A SUMMARY OF THE HISTORY OF ECONOMIC THEORIES Mgt. 704: Economics for Managers Allen Parkman

1. A SUMMARY OF THE HISTORY OF ECONOMIC THEORIESMgt. 704: Economics for ManagersAllen Parkman

2. Adam Smith and the Wealth of Nations (1776) • The Wealth of Nations is the cornerstone of economics. • It was a reaction to Mercantilism that viewed a positive balance of trade as the primary goal of government. • It presents a systematic approach to economic activity based on people acting in their self-interest, thereby, producing self-regulating markets (the invisible hand). • The wealth of a nation is based on the productivity of its workers. • One source of frustration was the diamond-water paradox.

3. The Neoclassical Economists (19th Century) • They added two insights to the earlier thinking: • decisions are made incrementally and • demand is based on utility. • Consequently, prices are determined by the interaction of supply--incremental costs--and demand--incremental utility--with markets tending toward equilibrium. • Most of the material in microeconomics today was summarized in Marshall's Principles of Economics (1890).

4. Marshall’s Supply and Demand

5. The Keynesian Revolution (1930s) • The General Theory of Employment, Interest and Money (1936) by John Maynard Keynes was a reaction to the apparent failure of economics to explain the Great Depression. • He created the field of macroeconomics by viewing the economy in terms of aggregates rather than as a sum of markets. • Prices could be sticky so that aggregate demand determined aggregate supply and there was no reason to expect that aggregate demand would generate full employment. • The need for more aggregate demand in an economy was used to argue for a larger presence of the government in the economy. • The Phillips Curve (1958) was interpreted as arguing that there is a long-term tradeoff between inflation and unemployment. • Since it was commonly accepted that government deficits caused inflation, the Phillips Curve was used to justify government deficits.

6. The Neoclassical Counter-revolution (1960s) • Milton Friedman and Anna Schwartz's, A Monetary History of the United States, 1867-1960 (1963), provides an important rebuttal to Keynes demonstrating that the primary cause of the Great Depression was the Federal Reserve’s mismanagement of the money supply. • Between 1929 and 1933, the money supply fell by 28 percent. • Between 1929 and 1933, consumer prices fell by 25 percent. • Friedman argued that private decisions tend to lead to stable outcomes. • Most countries in the world moved toward more market oriented economic policies.

7. The Modern Macroeconomic Synthesis (1990s) • Different perspectives are appropriate for analyzing the short run and the long run. • The primary difference is that prices and expectations are flexible in the long run, while they can be sticky in the short run. • Lags in the effects of fiscal and monetary policy make discretionary countercyclical policies difficult.

8. Economic Imperialism • Economics is the study of the choices that people make as wants tend to exceed resources. • Choices occur in all aspects of life. • Economists have won the Nobel Prize for extending economics into topics traditionally associated with other disciplines: • finance (Modigliani and Miller), • political science (Buchanan) and • sociology (Becker).