Classical Economic Thoughts

1. Classical Economic Thoughts Presented By: Ashtar Hussain Jan

2. Contents • Introduction • Classical Thoughts • Assumptions • Components • References

3. Introduction • Economics, not a separate subject, i.e. Political Economy • Mercantilists, to increase the nation-state • Bullionism – Precious Metals • Need for State Action • Classicals, Wealth of the Nation • Increase of the Stock of the Factors of Production with Advance Technology • Absence of the State Control

4. Cont.. • Attack on the Bullionism, Money has no Intrinsic Value so only Medium of Exchange • Consumption Never Needs Encouragement (Froyen 2004).

5. Classical Thoughts • An Inquiry into the Nature and Causes of the Wealth of the Nation, By Adam Smith in 1776 • Economics Emerged as a Separate Subject (Khan 2011) • Economics as Science of Wealth (Shah 2011) • Laissez Faire Doctrine

6. Assumptions 1. Flexibility of the Nominal Variables 2. Constant State of Technology 3. Diminishing Marginal Values

7. Components 1. Quantity Theory of Demand for Money (Money Market) 2. Say’s Law of Market (Product Market) 3. Marginal Productivity (Labor Market)

8. 1. Quantity Theory of Demand for Money • Fisher Version – MV=PY, where M is money supply V is the velocity of money P is general price level Y is the output level Hence V & Y are assumed to be constant, so M=kP, direct and proportionate relationship between the money supply and prices

9. Quantity Theory of Demand for Money b) Cambridge Version – MV=PY, where one assumption was relaxed, i.e. only V is constant because of the Human Psyche, so M/P=1/vY which means that there is a direct relationship between the real balance and the output level

10. 2. Say’s Law of Market • Supply creates its own demand, AD=AS • Saving is the primary concern of the Classicals, i.e. first agents save and then consume whatever is left

11. 3. Marginal Productivity • Q=ƒ(L,K) • Inefficient Utilization of the Resources • Efficient Utilization of the Resources • Over-efficient Utilization of the Resources

12. Working of the Economy under the Classicals Version • Product Market – S=I • Money Market – Md = Ms • Labor Market – Nd = Ns

13. 1. Product Market • Equilibrium in the product market is determined by the interaction of the saving and investment • S=ƒ(i)+ & I=ƒ(i)- • Any disequilibrium in the product market would be a temporary phenomenon, so there is no need of the government intervention

14. 2. Money Market • Demand for money is represented by Cambridge Version while Supply of money is exogenously determined • Equilibrium in the money market is conditional to the equality of demand for and supply of money • Any mismatch between demand for and supply of money is temporary in nature, hence no need of the govt. intervention

15. 3. Labor Market • Labor responds to the real wage rate, with no money illusion • Equilibrium in the labor market will be at the point of interaction of the demand for and supply of workers • The demand for labor function is drawn from the Marginal Productivity • Any mismatch between demand for and supply of workers is temporary in nature, hence no need of the govt. intervention

16. Criticism • Invalidity of the Say’s law of market • Saving is the function of disposable income too • Consumption is the primary concerns of the economic agents, not saving • Money is not neutral • All the markets are not independent from one another • Rigidities of the nominal variables • Losse Fosse • In the long run we are dead

17. References • Froyen, Richard T. Macroeconomics, Theories and Policies. 8th. Prentice Hall; 8 edition (August 20, 2004), 2004. • Khan, Zahoor, interview by Ashtar Hussain. History of Economic Thoughts Peshawar, Khyber Pakhtunkhwa, (November 30, 2011). • Shah, SayedZamin, interview by Ashtar Hussain. Labor Economics Peshawar, Khyber Pakhtunkhwa, (December 07, 2011).