The Most Important Economic Schools of Thought | Economics Explained

0:00 An economy is a collection of production and consumption processed

0:03 that are all working towards solving the central economic problem.

0:08 The problem is that we only have access to a finite amount of resources,

0:12 but the potential for human consumption

0:15 of goods and services is pretty much limitless.

0:18 This is the foundation of economics,

0:21 every study, every paper, every theory, economic policy,

0:25 or experiment is ultimately an attempt to find a solution to a problem,

0:29 that by its very nature, has no solution.

0:34 Economics is considered a social science,

0:36 and although some other scientists from more “rigorous”

0:39 fields don’t always welcome it into their little club,

0:42 it still follows the same processes to explore the world around us.

0:47 And, as with science, or anything that is extremely complex for that matter,

0:51 there are disagreements between practitioners at all levels

0:54 of academia and throughout the entire history of the subject.

0:59 The economic schools of thought are very broad

1:02 ways that economists are clumped into basic groups.

1:06 Now the first thing to know about all of these schools

1:07 of thought is that they all agree with one another on most issues.

1:12 In the same way that two physicists will obviously agree

1:14 with one another that and object at rest will remain at rest,

1:18 but might disagree about string theory.

1:20 Two economists will obviously agree that there

1:22 are opportunity costs for every unit of production,

1:24 but they might disagree on the long term implications of a consumption tax.

1:30 The reason you are much more likely to hear

1:32 about disagreements in economics rather than physics are threefold.

1:36 One, the foundation of economics is an unanswerable question,

1:40 so there is a certain element

1:43 of philosophy and morality in this academic pursuit,

1:46 no matter how much economists attempt to sterilize it with mathematics.

1:50 Two, economies are really hard to experiment on.

1:55 If there is some radical new theory about effective taxation,

1:58 the only real way to see if it will work is

2:01 to get that tax law passed in a country and study the results.

2:05 If the experiment doesn’t work, then oh well you just destroyed a nation.

2:10 This difficulty in testing theories also means that a lot of fringe ideas are

2:14 hard to disprove in the same way they would be in a chemistry lab.

2:18 And three, economics is something we all feel day in and day out.

2:24 The economy impacts our financial situations,

2:27 our governments, retirements, environments, crime rates,

2:30 and basically anything else that is going to make news headlines.

2:34 As with anything that people are invested in they form opinions around it.

2:37 And those opinions are held by everybody from nobel laureate

2:41 career economists to that crazy guy advocating for a seed-based economy.

2:46 If this contention wasn’t enough then there

2:48 is one other issue that makes these schools

2:50 of thought difficult to deal with, and that is

2:53 that there are no strong borders between them.

2:56 There are plenty of economists that agree with some of the principles

2:59 of one school of thought and then disagree wildly on some other area’s.

3:03 Which is actually a good thing.

3:06 But more on that later.

3:11 For now, to try and make sens of this wild

3:13 world we are going to look at three major schools,

3:16 Classical, Austrian, and Keynesian.

3:19 To show the differences between these schools we are going to look

3:22 at the way they suggest solving the central economic problem in key areas.

3:27 What they suggest the role of government is.

3:29 What do they think the role of the individual is.

3:31 What they propose doing in an economic crisis.

3:34 And finally what is the key to delivering a wealthier happier economy?

3:45 INTRO AD– START][ INTRO AD– END] Now economies have always been a thing,

4:10 and before people even knew what they were doing they were attempting

4:14 to satisfy their desires with the limited resources they had available to them.

4:18 This went on for an extremely long time and great empires rose

4:23 and lived and died all harboring economies

4:25 that they didn’t think to specifically study.

4:28 Everybody from Aristotle to Jesus presented an answer to the question,

4:32 but nobody had yet thought to ask what the question was.

4:36 (insert jeopardy) Can I have how to satisfy

4:39 unlimited demands with limited resources for 1,000 alex?

4:42 (“that is correct”) this all turned around though

4:45 in the 18th century with a man called adam smith,

4:47 who gave birth to economics and formed the foundation of what

4:51 is now known as the Classical School The classical school of economics,

4:56 as the name would suggest was the first

4:58 incarnation of economics as a separate academic pursuit,

5:02 distinct from finance, governance and philosophy.

5:05 The early practitioners of economics,

5:07 namely adam smith started studying and writing about how

5:10 the world was operating to increase the wealth of nations.

5:14 They found that the world at that time was ruled

5:16 by theory that went on to be known as mercantilism.

5:20 Which could realistically be it’s own economic school of thought,

5:23 had it not been so fundamentally flawed.

5:27 This system relied on economies just desperately trying

5:29 to hoard as much gold as they could,

5:31 by either exporting more than they imported,

5:33 mining more of it within their borders

5:35 or colonies or by plundering it through hostile conflict.

5:40 Now we have explored mercantilism and adam smith before on this channel,

5:43 so if you want more insight on that, go and watch those videos.

5:47 But the big takeaway here is that mercantilism was realistically,

5:51 just fine for most nations throughout history.

5:55 These nations were extremely basic and their economic success primarily

5:59 revolved around the strength of the harvest in any given year,

6:02 and later turned into how many colonies they could claim.

6:06 More or less it was a zero-sum game,

6:08 if someone or some country was getting richer,

6:11 it was because someone else was getting poorer,

6:16 and mercantilism perfectly mirrored this reality.

6:19 Having a perfectly run fiscal and monetary policy would not have meant

6:23 very much to the overall prosperity of these types of very basic nations.

6:28 It would have been like putting nitrous on a horse-drawn carriage.

6:32 It wasn’t going to do anything and it would

6:35 probably just make everybody very confused with its needless complexity.

6:39 This was all starting to change though when adam smith

6:42 was putting pen to paper to write the wealth of nations.

6:45 The first steam-powered factories had sprung

6:48 into existence and for the first time ever,

6:51 wealth was not been grown or mined it was being created en masse.

6:56 This was a chance for all people to become wealthier"."==

7:22 Now this sounds like some commie nonsense but what smith

7:25 was trying to say here is that there is an optimal

7:28 distribution of wealth creation for all members in a society.

7:32 It definitely should not be equal,

7:34 but it shouldn’t be a swelling peasant class holding up a tiny nobility either.

7:39 The Reason for this was not some virtuous quest to feed the poor,

7:43 but rather it was to develop markets and divide labor.

7:48 To show the importance of this Smith used the example of a pin.

7:52 A small sharp poky metal stick, which sounds like an extremely simple product.

7:58 But if a single worker was to wake up in the morning and dedicate

8:03 themselves to making 1 single pin they probably wouldnt be able to do it,

8:07 because they would need to mine the materials, refine the steel,

8:11 forge it, and sharpen it all to make 1 pin.

8:15 Of course, if all of these tasks were done by separate workers,

8:19 then they could just focus on their role

8:21 and producing pins would be a lot easier.

8:24 So much so that there would be an abundance of pins that could

8:28 then be shared around all of the workers that contributed to this process.

8:34 Now this example of one person making a pin sounds silly to us,

8:38 but for a long time this was effectively how economies operated.

8:42 Feudal villages would produce pretty much everything they needed

8:46 and even individual households would be more or less self-sufficient.

8:50 The reason why people did this is that there was no real alternative,

8:54 village markets were basic at best and most peasant workers didn’t

8:58 even receive an income as you or I might know it.

9:02 But, by moving into factories and earning a cash

9:05 wage individuals now had the ability to make purchases,

9:08 which gave the entire economy the ability to specialize.

9:12 Immanuel Kant a legendary philospher of all people may have said

9:16 it best in his 1785 book the Groundwork and Metaphysics of Morals.

9:21 Where he quoted that.

9:23 “All crafts, trades and arts have profited from the division of labour;

9:26 for when each worker sticks to one particular kind of work

9:30 that needs to be handled differently from all the others,

9:32 he can do it better and more easily than when one person does everything.

9:36 Where work is not thus differentiated and divided,

9:40 where everyone is a jack-of-all-trades,

9:42 the crafts remain at an utterly primitive level.” So

9:45 with this new understanding of how to build a better world,

9:49 these were the prescriptions of these early

9:52 philosophers and financiers turned economists.

9:55 Markets should be free because the more that people

9:57 are allowed to trade freely with one another the more

9:59 they can specialize and count on others to specialize

10:02 to deliver all of the goods that they need.

10:05 Nations should also do the same thing,

10:08 stop trying to hoard gold and instead realise who does what well,

10:12 once this is known trade amongst other nations to to increase wealth.

10:17 Production is the most important part of the economy

10:20 and great efforts should be made to making

10:22 this more efficient so that more wealth can

10:25 be created from turning raw materials into complex products.

10:29 Government intervention in free markets should

10:31 be limited exclusively to making sure

10:33 that contracts are upheld and fraud is not allowed to take place.

10:37 And of individuals, classical economics assumes that everybody

10:40 buying and selling and working is perfectly

10:43 rational and will always make the most logical

10:47 decision possible to forward their own selfish interests.

10:52 More or less classical economics argues that we can all work

10:55 together to make the world a better place by being extremely selfish.

11:00 I guess Gordon Gecko was a classical economist

11:04 (cutaway clip) Now these theories worked very well,

11:07 and when applied the age of industry they

11:09 were a guiding force behind the development of jobs,

11:12 companies, and markets as we know them today.

11:15 But these ideals weren’t perfect,and now that the foundation was set,

11:19 the great thinkers from around the world.

11:25 The first to really shake up this new way of thinking were a collection

11:28 of economist from vienna who went on the form the, Austrian School The Austrian

11:34 school shares a lot of similarities

11:36 with classical economics and most of the economists

11:38 that have now gone on to define this field didn’t even know that they were,

11:43 in the same way, adam smith didn’t know

11:46 he would create the academic discipline of economics.

11:48 Rather what these early academics were trying to do

11:51 was fix up some loose ends of classical economics primarily

11:54 by realizing that an economy wasn’t some amorphous blob

11:58 of production but rather it was a collection of individuals.

12:03 With this, these scholars started adding

12:05 in more allowances for how individuals acted,

12:08 and specifically how they valued things.

12:11 Carl Menger was the father of the Austrian School of Economics and is credited

12:16 with contributing to the theory of Marginal

12:18 Utility along side his student Friedrich von Vieser.

12:22 The theory of marginal utility was an extremely

12:25 important contribution to economics as a whole.

12:28 It argued that goods provide a utility,

12:31 but their utility is decreased for every extra unit of that good there is.

12:37 For example the extra utility someone gets from having

12:40 1 kettle as opposed to zero kettles is pretty big.

12:44 Suddenly they can boil water and make tea or coffee

12:46 where they wouldn’t have otherwise been able to in the past.

12:51 Going from 1 kettle to 2 kettles also has its benefits,

12:54 you can now boil more water at any given time,

12:57 and if one breaks down you have a spare ready

13:00 to go for redundancy ready tea and coffee making duties.

13:03 But 3 kettles 4 kettles 20 kettles?

13:07 Th ere is only so much tea and coffee a household really needs and eventually,

13:12 these items start taking up so much space that people want less of them meaning

13:17 at extreme levels an extra item can have

13:20 a negative marginal utility value to the consumer.

13:24 This ran contrary to the classical school

13:26 of economics which simply advocated for making

13:28 as much stuff as possible and then

13:31 letting the free market decide what went where.

13:34 Now again this might sounds obvious to us now,

13:37 but you have to remember 2 important things.

13:41 The first was that this theory was

13:43 a huge contribution towards solving the central economic problem,

13:45 sure they still had unlimited desires and only

13:48 limited resources in which to fulfil those desires,

13:51 but they added the Asterix that actually,

13:54 some specific desires can be over satisfied so an economy must avoid that at all

13:59 costs so that there is more leftover

14:01 to satisfy other desires that haven’t been met yet.

14:05 The second was that this was the first inkling

14:08 of economic theory adapting to a world of genuine sustained growth.

14:13 Before the 1800’s the idea that anybody could

14:16 have too much of something was pretty bizarre,

14:18 but with factories all across Europe working day

14:21 and night to produce all manner of everything,

14:24 the decisions that everybody was making was starting to shift from, can

14:27 I afford this, to, would I rather have this or that.

14:32 This deeper understanding in a world that was becoming more

14:35 and more plentiful eventually culminated in the Subjective Theory of Value.

14:40 This theory argues that an item is not worth the sum

14:42 of the materials and labor that go into making it,

14:45 but rather it is worth a function of how important it is.

14:49 For example, a worker could spend their entire life digging

14:52 the deepest hole in the ground the world has ever seen,

14:56 but that hole is going to have less actual value than one

14:59 that was dug 3 feet deep before hitting a solid gold nugget.

15:03 Or as it relates to industry,

15:05 a factory could build car out of titanium and sure it

15:08 would probably be better than a car made out of steel,

15:11 but it would take 10 times the manhours and 10

15:15 times the costs of materials to make that car,

15:18 and it might be 20% lighter and stronger.

15:22 Now since people are not going to pay

15:24 300 thousand dollars for a titanium edition Toyota Camry,

15:27 these types of subjectively inferior goods don’t get made.

15:32 Who is it that decides that these goods dont get made?

15:36 Rational consumers.

15:37 So suddenly the Austrian school of economics

15:39 added a second role to the free market, not only was it a medium of exchange

15:45 that let people specialise and produce more,

15:47 it also decided what it is that would be produced and what it is that would not.

15:52 Suddenly, the most important thing in the world

15:55 was not how much you could manufacture,

15:57 but how carefully you could decide what to manufacture.

16:02 Consumers were no longer units of labor, no no, consumers were now king.

16:07 Austrian economics is today seen by most conventional economists

16:11 as a very fringe idelology for a few reasons.

16:15 The first reason is because as we will see soon,

16:18 consumers can be really dumb and irrational,

16:20 it’s no good to just give them free rein and hope for the best.

16:24 And secondly it is very controversial because it relies

16:27 pretty heavily on conjecture rather than rigorous mathematics and statistics.

16:32 This makes alot of their theories non-falsifiable.

16:36 Which is plain English means impossible to prove wrong, which sounds great,

16:40 but in reality it just means that because

16:42 there are no rigorous models drawn or prescriptions

16:45 set it’s very hard to say this outcome

16:48 here proves something contrary to your theory.

16:51 Now because economics is a science, it is extremely important that all

16:55 theories have robust framework for being tested.

16:59 You write a hypothesis, you conduct an experiment,

17:02 measure the results and record them.

17:04 If you can’t do that it is not science.

17:07 For this reason people like Paul Krugman have noted the Austrian

17:11 School more as a branch of philosophy rather than economics.

17:16 Ouch.

17:17 Outside of academics, the Austrian school remains very popular

17:19 in part because of it’s simple logical nature,

17:22 in part because it tends to support free-market principles,

17:26 in part because it does away with alot

17:28 of the modeling and mathematics that can make economic

17:30 boring and in part because it contributed a lot

17:34 to our modern understanding of how to world works.

17:37 Just because modern academics snob this school and its pundants

17:41 does not mean that its contributions were any less important.

17:44 Today things like marginal utility,

17:47 consumer choice and opportunity costs are the first things

17:51 that students will learn in their introduction to economics classes.

17:53 But there were still ways to improve upon this and turn these understandings,

17:57 and insights into a workable framework for how to run a nation,

18:01 outside of let people do what they do.

18:05 Which is where John Maynard Keynes Came in.

18:08 If a regular person has heard of any economists it would be Keynes,

18:13 he is touted as the most influential economist of the 20th ceturary and has

18:17 today defined the way that almost all

18:19 governments around the world manage their economic affairs.

18:23 His contributions were plentiful and too extensive

18:25 to explore in a single video but one of that was of particular importance during

18:30 his lifetime was the introduction of countercyclical fiscal policy.

18:34 Since the role out of classical economics in the wealth of nations,

18:37 economies had become many many times more complex.

18:41 Factories, markets, advanced financial systems, consumer debt,

18:44 public corporations were all now commonplace and the ebs and flows of national

18:49 prosperity were no longer determined by the harvest

18:53 but rather by the business cycle.

18:56 Around the early 1800’s economies started experiencing ups and downs

18:59 that could not be explained exclusively by outside forces,

19:03 but rather by the sentiment of the people within the nation.

19:07 Since consumers were the center of modern

19:10 economies their feelings impacted the economy as much

19:13 as if not more so than real forces like natural disasters, wars, or plagues.

19:20 This again shows that this school of economic though was a product of it’s time,

19:24 keynes started writing his most widely recognized work,

19:27 “the general theory of employment interest

19:29 and money” during the great depression.

19:31 Now these types ups and downs could be very unsettling

19:35 and could impact the health of an economy in the long term.

19:39 For example, who would want to invest in a company if they knew a devastating

19:43 recession was going to come about every

19:46 ten years which could send that business bankrupt?

19:49 Well nobody, but businesses needed funding to continue to grow the economy.

19:55 The solution was to try and smooth out

19:58 this business cycle by artificially influencing the spending of consumers.

20:03 Nations would do this through fiscal policy, which called for taxing people more

20:07 and spending less government money during economic booms,

20:10 and then taxing less and spending more during an economic downturn.

20:15 Higher taxation effectively forces people into having less

20:18 money which means they can’t go quiet as crazy

20:21 with their spending and taking on of debt

20:24 making the good times not quiet as crazy, conspicuous and gatsby esque.

20:29 On the flipside when that tax is lowered and the government

20:33 starts spending lots of money well suddenly people have a whole lot

20:36 of extra money in their pocket that they can go out

20:38 and spend to make the economy not as terrible during a recession.

20:43 Keynses plan was not to completely remove the business cycle,

20:46 but make it go from looking like this, to like this.

20:50 Now the benefits of this are kind of hard to see,

20:53 sure the bad times are not as bad

20:55 but the good times are not as good, so what gives?

20:59 Well the argument is that by making both of these less severe,

21:03 the economy was more consistent and people could plan for long term growth,

21:07 rather than just surviving the next catastrophic downturn.

21:11 The Austrian school hated this idea because it was

21:14 tampering with the free market which would limit efficiency.

21:18 This disagreement often saw Keynes at odds

21:20 with his Austrian contemporary Friedrich Hayek culminating in some

21:24 fantastic debates and a cringe-inducing rap battle which

21:27 you should definitely go and watch after this.

21:30 Now you can see keynsian economics in practice today.

21:35 In response to the economic fallout of the coronavirus governments around

21:38 the world have dropped their taxes

21:40 and rolled out massive government stimulus packages,

21:43 all in an attempt to make the downturn a little less severe.

21:47 The one critique that most modern economists

21:49 give to this practice is that governments

21:51 are very quick to roll out the keysian fiscal stimulus during a downturn,

21:56 but normally forget about the higher taxation

21:58 and lowered spending during the good times.

22:01 In the next video Economics is a very

22:05 diverse study that is founded on an unanswerable question.

22:08 By its very nature it is going to cause some disagreements,

22:12 conflicting ideologies and yes even some controversy.

22:16 Now this is not that much different from any other scientific pursuit,

22:19 if you ask any group of scientists about a new theory

22:23 in their respective field they are ging to have different opinions on it,

22:27 its just that the opinions of economists garner a lot more attention

22:31 because in many ways it is us who are being experimented on.

22:35 These three schools of economic though, classical, austrian,

22:38 and keysian agree on far more than they disagree

22:42 on, but as with any competing ideologies they are defined by their differences.

22:48 Now so far as we have seen these have been

22:51 more of an evolution on one another rather than a revolution,

22:54 which seques us nicely into the next video in this series...

22:59 Marxism.

23:00 But for now at least remember that amongst all

23:04 of these disagreements economists are still all working towards a common goal,

23:09 solving the central economic problem.

23:11 They agree on far more, then they disagree on, and one of thing that everybody

23:15 can agree on is the importance of investing in the future.

23:28 Fortunately, this is made a lot easier....