Classical economics, also known as liberal economics, is an economic school of thought that was first developed by Adam Smith in the late 18th Century. Later, it was further developed by David Ricardo and John Stuart Mills. Classical economics advocate for a laissez-faire economy where the markets determine the prices without government interventions. Smith developed classical economics to counter the mercantilism practices that had been practiced in Britain since the 16th Century. Smith ideology that the wealth of nations should be determined through trade and not the stockpile of gold, he believed that for parties to agree on an exchange of goods, both parties must have seen value in the products produced by the other party and that the government had no role in the agreement.
The Evolution of Classical Economics
The rise of capitalism in Western society led to the development of the Classical Economics theory. Many economists view the development of the industrial revolution as a consequence of capitalism and developed theories that would be used to guide the revolution. A classical group of thinkers led by Smith settled on the idea that the government should let the market dictate its course. Due to the similarity experienced in different markets, classical philosophers argued that three factors determine prices in a market. These were technology, wages, and the level of outputs at the level of Smith's "effectual demand”. The choice to use these factors was dismissed by many other Classical Economic thinkers later on. The development of the Marxist theories of economic communism by Karl Marx and the disagreements between classical philosophers eventually led to somewhat of a collapse of the theory, and the development of the Keynesian theory of economics which later became widely popular among American and British politicians.
Application of Classical economics
The development of classical economics led to the development of what are the current determinants of market prices, such as the law of demand and supply. Even though the theory was not popular during its introduction due to the government involvement in trade, much of what the theory advocated is practiced today. However, modern economists advocate for a balance in price control. Government participation in trade, particularly in international trade, could not be underestimated and the classical thought was less applicable.
Benefits of Classical Economics
Classical economists advocated for liberated markets, free from government influences that dictated the prices of goods. Smith argued that free markets could regulate and readjust themselves if third parties did not get involved, which they did using what he referred to as “the invisible hand.” The theory led to the development of the neoclassical and modern theories that considered a wide range of factors influencing an economy. It resulted in the further development of capitalism and the use of trade as a factor determine the effectiveness of an economy rather than the stockpiling of gold. The concept of comparative advantage developed by Ricardo reiterated that an economy should focus on what it can produce efficiently and trade it with what it cannot produce.
Drawbacks of Classical Economics
Classical economics has been rejected by many modern economists, corporations, and politicians due to potential problems arising from its ideologies of free markets and a lack of government regulation in the marketplace. The development of the Keynesian theory was a major blow to the classical theory. Keynes viewed free markets as under-consumption and under-spending. Classical economics was considered a hindrance growth of the economy and could not be practiced in modern, more diverse economies. Land and labor are no longer viewed as the main factors of production and cannot be used to determine the effectiveness of the economy.