What is Classical Economics?
Classical economics refers to the school of economics adopted by Western democracies in the 18th and 19th centuries. Classical economic theory was brought into the mainstream by Scottish economist Adam Smith, who many refer to as the “father of economics”.
Classical economics rejected the idea of government intervening in the market place. The theory was that any problem would eventually be sorted out by the markets. Classical economists were largely in favor of free trade.
The Rise of Classical Economics
The rise of classical economics coincided with the industrial revolution. Many of the fundamental economic theories such as supply & demand were a product of classical economics.
Prior to the rise of classical economics, most economies were under the control of some type of monarch. Under these systems, the economy was tightly controlled by the state which is why they are referred to as “Command and control” systems. If the king decides to raise your taxes, there is no one you can really complain to.
Classical economics is the opposite of “command and control” systems and became associated with freedom.
The Invisible Hand
The very first lesson in my economic 101 class was on Adam Smith’s theory of the “Invisible hand”, a “classic”, classical economic theory. The invisible hand is really a metaphor for how each person's action to address their own self-interest ends up benefiting society at large.
When I am on my way to work in the morning I might buy a coffee on my way to work. My decision to buy a coffee is one of complete self-interest. I buy a coffee because I need a jolt of energy and I enjoy the taste.
However, my purely selfish decision to buy a coffee has unintended benefits to society at large. The money I pay for my coffee is taken in by the person who owns the coffee shop, who reinvests that money into their business and hires new employees. This increases employment and consumption within the economy creating a virtuous cycle of economic growth.
Additionally, since millions of other people also make the selfish decision to buy a coffee (or twelve) every day we collectively help put the market for coffee in equilibrium. A similar process happens with nearly every product and market.
This is why classical economists argued that there was no need for the government to intervene in markets.
The Fall of Classical Economics
Following the great depression, classical economics declined in popularity and in a way was replaced by “Keynesian Economics”. A school of thought made popular by British economist John Maynard Keynes.
Keynes believed that if left completely to their own devices free markets would lead to underconsumption and left society vulnerable to “boom and bust cycles”. You can imagine that the message of reducing economic downturns would be particularly appealing during the great depression.
Keynes advocated that the government has a crucial role to play in maximizing social benefits. Raise taxes and interest rates, and lower government spending during economic expansion and do the opposite during economic recessions.
As Keynesian economics grew in popularity, Classical economics became less influential.
This article is for informational purposes only, it should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.