Classical Economics

The dominant theory of economics from the 18th century to the 20th century, when it evolved into neo-classical economics. Classical economists, who included Adam Smith, David Ricardo and John Stuart Mill, believed that the pursuit of individual self-interest produced the greatest possible economic benefits for society as a whole through the power of the "Invisible hand". They also believed that an economy is always in equilibrium or moving towards it. Equilibrium was ensured in the labor market by movements in wages and in the capital market by changes in the rate of interest. The interest rate ensured that total savings in an economy were equal to total investment. In disequilibrium, higher interest rates encouraged more saving and less investment, and lower rates meant less saving and more investment. When the demand for labour rose or fell, wages would also rise or fall to keep the workforce at full employment. In the 1920s and 1930s, John Maynard Keynes attacked some of the main beliefs of classical and neo-classical economics, which became unfashionable. His views are often summarized in what economists call Keynesian economics today. In particular, he argued that the rate of interest was determined or influenced by the speculative actions of investors in bonds and that wages were inflexible downwards, so that if demand for labour fell, the result would be higher unemployment rather than cheaper workers.