Classical Economics

Definition

Classical economics is a school of economic thought that developed in the 18th and 19th centuries, which emphasizes the self-regulating nature of the market and the benefits of free trade and limited government intervention. It forms the foundation for understanding concepts like Keynes' Law and Say's Law in the AD/AS model.

5 Must Know Facts For Your Next Test

1. Classical economists believed that the economy would naturally reach full employment equilibrium through the free market mechanism, without the need for government intervention.
2. Classical economics emphasizes the role of supply and demand in determining prices and resource allocation, with the assumption of rational, self-interested economic agents.
3. Classical economists argued that wages and prices would adjust flexibly to maintain full employment, and that government intervention would disrupt this natural equilibrium.
4. The classical view holds that markets are self-regulating and will automatically clear, meaning that supply and demand will always be in balance.
5. Classical economics formed the basis for understanding macroeconomic concepts like Keynes' Law and Say's Law, which describe the relationship between aggregate demand and aggregate supply.

Review Questions

• Explain how the classical economic perspective differs from the Keynesian view in terms of the role of government intervention.
  • Classical economists believed that the economy would naturally reach full employment equilibrium through the free market mechanism, without the need for government intervention. They argued that wages and prices would adjust flexibly to maintain full employment, and that government intervention would disrupt this natural equilibrium. In contrast, Keynesian economics emphasizes the role of government policies, such as fiscal and monetary policies, to manage aggregate demand and stabilize the economy during periods of recession or high unemployment.
• Describe how the classical economic principle of Say's Law relates to the AD/AS model.
  • Say's Law, a key tenet of classical economics, states that the production of goods creates its own demand, and that supply creates its own demand. This implies that the economy will naturally achieve full employment equilibrium, as the supply of goods will generate sufficient aggregate demand to purchase those goods. In the AD/AS model, this corresponds to the classical view that the economy will automatically adjust to the full employment level of output, without the need for government intervention to stimulate aggregate demand.
• Analyze how the classical economic perspective on the self-regulating nature of the market relates to Keynes' Law in the AD/AS model.
  • The classical economists' belief in the self-regulating nature of the market and the ability of the economy to automatically reach full employment equilibrium is in direct contrast with Keynes' Law, which states that aggregate demand determines the level of economic output. Keynes' Law suggests that the economy may not naturally adjust to the full employment level of output, and that government intervention through fiscal and monetary policies may be necessary to manage aggregate demand and stabilize the economy. This fundamental difference between the classical and Keynesian perspectives has important implications for understanding the dynamics of the AD/AS model and the appropriate role of government in economic policymaking.

Related terms

Laissez-Faire:

The economic policy of letting the market operate without government intervention, based on the belief that the economy will self-regulate.

Invisible Hand:

The concept that individuals pursuing their own self-interest will ultimately benefit society as a whole, as if guided by an 'invisible hand.'

Say's Law:

The economic principle that the production of goods creates its own demand, and that supply creates its own demand.