Theory on Economics


Economics is rich in theory. For economists, theory provides a framework for understanding and analyzing economic phenomena. The various theories of economics developed over the years could fill encyclopedias. A useful way to understand theories of economics and their development over time is to look at the major schools of economic thought that have developed over time.


Major schools of theory in economics include Classical, Marxian, Keynesian and Neoclassical.

Classical Economic Theory

Classical economic thought arose in the 18th century in response to the mercantilist thought that dominated the 16th and 17th centuries. Mercantilism postulated that a nation grew wealthy by accumulating gold and silver. Adam Smith, the key figure in classical economics, argued instead that national wealth was created in a self-regulating market characterized by a division of labor and only limited government intervention. Smith and other classical economic theorists advocated the notion that self-interested individuals pursuing their own interests end up benefiting society as a whole. Other classical ideas, such as market self-regulation and trade benefiting all parties involved, remain important principles of economics. In addition to Smith, other key Classical theorists include David Ricardo and John Stuart Mill.

Marxian Theory

Karl Marx’s ideas challenged those of the Classical theorists in the 19th century. While the Classical theorists largely separated economics from politics, Marx’s view was that the capitalist economy spawned powerful political forces along class lines. Marx saw workers and the owners of factories as classes with conflicting interests, and believed that capitalism exploited workers by paying them wages that fell short of the true value of their labor. This fuels worker alienation, which Marx believed would eventually usher in a worker uprising that would overthrow the capitalist class and seize control of the means of production.

Keynesian Theory on Economics

Keynesian theories grew out of the work of English economist John Maynard Keynes, an influential figure during the Great Depression of the 1930s. Keynes criticized the Classical arguments for a self-regulating market, contending that the market, left to its own devices, will not necessarily fully use its productive capacity. This failure, Keynes believed, requires government intervention. Keynes’ theories provided the rationale for government fiscal policy as a means to stabilize an economy.

Neoclassical Economic Theory

Neoclassical is the dominant school of economic theory. Building on the ideas of the Classical economists, Neoclassical theory has as its central assumption a self-interested individual who, faced with a set of choices, selects the one that brings her the greatest satisfaction. Thus, exchange in the marketplace relies on voluntary transactions between rational, self-interested parties. Government’s role in the economy is to intervene in cases where the market fails to allocate resources efficiently and to provide public goods, such as defense and infrastructure.

Other Theories of Economics

Other branches of economic theories include Institutionalism and the Austrian school of economic thought. In contrast to theories about the efficiency of capitalism, Institutionalists such as Thorstein Veblen argued that the motivation in capitalism was “conspicuous consumption” as a visible sign of success. Later Institutionalists such as John Kenneth Galbraith also questioned capitalist orthodoxy and advocated nationalization of health care and other activities. Austrian economic theories emphasize a strongly individualist approach to economics. This school of thought is derived from the work of Austrian-born economists such as Carl Menger and Ludwig von Mises. Other prominent Austrian economic thinkers include F.A. Hayek and Murray Newton Rothbard. A key characteristic of the Austrian school of thought is its reliance not on mathematical analysis like other branches of economic thought, but instead of complex philosophical arguments that are often just as intricate.

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