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Economics - Classical School of Thought, Keynesian School of Thought, Supply Side School of Thought, Monetarist School of Thought

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Introduction The word economics is derived from "oikonomikos" which means skilled household management. Modern economic thought emerged in the 17th and 18th centuries as the western world began its transformation from an agrarian to industrial society. Four major schools of thought have emerged over the years of economic development. 1) Classical School of Thought 2) Keynesian School of Thought 3) Supply Side School of Thought 4) Monetarist School of Thought Classical Theory: The Classical Theory is based on the automaticassumption of "of "Self Equilibration" tendency of the economic forces. The classical view holds that is the aggregate supply curve is vertical and is the sole determinant of the level of real output. tThe down sloping aggregate demand curve is stable and is the sole determinant of the price level. According to the classical economist the economy will operate at its full employment level of output because (1) Say's law (2) responsive flexible prices and wages., Tthey classical economist believed that supply does not change in response to the change in price level. As we knowunderstand that lower prices would make production less profitable and would cause producer to offer less output and employ fewer workers,. Tthe classical response to this view is that the input costs would fall along with products price and level real profits and out put unchanged. With perfectly flexible wages there would be no change in real reward &and therefore in the production decisions of businesses a change in the price level will not cause the economy to stray from full employment. History Of Classical Theory: The classical school betweenfrom 1770 to ----1870 mainly included such leading economist as Adam Smith, David Ricardo, J.B Say, John Stuart Mill and& Karl Marx. The later Neo-Classical economist list Alfred Marshall (1870-1930) had hardly any thing significant to add to the classical theory. Adam Smith published his "Wealth of Nation" (1776) he wrote this during the Enlightenment era. ...read more.


He is also recognized for influencing and establishing this idea as an advisor to Reagan during his terms in office. The idea of Supply-Economics, which was first put into effect during Reagan's years in office, was a complete failure because while tax cuts decrease government spending was never decreased. Instead government spending was increased, which caused our national debt to go from 730 billion to 2.1 trillion. Because the idea of Suppy-Side Economics (Reagonamics) failed to be successful, during the early 80's, the idea has lost a great deal of popularity and gained many critics. Recently economist such as, Robert Mundell, who is considered one of the most professional scholars of supply, has established and regained some popularity back to the idea of Supplied Economics with his Nobel prize win in 1999. A PhD economist who has taught in universities such as, Stanford and Colombia has brought life back in the idea of supplied economics through his contributions and ideas. One of his ideas is to decrease government spending. He believes in certain types of government spending such as education and research and development but is not in favor of welfare. He has also established his ideas that reducing taxes such as, the marginal tax rate, capital tax gains and corporate taxes will increase economic growth. He is also considered a theoretical contributor of the Laffer Curve. What do Supply Siders believe? Supply Side economists believe in increasing aggregated supply by lowering taxes, reducing regularity restrictions on production and reduce market restrictions. Supply Siders believe in reducing business taxes especially corporate taxes rates. Businesses and corporation can use the money saved on taxes to purchase more equipment for more production, which will increase more jobs and higher revenues. Supply siders believe that tax revenue will not decrease because although tax rate will be lower, a lot more product will be tax and more jobs will provide more taxable income. ...read more.


Monetarists and Neo-Classical Theory - AD & AS Modern monetarists have turned to the Neo-Classical views and therefore agree to the long term and short term effects as discussed for Neo Classical theory in the previous sections. They view the aggregate supply vs. aggregate demand as having different effects for the short term and long term. According to neo-classical theory, in the short term, any increase in money supply may lead to an increase in aggregate demand. This in turn, leads to more employment, but then expectations will catch up and the effects of the boost will be short-lived. Also, inflation picks up and wipes out short term gains. Refer to Figure 1.3. In the long term, attempts to reduce unemployment below its natural rate will result in inflation. The long run aggregate supply curve will be vertical. Refer to Figure 1.4. Criticism There has been much scrutiny about the main beliefs in monetarism. Hence, today, monetarists are few and monetarism is not formally practiced in current society. Constant Money Growth Rule Criticism stems from Friedman's suggested constant money growth rule at 3%. The suggested "historical" average output growth of 3% rarely exists in any given year nor is it an empirically validated average. From 1970s to early 1990s, the average output growth rate in the U.S. has hugged 1.5%. If 3-5% money supply growth rule were followed, then by quantity-theoretic reasoning, the U.S. would have had a good bout of sustained inflation. Friedman's Policy Proposition There has also been criticism on Friedman's policy proposition of whether the Federal Reserve could actually control the supply of money and which money supply it ought to control. The Fed can only control the monetary base. The monetary base can be quite fluid because of banks borrowing from Central bank at "discount window borrowing"; consequently, economies risk a banking crisis. If one targets, quantity of money, one cannot really control its degree of turnover, so that its velocity may be quite unstable-as proved in 1970s and 1980s. Therefore, monetarism has taken criticism for Friedman's analysis of lags and quantity theory of money. Schools of Thought 1 ...read more.

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