How do Economic Theories Affect our Economy?

Dr. Gerald House
5 min readOct 13, 2022

“Oh, what a tangled web we weave/when we first practice to deceive,”

Sir Walter Scott

Addressing all the economic theories would take us a month or longer. In an effort not to get too much “in the weeds”, let’s just look at the four major theories and how they have morphed into our current way of thinking about economic and financial issues here in the United States. We can also determine how these theories have shaped our political biases. The four major economic theories are Classical, Neoclassical, Marxian, and Keynesian. However, the one missing ingredient absent from most economic theories is the human element or behavioral actions. We will also address how the Austrian Economic theory attempts to add a behavioral element to their thought process.

Adam Smith originally developed the classical theory in the 19th century. The original contributors were John Locke’s conception of natural order, Adam Smith’s theory of self-interest, and Jean-Baptiste Say’s law of equality of market demand and supply (Economics). It forms the basis of our original economic development here in the United States. The classical economic theory is based on self-regulating democracies and capitalist markets. This is where the term laissez-faire or “let it be” came from (Young, 2022).

The Neoclassical economic theory came as a response to the pull-back from the Classical theory, because it is too idealistic, and does not represent how people make decisions. The basic premise for neoclassical theory is people make purchases based on the utility of the product, not the cost of capital as the Classical theory purports. Additionally, Neoclassical theorists believe the product has value over its cost (Kenton, 2022).

One of the most controversial economic theories devised by Karl Marx is referred to as Marxian Economic Theory, also in a response to the Classical economic theory by Adam Smith. Marxian economics focuses on the division of labor and how specialization and increased population can reduce wages. Marx argued that the cost of labor is not accurately reflected because the ruling class is taking advantage of the workers by exploiting excess workers’ compensation. The Marxian theory concludes that the workers will eventually overtake the ruling class by revolting against their capitalist ways (Liberto, 2022).

John Maynard Keynes developed Keynesian Economic Theory during the 1930s in response to the Great Depression. Keynesian Economics is considered Demand Side theory as opposed to Supply Side theory. Keynes believed the government can regulate the economy by the intervention of government taxes and expenditures. Actively intervening in the fiscal and monetary policy of the government is viewed by Keynesians as the primary tool to guard against poor unemployment (Team, 2022).

The Austrian School of Economics rejects the technical nuances of the Classical, Neoclassical, and Keynesian theorists in favor of a more logical economic model. We consider Carl Menger the founder of the Austrian School of Economics with the writing of his book “The Principals of Economics” in 1871. Other authors have contributed to the Austrian thought process over the years, such as Ludwig von Mises, Eugen von Bohm-Bawerk, and Friedrich Hayek. The basic premise of the Austrian School is the use of logic to discover the laws of universal application as opposed to mathematical models. Menger posits that the economic value of goods and services is subjective. For instance, what is valuable to one person may not be as valuable to someone else. Additionally, Menger suggests that the increase in goods will create a diminishing value for individuals. This diminishing value is what they define as diminishing marginal utility. The Austrian School believes that any increase in the money supply not supported by the increase in goods and services will lead to inflation (Hall, 2022).

Economists have adopted all the economic theories above throughout history, both in the U.S. and globally. However, which ones are relevant today? After the economic crisis of 2008–2009 and now the global pandemic, we can throw out most of the old theories in favor of good old common sense. Does this mean the Austrian School has it right? If so, why do economists still promote Keynesian and Neoclassical theories? We even have a small faction, mostly the younger generation, who are convinced that the Marxian theory of socialism is best. We can see evidence of economic biases by observing our politicians as they attempt to convince people their economic plan is superior to their opponents. One can easily infer the economic leaning of a political party just by listening to their key principles of prosperity arguments.

Dr. Alvin Felzenberg, an American presidential historian, rated the four best economic presidents and concluded that George Washington, Abraham Lincoln, Theodore Roosevelt, and Ronald Reagan deserve the top ratings (The Economist, 2008). I think we can agree, regardless of how you may feel about him, that Donald Trump would be the 5th on Dr. Felzenberg’s list had he conducted his investigation today. President Trump selected an outstanding group of economists to head up his advisory team. Trump’s top economic advisors were Stephen Moore, Author Laffer, Ph.D., and Larry Kudlow who later became Trump’s head of the National Economic Council. Dr. Laffer is considered the father of supply-side economics and was a member of Ronald Reagan’s Economic Policy Advisory Board (Moore & Laffer, 2018).

The argument on which economic theory is best for our economy boils down to just two choices: supply-side theory (Classical Theory or Austrian School) or demand-side theory (Keynesian Theory or Marxian). Do you believe that there should be less government intervention in business and reduced taxes to spur economic growth — a supply-side theory or that the government should spur growth by artificially stimulating consumer demand by government borrowing (deficit spending) and increasing taxes from wealthy individuals and corporations to redistribute to boost the relative wealth of individuals — demand-side theory? You be the judge!

Your faithful servant


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