Definition of classical economics

A school of economic thought, exemplified by Adam Smith's writings in the 18th century, that states that a change in supply will eventually be matched by a change in demand - so that the economy is always moving towards equilibrium.

Overtaken first by neo-classical economics in the early 20th century, it was then overtaken by Keynesian thought in the 1920s and 1930s. The re-emergence in the late 20th century of policies aimed at minimising government intervention in the economy, including efforts towards free trade, was backed to some extent by principles related to classical economics. [1]

The term classical economics was first used by Karl Marx (1818 – 1883) to describe early economists like Adam Smith (1723 – 1790), David Ricardo (1772 – 1823), John Stuart Mill (1806 – 1873) and Thomas Robert Malthus (1766 – 1834). Most important is Smith’s work An Inquiry into the Nature and Causes of the Wealth of Nations (1776) because it marks the starting point of economics as a science.

Still today, Smith’s concept of the ‘invisible hand’ shapes our understanding of the market economy. It is interpreted as the work of the price mechanism bringing together supply and demand in a market. The result is that the market economy simultaneously maximises the benefits for consumers and firms.

Furthermore, his promotion of the ‘laissez-faire’ concept – where economic performance is optimised when there is limited government interference – opened the door for free trade and a proper role for governments. In terms of trade, the concept means no protectionism. In terms of the role of the government, the ‘laissez-faire’ approach advocates setting up and enforcing a legal system that protects free markets and competition.

Example
David Ricardo’s concept of comparative advantage between countries in international trade, for example, is one theory from classical economics that is still applied today. It states that a country should produce for export goods and services whose production costs are lower than that of other goods.

Ricardo makes his famous example of England and Portugal both producing wine and cloth, but at lower costs in Portugal than in England. Consequently, Portugal has an absolute advantage in trade. However, it makes sense for both countries to trade.

England should focus on the production of cloth and Portugal on wine, because these are the products where both countries have a comparative advantage. That is, Portugal’s production cost for wine is lower than for cloth and in England it is the other way around. For example, with the wine produced, Portugal can buy more cloth through trade than if it used its resources to produce the cloth. The same is true for England . It will get more wine in exchange for cloth, compared to a situation in which it produces its own wine. [2]

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