Economic Thought (DP IB Economics): Revision Note

Introduction to Economic Thought

• Understanding the evolution of economic thought over the past 400 years, helps us to understand the strengths and weaknesses of economic policies we use today

• Each period of economic revolution was created as a result of challenges societies were facing at the time e.g. classical economics was the solution to centuries of mercantilism while Marxism was the solution to capitalism and worker exploitation

• There is a strong debate around whether societies should create a new economics fit for the 21st century challenges

A summary of the economic schools of thought from the 18th century

Economic Ideas from the 18th Century

• Adam Smith published his famous book on Economics in 1776: The Wealth of Nations

  • He is widely regarded as the father of Classical Economics
     

• Written at the start of The Industrial Revolution, it captured his thoughts on how markets could be coordinated by demand and supply

  • This book was a natural response to the previous century of government intervention in markets in Europe during a period known as mercantilism

 
Key ideas from Adam Smith in the 18th Century

Economic Ideas from the 19th Century

• During the 19th century, several key ideas emerged including classical microeconomics (utility); the concept of the margin; classical macroeconomics (Say’s law)

• During this period Karl Marx also developed his critique of classical economic thought 
   

Key ideas from the 19th Century

Karl Marx's Critique of Classical Economic Thought

• Free markets generated incredible wealth in the Western World

• Karl Marx, a German philosopher, identified that wealth seemed to come from worker exploitation (a natural function of profit maximisation) and that inequality was deepening in societies

  • The exploitation was seen in low wages and poor working conditions 

  • The owners of the factors of production (capitalists) generated the highest income (wages, interest, rent and profit)

  • If all someone had to offer was labour, and wages were suppressed: then inequality was bound to increase
     

• Marx argued that capitalism would eventually lead workers to revolt and that periods of exploitation would be followed by revolutions

  • These revolutions would require government intervention to restore stability and equality

  • Governments would need to be involved in the allocation of resources (command economy) to prevent the pattern from repeating
     

• Marx's ideas were incredibly influential and within a relatively short time frame resulted in more than a third of the world's population living in economies influenced by his ideas

Economic Ideas from the 20th Century

• The first half of the 20th Century was dominated by the two World Wars and the Great Depression

• The economic ideas of the previous century no longer worked

• In this severe recession, Say's Law became obsolete as households were unable to buy goods/services due to a complete lack of income

• John Maynard Keynes, a British economist from Cambridge felt new ideas were needed

• His ideas were quickly embraced and the next 50 years saw a widespread Keynesian revolution as governments adopted Keynesian economics
   

Key ideas from Keynes in the 20th Century

The Monetarist/New Classical Counter Revolution 

• Monetarism is an economic school of thought which emphasises the use of Monetary Policy to influence an economy

  • Monetarists believe that poor monetary policy lead to the Great Depression

  • Monetarists believe that the use of fiscal policy leads to inflation as government spending increases aggregate demand
     

• Milton Friedman was one of the leading Monetarists of the late 20th Century

  • His ideas influenced Ronald Reagan in the USA and Margaret Thatcher in the United Kingdom

  • Both Governments moved away from Keynesian economics
     

• From the early 1980s there was a resurgence in the belief in classical economics and laissez-faire markets

  • Government spending reduced and the focus shifted to Supply-Side Policies

  • One prominent Supply-Side Policy that the USA and the UK embraced was the use of privatisation

Economic Ideas from the 21st Century

• The early part of the 21st Century has seen several significant global challenges emerge

  • Climate change

  • On-going wars and displacement of populations

  • An increase of global population in the last 100 years by 7 billion people

  • The Global Financial Crisis of 2008

  • The Covid Recession of 2020
     

• Keynesian economic thought came to prominence again with the 2008 Financial Crisis as governments chose to spend their way out of trouble

  • Government spending increased to levels never seen before, continuing for more than a decade

  • This increased spending was financed by increased government borrowing

  • Increased Government borrowing creates increased tax burdens for future generations
     

• Even with Government spending extraordinarily high in many economies, expansionary Monetary Policy had to be widely used to bring stability
   

• This pattern of events prompted calls for societies to rethink Economics

  • It called for an economic philosophy to emerge that is no longer rooted in 'old thinking'

  • It called for ideas fit for a 21st Century world
     

21st Century Ideas