Classical and Neo Classical Economics

Classical and Neoclassical
Economics
ABIR GOLDAR
Development Studies Discipline
Khulna University

Outline of the Presentation
 Enlightenment origins of political Economy
 The British Enlightenment
 The Classical Economists
 Adam Smith
 William Godwin
 Thomas Robert Malthus
 David Ricardo
 Critique of Classical Economics
 Assumptions of Neoclassical Theory
 Criticisms

 Economic ideas were first developed within the philosophical tradition
of Western scientific rationalism. Modern economics was developed as
a symbolic representation of real events in early capitalism.
 Economics was developed positively by theorists thinking on behalf of
a new progressive capitalist class—economics was a theoretical part of
their revolutionary effort.
 Modern economics seemingly belied the concepts of the old medieval
order. These concepts included a feudal-era inclination to believe that
communal economic justice reflected God’s will. The most radical
version of this protracted changeover came with the 16th-century
Protestant belief in glorifying God actively rather than just
meditatively— please God . . . by working hard!
Enlightenment origins of political Economy

 Every throw of the shuttle, every inch of cloth passing through the
weaving machine, proved that the weaver’s labor time was adding value—
more time, more cloth, more value. Thus, eternal repetition was the
experience from which the labor theory of value emerged. Classical
economists merely translated these beliefs, based on real work experience,
into the more abstract realm of theory.
 Classical economics also developed in conflict with an earlier set of ideas
called mercantilism(15th century to the early to mid-19th century)
Mercantilist political policy aimed at increasing national power,
symbolized by the might of the state.
 The period 1600– 1850 can be seen as one long class struggle between the
landed nobility and the new bourgeoisie for control of the state, control
over ideas, and control over the economy and its products. Classical
economics was one element in this class struggle.
Enlightenment origins of political Economy

 “The Enlightenment” is a Eurocentric term referring to the revolution in
philosophy and theory that occurred during the 17th and 18th centuries in
western Europe.
 During the 18th century, certain thinkers and writers, primarily in London
and Paris, believed that they were more enlightened than their compatriots
and set out to enlighten them.
 These thinkers believed that human reason could be used to combat
ignorance, superstition, and tyranny and to build a better world.
 Their principal targets were religion (the Catholic Church in France) and
the domination of society by a hereditary aristocracy.
 their political-economic philosophy supported the cause of the class of
small producers, the tenant farmers, mechanics, and artisans whose hard
work formed the basis of mercantilist state power but who supported the
Protestant cause.
The British Enlightenment

 Thomas Hobbes reconceptualized society as a calculus of power
relations, with power, in effect, traded like a commodity, and the value of
the individual measured by the deference accorded him or her by others.
 John Locke began by accepting the medieval Christian view that God
originally gave the earth and its products to all people in common. Yet,
Locke contended, human individuals had the right to preserve their own
lives and, therefore, had rights to the subsistence (food, drink) derived
from the earth.
 Scottish philosopher David Hume saw human beings as compelled by a
consuming passion—avidity (greed) for goods and possessions, a drive
that he found directly destructive of society. Hume supported free trade
against mercantilist restrictions and yet found a need still for government
intervention to preserve national economic advantage
The British Enlightenment

The Classical Economists
Classical Economics: Classical economics (also known
as liberal economics) asserts that markets function best with
minimal government interference. The theories of the
classical school, which dominated economic thinking in
Great Britain until about 1870, focused on economic
growth and economic freedom, stressing laissez-faire ideas
and free competition.
Lists of Classical Economist: Adam Smith, William
Godwin, Malthus, Jeremy Bentham, David Ricardo, John
Stuart Mill.

Adam Smith(1723-1790)
Theory of Moral Sentiments
“self-interest” an important human instinct, inevitably leads
to a cruel and terrible society.
Smith argued that we are able to imagine what others are
going through; we are able to understand with the
sufferings of others.
We feel pain when we see the pain of others.
We can act to reduce the pain of others in order to reduce
our own discomfort, if nothing else.
So, it is perfectly consistent to believe that human beings
pursue self-interest and are generous towards others.

Division of labor and capital
Society is divided into three classes
• Capitalists
• Landlords
• Workers
Income is divided into three categories.
•Profits
•Annuity Land Charge
•Wages

 Labor is the main source of wealth of nation.
 The division of labor is the specialization of co-operating
individuals who perform specific tasks and roles.
 Also, having workers perform single or limited tasks
eliminated the long training period required to train
craftsmen, who were replaced with lesser paid but more
productive unskilled workers.
 Historically, an increasingly complex division of labor is
associated with the growth of total output and trade, the rise
of capitalism and of the complexity industrialized process

Advantage: The Division of Labor
1) Increased output:
2) Increase in skill of labor
3) Saving in Time
4) Introduction of machinery

Free Trade
Smith was in favor of free trade.
He derived his support for free trade among nations by
basing it on the obvious desirability of trade among
individuals:
According to Smith, free trade expands the extent of the market
and, thereby, allows greater division of labor
1) Those tariff that protect the domestic industry essential to
the defense of the country.
2) Those who equalize the tax burden on the particular
domestic industry by imposing tariff on import of that
goods.

Free Trade ( Continue)
• Smith also suggest that free trade is to be introduced in a
country after a long period of protectionism, it should be
done gradually in order to avoid unemployment.

Invisible Hand:
 Our preferences are consistent
 We act based on self-interest
Individual Good adds up to Social Good Government
Ensures Property
Rights.
 Enough buyers and sellers as for there not to be a
monopoly
 Perfect Information that backs up our economic decisions
 No Externalities

William Godwin (1756-1836)
“Enquiry Concerning the Principles of Political Justice”……
1793
Godwin believed in the perfectibility of humankind
through the establishment of small societies anarchic, the
dissolution of government and private property. Only in
these small societies, could sympathy and virtue prevail.
Labor as the source of all value; labor as the measure of
value; classical view of the relation of propertied classes
and working classes.

Thomas Robert Malthus (1766–1834)
Malthus’ population theory became an integral part of
classical economics.
 Population cannot increase without food
 Population invariable increases if food is available,
“passion between the sexes” is a given
 The “superior power of population cannot be checked
without producing misery or vise.”

Jeremy Bentham (1748–1832)
An Introduction to the Principles of Morals and Legislation
(1780)
 Bentham’s Utilitarianism is a universal hedonism – the
highest good is the greatest happiness for the greatest
number.
 Actions are judged as a means to an end.
 What is right is that which is calculated to bring about the
greatest balance of good over evil, where good is defined as
pleasure or happiness.
 Bentham’s view is described as Act Utilitarianism.
 Bentham argued that we should be guided by the principle of
utility and not by rules.

David Ricardo (1772–
1823)
• Ricardo was a British political economist.
• He wrote Principles of Political Economy and
Taxation.
• David Ricardo stated a theory of Comparative
Advantages.

Functional Distribution of Income
• There are
– three factors of production
• land,
• labor, and
• capital goods
– three classes of people:
• landlords,
• workers, and
• capitalists.
• Ricardo focused on income distribution among
the three classes

Comparative Advantages
• Other things being equal a country tends to
specialise in and exports those commodities in
the production of which it has maximum
comparative cost advantage or minimum
comparative disadvantage.

Ricardo's Assumptions about
Comparative Advantages
• There are two countries and two commodities.
• There is a perfect competition both in commodity
and factor market.
• Labour is the only factor of production other than
natural resources.
• Labour is homogeneous i.e. identical in
efficiency, in a particular country.
• Labour is perfectly mobile within a country but
perfectly immobile between countries.

Cont’d…..
• There is free trade i.e. the movement of goods
between countries is not hindered by any
restrictions.
• Production is subject to constant returns to scale.
• There is no technological change.
• Trade between two countries takes place on barter
system.
• Full employment exists in both countries.
• There is no transport cost.

Examples
• England (specializing in
cloth, for which it has
the least comparative
disadvantage)
• Portugal (specializing in
wine, for which it has
the greatest comparative
advantage)

Ethics of John Stuart Mill (1806-1873)
• He was an English political philosopher and
economist who was an advocate of utilitarianism.
• He mentioned guarantee the civil liberty the
citizens and their protection against interference
by abusive authority.
• Mill suggested to redistribute wealth through state
intervention.
• Workers and capitalists gap relieved by profit
sharing.
• Laissez faire should be the general rule.

Classical Economics
It basically combines Smithian notions of self-interested,
rational, and competitive behavior by capitalists with a technical
apparatus of specialization based on comparative advantage,
interlocking markets, expanding trade, and innovations
specifically in industrial production.

Critique of Classical Economics
 The classical economists legitimated selfish behavior of
human being, competitive profit making as “natural.”
 Profits and rents are seemingly so much higher than wages
 The classical economists were definitely inclined to defend the
interests of the British industrial bourgeoisie. So The classical
economists did not hide their class commitments. They were
proud to support their bourgeois friends.

Ricardo Was Wrong
For considerable period the theory of comparative costs
formulated by David Ricardo was the most acceptable
explanation of the international trade. However, Ricardo's theory
was subjected to number of criticisms:
 Restrictive Model
 Transport costs may outweigh any comparative advantage
 Increased specialisation may lead to diseconomies of scale
 Governments may restrict trade

Cont.
 Not possible full employment
 Not applicable to developing countries
 Comparative advantage measures static advantage but not
any dynamic advantage for example in the future India
could become good at producing books if it made the
necessary investment

An approach to economics
 Focus on the determination of goods, outputs, and
income distributions in markets through supply and
demand.
Neoclassical
Economics
 An individual's rationality and his ability to
maximize profit.

For example,
 I want to buy a new car. At that same price others may also
want to buy cars. But manufacturers may not want to
produce as many cars as we all want. Our frustration may
lead us to "bid up" the price of cars, eliminating some
potential buyers and encouraging some marginal producers.
 As the price changes, the imbalance between buy orders
and sell orders is reduced. This is how optimization under
constraint and market interdependence lead to an economic
equilibrium. This is the neoclassical vision.

 Decisions on economic issues are always made
rationally, based on full information on the
usefulness of the product or service.
Assumptions of Neoclassical
Theory
 Consumers compare goods and then make the
purchase decision based on the perceived utility.
 The customer's main objective is to capitalize on
the satisfaction afforded by the use of the product.

 The main aim of companies is to maximize profits
Market equilibrium is achieved only when both the
customer and the company achieve their respective
goals.

 Having a normative bias.
Criticisms
 It does not focus on explaining actual economies, but
instead on describing a theoretical world.
 Denial for the physical limits of the Earth.
 The assumption that individuals act rationally may
be viewed as ignoring important aspects of human
behavior.

 Neoclassical economics is also often seen as relying
too heavily on complex mathematical models
Yet, to the frustration of
"heterogeneous" antagonists the
neoclassical paradigm remains
dominant.

Classical and Neo Classical Economics

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