Before you read on: how did classical economists expect a glut of unsold goods to end?
Classical economists expected free markets to adjust on their own, and Jean-Baptiste Say held that a general glut could not last.
- Began
- In Britain in the late 18th century; Adam Smith's The Wealth of Nations (1776) set out many of its core principles
- Key figures
- Adam Smith, David Ricardo, Thomas Malthus and John Stuart Mill; they debated the law of markets of Jean-Baptiste Say
- Where it dominated
- Economic thinking in Great Britain, until about 1870
- Main rivals
- Marxism, which grew out of classical value theory; the marginalist, later neoclassical, economists from the 1870s; Keynesian economics from the 1930s
What it was reacting to
Classical economics grew up as a reply to mercantilism, which had shaped British policy since the 16th century. Mercantilists held that gold and silver are central to a nation's wealth, and that a nation grows rich by selling more abroad than it buys. Governments backed this with limits on imports and monopolies for favoured companies.
Adam Smith attacked mercantilism in The Wealth of Nations (1776). He and the economists who followed asked how markets set prices, how a nation's output is shared between classes, and what makes an economy grow.
The key ideas
Can you name the four key ideas of classical economics?
Classical economists held that the whole community gains most when each person follows their own interest under competition. They backed laissez-faire, the policy of leaving trade and industry largely free of state control.
Can you think of an example?
No official decides how much bread a city needs. Bakers bake to earn a living. In Smith's view, competition for customers keeps quality up and prices down.
Jean-Baptiste Say held that supply creates its own demand, because making goods earns the income to buy other goods. Some markets can be overstocked for a while, yet a general glut of everything cannot last.
Can you think of an example?
A farmer who grows more wheat earns more, and spends that income on tools and clothes. In Say's view, the extra wheat creates demand for other goods.
Smith argued that a nation, like a household, should buy from whoever makes goods most cheaply. Ricardo added comparative advantage: a country gains by specialising where its relative cost is lowest, even if it is better at making everything.
Can you think of an example?
Ricardo's Portugal could make both wine and cloth with less labour than England. Both countries still gained when Portugal made wine and England made cloth.
Classical economists, Ricardo above all, held that under competition prices tend to follow the labour needed to make goods.
Can you think of an example?
On this theory, if a coat takes twice as much labour to make as a hat, over time it tends to sell for about twice as much.
Check yourself
A change in fashion leaves workshops with far more hats than buyers want, while coats are in short supply. What would a classical economist expect next?
Where it shaped policy
In 19th-century Britain, classical economics gave strong support to laissez-faire. John Stuart Mill's Principles of Political Economy (1848) weighed the arguments for and against state action, and put the burden of proof on those who wanted the state to step in. He also set out large exceptions, such as the education of every child.
On money, David Ricardo blamed rising prices on the Bank of England issuing too many notes, and backed the call to tie notes to gold again. He also opposed the Corn Laws, which restricted grain imports.
Laissez-faire reached the peak of its popularity around 1870. After the Great Depression of the 1930s, it gave way to Keynesian economics.
Laisser-faire, in short, should be the general practice: every departure from it, unless required by some great good, is a certain evil.
Check yourself
Who argued that, under competition, prices tend to follow the labour needed to make goods?
The critics
Thomas Malthus attacked the short-run form of Say's law. He warned that saving pushed too far would weaken the motive to produce, and he proposed public works and private spending on luxuries to raise demand.
The German economist Friedrich List attacked the free-trade school that followed Smith. In 1841 he argued that a country in the early stages of industrialisation needs tariffs to protect its industries.
Karl Marx adopted Ricardo's labour theory of value and turned it against capitalism. He argued that capitalists keep part of the value workers create, which he called surplus value.
From the 1870s, marginalists such as William Stanley Jevons broke with the classical view that value comes from the cost of production. Jevons argued that value depends on utility, the satisfaction a good gives.
In the 1930s, John Maynard Keynes challenged the classical expectation that free markets restore full employment on their own. He argued that wage cuts would not cure unemployment, because lower pay cuts what workers spend.
Check yourself
Whose Principles of Political Economy weighed the case for and against state action, and put the burden of proof on those who wanted it?
Where it stands today
Neoclassical economics, which grew out of the marginal revolution, is today's mainstream economics. Comparative advantage is still taught as part of the case for free trade and specialisation.
From the 1970s, new classical economists built theories in which markets clear and prices adjust, leaving little room for lasting unemployment. Later, most economists, new classicals among them, came to accept that wages and prices move slowly in the short run.
Check yourself
Who argued that capitalists keep part of the value that workers create?
- Keynesian and classical aggregate supplyThe two views of output, drawn side by side.
- Absolute and comparative advantageSmith's and Ricardo's trade ideas, worked through.
- The Great DepressionThe slump that turned policy away from laissez-faire.
- Market, command and mixed economiesWhere markets end and the state begins.
Classical economics began with Adam Smith in 1776 and dominated British economic thinking until about 1870. Its economists argued that competition turns self-interest to everyone's benefit, that markets correct themselves, that free trade benefits nations, and that labour costs shape prices. Malthus, Marx, the marginalists and Keynes challenged it.