Economic Theory Essay Example for Free

Economic Theory Essay The word economics is derived from oikonomikos, which means skilled in household management. The society is faced with the following economic problems a). How to what to produce with limited resources? b). How to ensure stable prices and full employment of resources? c). How to provide a rising standard of living both for now and future. The Classical School of economic theory began with the publication in 1776 of Adam Smiths monumental work, The Wealth of Nations. The book identified land, labor, and capital as the three factors of production and the major contributors to a nations wealth. In Smiths view, the ideal economy is a self-regulating market system that automatically satisfies the economic needs of the population. He described the market mechanism as an invisible hand that leads all individuals, in pursuit of their own self-interests, to produce the greatest benefit for society as a whole. While Adam Smith emphasized the production of income, David Ricardo focused on the distribution of income among landowners, workers, and capitalists. Ricardo saw a conflict between landowners on the one hand and labor and capital on the other. He posited that the growth of population and capital, pressing against a fixed supply of land, pushes up rents and holds down wages and profits. Thomas Robert Malthus used the idea of diminishing returns to explain low living standards. Population, he argued, tended to increase geometrically, outstripping the production of food, which increased arithmetically. The force of a rapidly growing population against a limited amount of land meant diminishing returns to labor. The result, he claimed, was chronically low wages, which prevented the standard of living for most of the population from rising above the subsistence level. Malthus also questioned the automatic tendency of a market economy to produce full employment. He blamed unemployment upon the economys tendency to limit its spending by saving too much. . Classical economists theorized that prices are determined by the costs of production. Marginalist economists emphasized that prices also depend upon the level of demand, which in turn depends upon the amount of consumer satisfaction provided by individual goods and services. Marginalists provided modern macroeconomics with the basic analytic tools of demand and supply, consumer utility, and a mathematical framework for using those tools. Marginalists also showed that in a free market economy, the factors of production land, labor, and capital receive returns equal to their contributions to production. This principle was sometimes used to justify the existing distribution of income: that people earned exactly what they or their property contributed to production An advocate of a labor theory of value, Marx believed that all production belongs to labor because workers produce all value within society. He believed that the market system allows capitalists, the owners of machinery and factories, to exploit workers by denying them a fair share of what they produce. Marx predicted that capitalism would produce growing misery for workers as competition for profit led capitalists to adopt labor-saving machinery, creating a reserve army of the unemployed who would eventually rise up and seize the means of production. Institutionalist economists regard individual economic behavior as part of a larger social pattern influenced by current ways of living and modes of thought. They rejected the narrow Classical view that people are primarily motivated by economic self-interest. Opposing the laissez-faire attitude towards governments role in the economy, the Reacting to the severity of the worldwide depression, John Maynard Keynes in 1936 broke from the Classical tradition with the publication of the General Theory of Employment, Interest, and Money. The Classical view assumed that in a recession, wages and prices would decline to restore full employment. Keynes held that the opposite was true. Falling prices and wages, by depressing peoples incomes, would prevent a revival of spending. Summary Economic theories are constantly changing. Keynesian theory, with its emphasis on activist government policies to promote high employment, dominated economic policymaking in the early post-war period. But, starting in the late 1960s, troubling inflation and lagging productivity prodded economists to look for new solutions. Supply-side Economics recalls the Classical Schools concern with economic growth as a fundamental prerequisite for improving societys material well-being. It emphasizes the need for incentives to save and invest if the nations economy is to grow A Production Function and Labor Market Model Graph and the Date Production theory refers to the knowledge of what is permanent and normal in industrial production. There are two main types of production theories i. e. descriptive theory and normative theory. Descriptive theory has the knowledge about past or present production but does not much help for modifying it to correspond better to latest requirements. Examples are the academic and historical stud types. They are sometimes categorized in two types: extensive studies of a large number of cases, and intensive studies of one or a few cases. Normative theory of production consists of generally applicable knowledge and tools that can be used in the management of production, especially for optimizing existing production and planning new production.