The Most Important Economic Schools of Thought | Economics Explained

The first steam-powered factories fundamentally changed the economic reality because wealth was no longer being grown or mined but being created en masse for the first time, which meant that all people could become wealthier simultaneously rather than in a zero-sum competition.

“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.”

Before the industrial era, feudal villages and individual households were largely self-sufficient because village markets were basic and most peasant workers did not receive cash wages, but factory work and cash wages enabled specialization because individuals could now make purchases in markets rather than being locked into self-sufficiency.

“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.”

Since the rollout of Classical economics, economies became increasingly complex with factories, markets, advanced financial systems, consumer debt, and public corporations, shifting the determinants of national prosperity from harvest strength to the business cycle—ups and downs that could not be explained by outside forces but by the sentiment and psychology of people within the nation.

“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 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.”

Business cycle volatility is economically damaging to long-term growth because investors face uncertainty about whether investments will be bankrupted by recurring recessions, making investors unwilling to fund businesses needed for economic growth, so smoothing the business cycle is necessary to enable consistent planning and growth.

“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 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.”

Adam Smith argued that there is an optimal distribution of wealth creation among all members of society—it should not be equal but also should not consist of a swelling peasant class supporting a tiny nobility—not for virtuous reasons but because developing markets and dividing labor requires a certain wealth distribution to function efficiently.

“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.”

Marginal Utility theory was the first inkling of economic theory adapting to a world of sustained growth, becoming important only after the Industrial Revolution made abundance a realistic possibility rather than a bizarre scenario.

“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.”

The central economic problem is that human consumption potential is limitless while access to resources is finite, and every economic theory, policy, and experiment is ultimately an attempt to solve this fundamentally unsolvable problem.

“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.”

The Subjective Theory of Value argues that an item's worth is not determined by the sum of materials and labor required to make it, but rather by how important it is to consumers, exemplified by a titanium car being objectively superior but economically inferior because consumers won't pay 300,000 dollars for a marginally better Toyota Camry.

“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.”

Rational consumers, through their purchasing decisions, determine which goods get produced and which do not through the free market mechanism of expressing subjective value preferences, making the most important aspect of production not manufacturing capacity but careful decisions about what to manufacture.

“Suddenly, the most important thing in the world was not how much you could manufacture, but how carefully you could decide what to manufacture. Consumers were no longer units of labor, no no, consumers were now king.”

All economists work toward the common goal of solving the central economic problem, despite disagreeing on methods and theory, making agreement on this shared goal fundamental to the discipline.

“But for now at least remember that amongst all of these disagreements economists are still all working towards a common goal, solving the central economic problem.”

Mercantilism was fundamentally flawed as an economic system because it relied on zero-sum wealth accumulation through gold hoarding, which meant the system was realistic and functional for basic historical economies where economic success revolved around harvest strength or colonial possession, but became obsolete when wealth could be created rather than just transferred.

“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 colonies or by plundering it through hostile conflict.”

Marginal utility theory contradicted Classical economics' approach because it recognized that some desires can be over-satisfied, meaning an economy must avoid over-producing those goods so that resources remain available to satisfy other desires that have not yet been met.

“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.”

Austrian economics emphasizes that consumers, not producers, are the ultimate power in the economy, shifting the role from 'units of labor' to 'king.'

“Consumers were no longer units of labor, no no, consumers were now king.”

Carl Menger, the father of the Austrian School, and his student Friedrich von Vieser developed the theory of Marginal Utility, which argued that goods provide utility but that utility decreases for every extra unit of that good, meaning that eventually additional units can have negative marginal utility value to consumers.

“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 unit of that good there is.”

The Austrian School opposed Keynesian countercyclical fiscal policy because tampering with the free market would limit efficiency, leading to famous debates between Keynes and his Austrian contemporary Friedrich Hayek.

“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.”