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0:00
An economy is a collection of production and consumption processed that are all working towards solving the central economic problem. The problem is that we only have access to a finite amount of resources, but the potential for human consumption of goods and services is pretty much limitless. This is the foundation of economics, every study, every paper, every theory, economic policy, or experiment is ultimately an attempt to find a solution to a problem, that by its
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very nature, has no solution. Economics is considered a social science, and although some other scientists from more “rigorous” fields don’t always welcome it into their little club, it still follows the same processes to explore the world around us. And, as with science, or anything that is extremely complex for that matter, there are disagreements between practitioners at all levels of academia and throughout the entire history of the subject.
0:59
The economic schools of thought are very broad ways that economists are clumped into basic groups. Now the first thing to know about all of these schools of thought is that they all agree with one another on most issues. In the same way that two physicists will obviously agree with one another that and object at rest will remain at rest, but might disagree about string theory. Two economists will obviously agree that there are opportunity costs for every unit of production,
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but they might disagree on the long term implications of a consumption tax. The reason you are much more likely to hear about disagreements in economics rather than physics are threefold. One, the foundation of economics is an unanswerable question, so there is a certain element of philosophy and morality in this academic pursuit, no matter how much economists attempt to sterilize it with mathematics. Two, economies are really hard to experiment on.
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If there is some radical new theory about effective taxation, the only real way to see if it will work is to get that tax law passed in a country and study the results. If the experiment doesn’t work, then oh well you just destroyed a nation. This difficulty in testing theories also means that a lot of fringe ideas are hard to disprove in the same way they would be in a chemistry lab. And three, economics is something we all feel day in and day out.
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The economy impacts our financial situations, our governments, retirements, environments, crime rates, and basically anything else that is going to make news headlines. As with anything that people are invested in they form opinions around it. And those opinions are held by everybody from nobel laureate career economists to that crazy guy advocating for a seed-based economy. If this contention wasn’t enough then there is one other issue that makes these schools
2:50
of thought difficult to deal with, and that is that there are no strong borders between them. There are plenty of economists that agree with some of the principles of one school of thought and then disagree wildly on some other area’s. Which is actually a good thing. But more on that later. For now, to try and make sens of this wild world we are going to look at three major schools, Classical, Austrian, and Keynesian.
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To show the differences between these schools we are going to look at the way they suggest solving the central economic problem in key areas. What they suggest the role of government is. What do they think the role of the individual is. What they propose doing in an economic crisis. And finally what is the key to delivering a wealthier happier economy? [ INTRO AD – START ] [ INTRO AD – END ] Now economies have always been a thing, and before people even knew what they were doing
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they were attempting to satisfy their desires with the limited resources they had available to them. This went on for an extremely long time and great empires rose and lived and died all harboring economies that they didn’t think to specifically study. Everybody from Aristotle to Jesus presented an answer to the question, but nobody had yet thought to ask what the question was. (insert jeopardy) Can I have how to satisfy unlimited demands with limited resources for
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1,000 alex? --- (“that is correct”) this all turned around though in the 18th century with a man called adam smith, who gave birth to economics and formed the foundation of what is now known as the Classical School The classical school of economics, as the name would suggest was the first incarnation of economics as a separate academic pursuit, distinct from finance, governance and philosophy. The early practitioners of economics, namely adam smith started studying and writing about
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how the world was operating to increase the wealth of nations. They found that the world at that time was ruled by theory that went on to be known as mercantilism. Which could realistically be it’s own economic school of thought, had it not been so fundamentally flawed. This system relied on economies just desperately trying to hoard as much gold as they could, by either exporting more than they imported, mining more of it within their borders or
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colonies or by plundering it through hostile conflict. Now we have explored mercantilism and adam smith before on this channel, so if you want more insight on that, go and watch those videos. But the big takeaway here is that mercantilism was realistically, just fine for most nations throughout history. These nations were extremely basic and their economic success primarily revolved around the strength of the harvest in any given year, and later turned into how many colonies they could claim.
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More or less it was a zero-sum game, if someone or some country was getting richer, it was because someone else was getting poorer, and mercantilism perfectly mirrored this reality. Having a perfectly run fiscal and monetary policy would not have meant very much to the overall prosperity of these types of very basic nations. It would have been like putting nitrous on a horse-drawn carriage. It wasn’t going to do anything and it would probably just make everybody very confused
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with its needless complexity. This was all starting to change though when adam smith was putting pen to paper to write the wealth of nations. The first steam-powered factories had sprung into existence and for the first time ever, wealth was not been grown or mined it was being created en masse. This was a chance for all people to become wealthier " ."== Now this sounds like some commie nonsense but what smith was trying to say here is that
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there is an optimal distribution of wealth creation for all members in a society. It definitely should not be equal, but it shouldn’t be a swelling peasant class holding up a tiny nobility either. The Reason for this was not some virtuous quest to feed the poor, but rather it was to develop markets and divide labor. To show the importance of this Smith used the example of a pin. A small sharp poky metal stick, which sounds like an extremely simple product.
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But if a single worker was to wake up in the morning and dedicate themselves to making 1 single pin they probably wouldnt be able to do it, because they would need to mine the materials, refine the steel, forge it, and sharpen it all to make 1 pin. Of course, if all of these tasks were done by separate workers, then they could just focus on their role and producing pins would be a lot easier. So much so that there would be an abundance of pins that could then be shared around all
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of the workers that contributed to this process. Now this example of one person making a pin sounds silly to us, but for a long time this was effectively how economies operated. Feudal villages would produce pretty much everything they needed and even individual households would be more or less self-sufficient. The reason why people did this is that there was no real alternative, village markets were basic at best and most peasant workers didn’t even receive an income as you or I might know it.
9:02
But, by moving into factories and earning a cash wage individuals now had the ability to make purchases, which gave the entire economy the ability to specialize. Immanuel Kant a legendary philospher of all people may have said it best in his 1785 book the Groundwork and Metaphysics of Morals. Where he quoted that. “All crafts, trades and arts have profited from the division of labour; for when each worker sticks to one particular kind of work that needs to be handled differently from
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all the others, he can do it better and more easily than when one person does everything. Where work is not thus differentiated and divided, where everyone is a jack-of-all-trades, the crafts remain at an utterly primitive level.” So with this new understanding of how to build a better world, these were the prescriptions of these early philosophers and financiers turned economists. Markets should be free because the more that people are allowed to trade freely with one
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another the more they can specialize and count on others to specialize to deliver all of the goods that they need. Nations should also do the same thing, stop trying to hoard gold and instead realise who does what well, once this is known trade amongst other nations to to increase wealth. Production is the most important part of the economy and great efforts should be made to making this more efficient so that more wealth can be created from turning raw materials into complex products.
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Government intervention in free markets should be limited exclusively to making sure that contracts are upheld and fraud is not allowed to take place. And of individuals, classical economics assumes that everybody buying and selling and working is perfectly rational and will always make the most logical decision possible to forward their own selfish interests. More or less classical economics argues that we can all work together to make the world a better place by being extremely selfish.
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I guess Gordon Gecko was a classical economist (cutaway clip) Now these theories worked very well, and when applied the age of industry they were a guiding force behind the development of jobs, companies, and markets as we know them today. But these ideals weren’t perfect,and now that the foundation was set, the great thinkers from around the world. The first to really shake up this new way of thinking were a collection of economist from vienna who went on the form the, Austrian School
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The Austrian school shares a lot of similarities with classical economics and most of the economists that have now gone on to define this field didn’t even know that they were, in the same way, adam smith didn’t know he would create the academic discipline of economics. Rather what these early academics were trying to do was fix up some loose ends of classical economics primarily by realizing that an economy wasn’t some amorphous blob of production but rather it was a collection of individuals.
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With this, these scholars started adding in more allowances for how individuals acted, and specifically how they valued things. Carl Menger was the father of the Austrian School of Economics and is credited with contributing to the theory of Marginal Utility along side his student Friedrich von Vieser. The theory of marginal utility was an extremely important contribution to economics as a whole. It argued that goods provide a utility, but their utility is decreased for every extra
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unit of that good there is. For example the extra utility someone gets from having 1 kettle as opposed to zero kettles is pretty big. Suddenly they can boil water and make tea or coffee where they wouldn’t have otherwise been able to in the past. Going from 1 kettle to 2 kettles also has its benefits, you can now boil more water at any given time, and if one breaks down you have a spare ready to go for redundancy ready tea and coffee making duties. But 3 kettles 4 kettles 20 kettles?
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Th ere is only so much tea and coffee a household really needs and eventually, these items start taking up so much space that people want less of them meaning at extreme levels an extra item can have a negative marginal utility value to the consumer. This ran contrary to the classical school of economics which simply advocated for making as much stuff as possible and then letting the free market decide what went where.
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Now again this might sounds obvious to us now, but you have to remember 2 important things. The first was that this theory was a huge contribution towards solving the central economic problem, sure they still had unlimited desires and only limited resources in which to fulfil those desires, but they added the Asterix that actually, some specific desires can be over satisfied so an economy must avoid that at all costs so that there is more leftover
14:01
to satisfy other desires that haven’t been met yet. The second was that this was the first inkling of economic theory adapting to a world of genuine sustained growth. Before the 1800’s the idea that anybody could have too much of something was pretty bizarre, but with factories all across Europe working day and night to produce all manner of everything, the decisions that everybody was making was starting to shift from, can I afford this, to, would I rather have this or that.
14:32
This deeper understanding in a world that was becoming more and more plentiful eventually culminated in the Subjective Theory of Value. This theory argues that an item is not worth the sum of the materials and labor that go into making it, but rather it is worth a function of how important it is. For example, a worker could spend their entire life digging the deepest hole in the ground the world has ever seen, but that hole is going to have less actual value than one that
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was dug 3 feet deep before hitting a solid gold nugget. Or as it relates to industry, a factory could build car out of titanium and sure it would probably be better than a car made out of steel, but it would take 10 times the manhours and 10 times the costs of materials to make that car, and it might be 20% lighter and stronger. Now since people are not going to pay 300 thousand dollars for a titanium edition Toyota Camry, these types of subjectively inferior goods don’t get made.
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Who is it that decides that these goods dont get made? Rational consumers. So suddenly the Austrian school of economics added a second role to the free market, not only was it a medium of exchange that let people specialise and produce more, it also decided what it is that would be produced and what it is that would not. Suddenly, the most important thing in the world was not how much you could manufacture, but how carefully you could decide what to manufacture.
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Consumers were no longer units of labor, no no, consumers were now king. Austrian economics is today seen by most conventional economists as a very fringe idelology for a few reasons. The first reason is because as we will see soon, consumers can be really dumb and irrational, it’s no good to just give them free rein and hope for the best. And secondly it is very controversial because it relies pretty heavily on conjecture rather than rigorous mathematics and statistics.
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This makes alot of their theories non-falsifiable. Which is plain English means impossible to prove wrong, which sounds great, but in reality it just means that because there are no rigorous models drawn or prescriptions set it’s very hard to say this outcome here proves something contrary to your theory. Now because economics is a science, it is extremely important that all theories have robust framework for being tested.
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You write a hypothesis, you conduct an experiment, measure the results and record them. If you can’t do that it is not science. For this reason people like Paul Krugman have noted the Austrian School more as a branch of philosophy rather than economics. Ouch. Outside of academics, the Austrian school remains very popular in part because of it’s simple logical nature, in part because it tends to support free-market principles, in
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part because it does away with alot of the modeling and mathematics that can make economic boring and in part because it contributed a lot to our modern understanding of how to world works. Just because modern academics snob this school and its pundants does not mean that its contributions were any less important. Today things like marginal utility, consumer choice and opportunity costs are the first things that students will learn in their introduction to economics classes.
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But there were still ways to improve upon this and turn these understandings, and insights into a workable framework for how to run a nation, outside of let people do what they do. Which is where John Maynard Keynes Came in. If a regular person has heard of any economists it would be Keynes, he is touted as the most influential economist of the 20th ceturary and has today defined the way that almost all governments around the world manage their economic affairs.
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His contributions were plentiful and too extensive to explore in a single video but one of that was of particular importance during his lifetime was the introduction of countercyclical fiscal policy. Since the role out of classical economics in the wealth of nations, economies had become many many times more complex. Factories, markets, advanced financial systems, consumer debt, public corporations were all
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now commonplace and the ebs and flows of national prosperity were no longer determined by the harvest but rather by the business cycle. Around the early 1800’s economies started experiencing ups and downs that could not be explained exclusively by outside forces, but rather by the sentiment of the people within the nation. Since consumers were the center of modern economies their feelings impacted the economy as much as if not more so than real forces like natural disasters, wars, or plagues.
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This again shows that this school of economic though was a product of it’s time, keynes started writing his most widely recognized work, “the general theory of employment interest and money” during the great depression. Now these types ups and downs could be very unsettling and could impact the health of an economy in the long term. For example, who would want to invest in a company if they knew a devastating recession
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was going to come about every ten years which could send that business bankrupt? Well nobody, but businesses needed funding to continue to grow the economy. The solution was to try and smooth out this business cycle by artificially influencing the spending of consumers. Nations would do this through fiscal policy, which called for taxing people more and spending less government money during economic booms, and then taxing less and spending more during an economic downturn.
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Higher taxation effectively forces people into having less money which means they can’t go quiet as crazy with their spending and taking on of debt making the good times not quiet as crazy, conspicuous and gatsby esque. On the flipside when that tax is lowered and the government starts spending lots of money well suddenly people have a whole lot of extra money in their pocket that they can go out and spend to make the economy not as terrible during a recession.
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Keynses plan was not to completely remove the business cycle, but make it go from looking like this, to like this. Now the benefits of this are kind of hard to see, sure the bad times are not as bad but the good times are not as good, so what gives? Well the argument is that by making both of these less severe, the economy was more consistent and people could plan for long term growth, rather than just surviving the next catastrophic downturn.
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The Austrian school hated this idea because it was tampering with the free market which would limit efficiency. This disagreement often saw Keynes at odds with his Austrian contemporary Friedrich Hayek culminating in some fantastic debates and a cringe-inducing rap battle which you should definitely go and watch after this. Now you can see keynsian economics in practice today. In response to the economic fallout of the coronavirus governments around the world have
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dropped their taxes and rolled out massive government stimulus packages, all in an attempt to make the downturn a little less severe. The one critique that most modern economists give to this practice is that governments are very quick to roll out the keysian fiscal stimulus during a downturn, but normally forget about the higher taxation and lowered spending during the good times. In the next video Economics is a very diverse study that is founded on an unanswerable question.
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By its very nature it is going to cause some disagreements, conflicting ideologies and yes even some controversy. Now this is not that much different from any other scientific pursuit, if you ask any group of scientists about a new theory in their respective field they are ging to have different opinions on it, its just that the opinions of economists garner a lot more attention because in many ways it is us who are being experimented on.
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These three schools of economic though, classical, austrian, and keysian agree on far more than they disagree on, but as with any competing ideologies they are defined by their differences. Now so far as we have seen these have been more of an evolution on one another rather than a revolution, which seques us nicely into the next video in this series... Marxism. But for now at least remember that amongst all of these disagreements economists are
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still all working towards a common goal, solving the central economic problem. They agree on far more, then they disagree on, and one of thing that everybody can agree on is the importance of investing in the future. Fortunately, this is made a lot easier....
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