effects
• Holistic analysis integrates economics with sociology, history, and political science rather than treating the economy in isolation

New Institutional Economics

• Transaction costs (Coase, Williamson) explain why firms exist—some exchanges are cheaper to coordinate internally than through markets
• Property rights clarity determines investment incentives and economic development—weak rights discourage long-term planning
• Formal modeling distinguishes NIE from older institutionalism—it uses game theory and econometrics while keeping institutions central

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Quick Reference Table

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Self-Check Questions

1. Which two ideologies both emerged as direct critiques of Keynesianism, and how do their proposed solutions differ?

2. Compare and contrast how Marxism and Institutional Economics analyze power imbalances in capitalist systems—what does each identify as the primary source of economic inequality?

3. If an FRQ asks you to explain why the Great Depression challenged Classical Economics, which ideology's core assumptions would you need to contrast with Keynesian insights?

4. Both Neoclassical Economics and the Austrian School favor free markets, yet they disagree fundamentally on methodology. What is this methodological difference, and why does it matter?

5. How would a Behavioral Economist critique the "rational actor" assumption central to Neoclassical Economics? Identify one specific cognitive bias and explain how it leads to market inefficiency.