Schools of Thought

Perspective	Classical	Neoclassical	Marxist	Keynesian	Institutionalist	Behaviouralist
Economy is made up of…	Classes	Individuals	Classes	Classes	Individuals and institutions	Individuals, organizations, and institutions
Individuals are…	Selfish and rational (class-based)	Selfish and rational	Selfish and rational (except workers fighting for socialism)	Not very rational (driven by habits and animal spirits); ambiguous on selfishness	Layered (instinct → habit → belief → reason)	Only boundedly rational and layered
The world is…	Certain (“iron laws”)	Certain with calculable risk	Certain (“laws of motion”)	Uncertain	Complex and uncertain	Complex and uncertain
Most important domain of economy…	Production	Exchange and consumption	Production	Ambiguous, with a minority focusing on production	No strong view, but more emphasis on production than Neoclassicals	No strong view, but some bias toward production
Economies change through…	Capital accumulation (investment)	Individual choices	Class struggle, capital accumulation, technological progress	Ambiguous, depends on economist	Interaction between individuals and institutions	No strong view
Policy recommendations	Free market	Free market or interventionism (depends on failures)	Socialist revolution and central planning	Active fiscal policy, income redistribution toward the poor	Ambiguous, depends on economist	No strong view, but often accepting of government intervention

Classical: The Market remains free, competition auto balances it.

Invisible Hand (Free Market) ( Adam Smith)

• Believes in the invisible hand that guides the market if the demand/supply decreases. (comes from Wealth of Nation by Adam Smith)
• Workers, Capitalists and landlords are the key class structure in this idea.
• If everyone acts on their selfish intent the market will be good for all because this invisible hand will guide it to manage itself, and government shouldn't interfere here.

Say's Law

• Supply creates it's own demand.

Comparative Advantage ( Ricardo )

• Each state( nation ) should be more focused on what they are comparatively better at , this will be better for the market.
• For example, if Britain is making cotton, wine and ships and France is making Cotton and Wine, but France is better at making Wine compared to Britain, then Britain should focus more on making cotton(being good at what they specialize.) It strengths the free trade .
• Maximize output for all the nations that are involved in free trade.

Limitations:

• Say's Law is just wrong, doesn't account for macroeconomics issues like unemployment,recession( he just denies that recession will never happen if we continue to free trade )

Neo-Classical : Individuals are rational beings so give them independence, until and unless market is stable.

Labour Theory of Value

• It says that the value of a product(commodity) is determined by the amount of time/effort ( labor) has been put into it.
• ( Neo-Classical Doesn't Believe in that btw)
• Neo-Classical would say, just because something is really hard to make doesn't mean it's worth more.
• Marshall: demands matter short-run, supply matter long-run.

Analytics

• Uses analytics , calculus and mathematics in general to analyze the market.
• Assumes people are rational actors and make decision to maximize their satisfaction ( utility ) given their limited resources.

Marginalism

• an economic law that states that all else being equal , as consumption increases , satisfaction decreases from each additional unit.

General equilibrium theory

Marxian Economics: Capitalism is powerful but it will collapse, as private property ownership becomes a hindrance to further progress.

Mode of Production ( economic base)

• Production is basis of social order:
  • Forces of Production include technologies,machinery, skills, factories etc.
  • Relations of production include employments, division of labour etc.
• Superstructure(culture, politics, art) rests on this base and influences it. ( not related to forces of production directly kinda )

Historical Stages & Class Struggle

• Societies evolve through modes of production ( primitive communism, antiquarian, feudalism, capitalism, communism).
• Class conflict is the thing that drives this historical (social ) change.

Nature of Work

• Work can be creative as welll but it is dehumanizing under capitalism due to fine divisions of labour (alienation). and this just comes under theory of alienation

Production Focus & Theory of the Firm

• Focuses on production, unlike Neoclassical focus on exchange.
• Saw firms as 'islands of planning' in the market's 'anarchic sea'.
• Foresaw the rise of large joint-stock companies (corporations).

Keynesian : What is good for an individual isn't usually good for the whole economy.

Macroeconomics:

• Kinda invented this as he studied the whole of economy and how it is affected by the economic actors .
• Macroeconomics: branch of eco that deals with performance, structure , behavior and decision-making of an economy as a whole.

Recession and Ideas Around It:

• He argued against the idea of self-balancing markets, he said it's impossible and there's a flaw when we reach recession.
• He said we shouldn't thrift ( save ) during a recession, but rather spend, government should do their best to spend more money creating more jobs increasing the GDP.
• If everyone saves, people get laid off, they also save, prices go up, economy goes down.
• We need fiscal/monetary policies during recession.
• Eg: Government can make a bridge, so we get more workers, employment increases, they spend more so overall economy boosts.

The main policy prescription from Keynesian theory is the necessary role of governments in boosting demand through public investment

Institutional Economics: Individuals are product of society, even though they can change it's rules.

Ideas:

• Challenges classical and neo-classical for underplaying or bare right ignoring the social conditions of individuals in an economy.
• Individuals are shaped by society: the rise of the Institutionalist school.
• Human motivation is layered (instinct, habit, belief, reason). Rationality is context-dependent.

Institutions (Formal & Informal Rules)

• Focuses on analyzing formal rules (laws, company policies) and informal rules (customs, social norms) that shape behaviour and the economy.

• Institutions both constrain and shape individuals.

Transaction Costs

• Focuses on the costs of organizing economic activity: finding information bargaining , monitoring, making contracts.
• Institutions (rules, firms) actually rise to minimize these costs.

Behavioural Economics: We aren't that deep so we gotta constrain ourselves our own freedom through rules.

Kinda rejects the Neo-Classical theory by saying individuals aren't rational and gives examples.

Bounded Rationality (Herbert Simon)

• People try to be rational but their reasoning is limited to their understanding and comprehension of the world
• Information processing capacity is often the key limitation.

Role of Emotion, Loyalty, Fairness

• Emotion focuses attention.
• loyalty reduces monitoring costs
• perceived fairness builds loyalty.

Organizational Routines & Institutions as Rules

• Organizations and social institutions develop rules(routines kinda) to compensate for individual cognitive limits, simplify problems, and make their behaviour predictable. As in like enforcing rules as we aren't smart enough

Heuristics ( mental shortcuts ) & Satisficing

• People use mental shortcuts (heuristics, rules of thumb, pattern recognition) to ease decisions.
• People aim for 'good enough' outcomes (satisfice) but that doesn't lead to the absolute best (optimize).

GDP

What is it?

• G = Gross ( meaning Total)
• D = Domestic ( Meaning in Country )
• P = Product ( total goods and services )
  So the definition becomes:

The monetary total value produced by all the final goods and services within the country borders within a certain period of time(usually a year or a quarter) is GDP.

It is one of the most important economic factors that we use to understand the economy as a whole.

How do we calculate it?

To understand this first we need to understand what exactly does "final goods and services" mean exactly, to simply put they are the final and finished products.

For example if our country is a bakery, the cake that we make is the product whose value will be counted in GDP, not the flour you brought, not the sugar you brought.
But if some country can not produce the Cake but gives you flour, than that is counted in their GDP.

And also "within country's border" means even if the producer is foreign it counts in the country's border where it is produced.

Problem: While doing this calculation there is a problem of multiple counting because if we just sum up everything we are bound to make errors so we use certain methods to calculate GDP.

Methods to Calculate:

Value Addition Method:

• We add the value of the good by the profit it made by each iteration ( each stage of production ).
• This way we don't accidentally include the previous price by solely just adding the profit.
  For example:
• A bakery bought flour for 10 rupees, made bread, sold that bread for 20 , a sandwich shop bought bread and made sandwich and sold for 50. So if we calculate normal we would have 10+20+50 which isn't an accurate representation.
• So what we would do is we would add 10 + (20 - 10) + (50 - 20) = 50 , which is the final value of the product so GDP increases by 50.

Expenditure Method:

• This just counts the total "expenditure" ( spending ) by all sorts of entities.
• Consumer( C ) = Products that are bought by local household and by individuals.
• Investments ( I ) = Investments done by Businesses in order to scale their economy on capital goods like machinery, land etc.
• Government Expenditure ( G ) = Spending done by government in order to facilitate new infrastructure and public services.
• Net Exports : We deduct the imports from exports to get net exports.

Totaling all of this we get out GDP as :
C + I + G + (X - M).

Income Method:

• Here we just add up income from all the classes to get total GDP.
• Wages of Labour, Rents for Landlords, Profits from Entrepreneur and Interest for Capital.
• GDP = Wages + Rent + Interest + Capital ( RICW )

Ideally all the methods should give same GDP but they don't. Hence we have different ways to understanding GDP.

GDP's Variants

GDP Per Capita

It just means GDP divided by total population.
$\text{GDP Per Capita}=\frac{GDP}{Population}$
It is kind of used to compare standards of living across countries, for example GDP of India is Huge compared to Norway but GDP Per Capital shows that our standards of living are comparatively lower than that of Norway because of our large population.

GDP Growth Rate

This measures how fast the economy is expanding or growing.
Higher GDP growth rate shows booming economy while lower growth rate indicates recession of economic crisis.
China and India have really good growth rate right now making us amazing economies while other developing countries aren't so booming.

Limitations:

While GDP can be a really nice measure of how well economy is doing in a country, measuring it across space gives us good result but measuring across time gives us results which aren't so good because it doens't account for inflation, purchasing power, currency rates etc. So we have to make adjustments. Those are:

GDP Comparison with Time

Real vs Nominal GDP

• Real GDP accounts for inflation as we see that in year 2000 if our GDP was 100 Crores, and in 2001 it became 120 Crore that shows we have 20% increase in GDP but this is nominal GDP it increases with inflation which is not desirable.
• Real GDP is calculated by using $\text{Real GDP}=\frac{\text{Nominal GDP}}{\text{GDP Deflator}}\cdot 100$
• If let's say in the above example inflation was 10% $\therefore$ GDP Deflator becomes 110, and Real GDP becomes 109.1% showing the actual growth.

Comparing Across Countries

Because countries use their own currency we convert it into one common currency usually the USD to compare them.

Exchange-Rate Comparison

• Directly divide by exchange-rate the GDP.
• This has limitations and doesn't capture the actual comparison as exchange rate are fluctuating.

PPP ( purchasing power parity )

• After doing the exchange-rate we also calculate the PPP, which means in simple terms that the value of a dollar will be different everywhere, what you can get from 1 dollar in the US isn't the same as what you can get it in India.
• ​ PPP adjusts GDP based on what money can actually buy in each country giving actual comparison.
• For example India's Nominal GDP = $1 Million ( exchange rate )
• PPP Factor = 3 ( meaning 1 dollar in India would buy the same as 3 dollars in US, to put this in perspective 1 dollar in india let's say can buy a lunch while 3 dollars might require in the US for the same lunch)
• So India's GDP ( PPP ) becomes $3 Million.

Why is this used?

• Poor countries have cheaper goods and services making their actual economic output higher than the exchange rate.
• This is a better comparison for standards of living across countries.
• IMF, World Bank all of them use this for developmental analysis.

Limitations of GDP as Economic Welfare

GDP doesn't fully capture the whole societal well-being that we think it does, here are some of the cases where it fails:

Excludes Non-Market Activities

• GDP only counts market transactions goods are services bought and sold etc.
• Household work like chores, cooking , cleaning often done by women is not counted.
• This leads to underestimation of the economic where household work is prominent.

Illegal Activities

• Many countries have a large informal sector( which goverment is sometime unaware of or aware of and chooses to avoid) where people work without official records (e.g., street vendors, small-scale farmers).
• Illegal Activittes like black market trade, buying / selling drugs which have no records are also a large part of an economy but isn't accounted in GDP.

War and it's Effects

• GDP rises during war and conflict which doesn't mean the economy is thriving as the money expenditure is going to the military which creates job in that sector.
• But war also destroys infrastructure , lives and economics but we count that as rebuilding as a positive growth but it isn't

GDP Per Capita and Inequality

• It gives an average but does not show how income is distributed which in small countries showcase poor standards of living as the wealth is usually distributed among very few people in the state .

Foreign Investments and Tax Havens

• Businesses go to Tax Havens countries like Ireland , Monaco, some countries in Europe where Tax laws are light and keep their production sector there, so any revenue that is generated by the sector counts under that countries GDP but the money is sent back to the parent nation which inflates the GDP as it's not used for that nation in any form.

Economic Welfare and Understanding

• This will be from Employment and Unemployment go shu shu.