What is Classical Economics？ ｜ Adam Smith ｜ New IB Economics Syllabus ｜ IB Microeconomics

Hey, hey, everybody. I hope you're doing well today. My name is Brad Cartwright, and the following video is a free preview from bradcartwright.com, a website designed for IB Economics students all around the world so that you know you will have all of the information you need to feel empowered for a unit test, a semester exam, or ultimately the IB exam at the end of your two-year journey. So take a look at the website when you get a chance, and in the meantime, enjoy this free preview. All right, now let's take a look at the beginning of the story, right? Every historical process has a beginning, and our beginning is with classical economics, and this starts in the 18th century, which is the 1700s, okay? So as I said, remember, in order to be a fully informed economist, you've got to realize that economic theory has evolved, and it evolved basically from philosophers in the 1700s and 1800s. In the late 1800s, as things got more industrialized and more complex in the sense of what to look at in terms of human behavior, mathematics became part of the story in economics, which is where we started getting all of our graphs and things. And then, as you get into the 1900s and the 20th century and 21st century, the 2000s, what you find is you have a combination of philosophy, mathematics, and psychology. Remember that. Philosophy, mathematics, and psychology. And with those three tools is what we look at economics with in this course, okay? So let's start at the beginning of the story, right? The beginning of the story starts in 1776, but before Adam Smith wrote his book called The Wealth of Nations, the world functioned in a form called mercantilism. And if you think about your history classes, like mercantilism is the form of the economic system that was employed by the British more than anybody else, which was basically the government was heavily, heavily involved in the economy, okay? And at that time, what created wealth for a nation, and that's what you have to understand, that like we're talking about the wealth of a nation, and that means wealthier people in it, was the supremacy of gold and silver. So if you were Spain, or France, or Great Britain, or Portugal, or the Dutch, right, or the Belgians, what you're looking for is gold in the first place, right? Well gold and silver established the wealth of a nation. And the goal therefore was to maximize exports, so I'm British and I want to sell my stuff to other people, so I'm gonna go get colonies all around the world, and minimize imports. I don't want your stuff, Spanish. I don't want French wine, I just want my German beer, my German beer maybe, or my British beer, or my Irish beer, okay, or my English beer, right? So you minimize imports, and that was the model, okay? So if you think about the colonial era of European history, you understand how it is that it functioned before Adam Smith got involved, okay? So Adam Smith, remember this too, he's Scottish, okay? He's living in what is now the United Kingdom. He is looking at the most industrialized economy at the time in the world because the Industrial Revolution starts in Great Britain, in England, okay? So with Adam Smith, we consider him to be the place where the birth with him is the birth of modern economics, or what we're gonna call now, and you need to know these terms, classical economics. He wrote The Wealth of Nations in 1776, which revolutionized economic thought, okay? So here is his major transformational thought, and this is substantially different from what was the view beforehand, and that is the wealth of a nation is not based on the accumulation of gold and silver, but on the value of the goods and services it produces. Did you hear that? The wealth of a nation, this is what Adam Smith said, this is the modern economics, this is what we're gonna study together, is not based on the accumulation of gold and silver, but on the value of the gold, the value of the goods and services it produces, and what that's what we now call gross domestic product. Fast forward to present tense, the largest economy on this planet, the most powerful economy on this planet is the United States, and why is it so powerful? Because it has the most gold and silver? No, because the stuff that it produces has the highest value. What do they produce? Goods and services. You add up that output, that's the gross domestic output product of the United States, and they're the largest economy, okay? This idea, and you can see it, pervades even now. A lot of this stuff pervades in our studies of economics now, and it started with Adam Smith. So, what else did he say? Okay, Adam Smith's transformational thoughts that worker productivity is key to increasing wealth. So, think about it, if wealth is now not about gold and silver, it's about producing goods and services, then how do you produce goods and services as efficiently as possible, because that's the way you're gonna get wealthy, right? Well, I'll tell you how you do it. The division of labor, okay? The division of labor is one thing, and it's the specialization of labor, and there's a great, there are lots of examples of this, but what I like to think about is like an assembly line, Henry Ford, 1900s, he said he had specialization of labor, and he had one worker doing one thing over and over and over and over again, and the assembly line thing is like, you know, the car moved through the workers as opposed to the workers going to the car. So, there was an assembly line, and as these parts were added, they ended up creating a car, and one person just, you know, they just put the bolt in, they just put the bolt in, they just put the bolt in, the next person screwed it in, right? So, division of labor and specialization of labor is a critical under mining, underpinning of economic growth nowadays, okay? He also created something called the labor theory of value. So, what it's sometimes like best to read economic terms backwards. The value of something is based on its, the theory of the labor, okay? So, what does that mean? Yeah, what does that mean, really? It means cost of production equals the value of the product produced. So, if this, what is the value of this mate cup? Well, this mate cup, according to Adam Smith, is worth the cost of producing it. So, in order to make this mate cup, which is made out of tin, metal, and paint, blah blah blah, and the workers and all that, you would add up the cost of production. So, the value of this might be five dollars, but where do you get that value? From the cost of the production of it, okay? So, the value of this comes from the cost of production. Remember that. It's gonna change in a little bit, but remember that. The cost, the value of this mug, comes from the cost of it, of the, of the cost of the inputs, the cost of production, okay? The other thing, and you, if you've studied Adam Smith, you may know this, there's this notion of this invisible hand, right? The invisible hand is, is, as opposed to the governmental hand. So, in mercantilism, the government's hand was heavily, like, involved in the market. So, the government's in there, like, moving pieces around, deciding production, deciding exports, deciding imports, deciding taxes, deciding who's gonna do what, right? So, that's called the allocation of resources. The allocation of resources, in the mercantile system, or the system before the free markets, the government's hand was in there, and it was sort of, like, quote, fixing things, okay? What Adam Smith said is, like, if you really want the best allocation of resources, which just means the people who are best at doing one thing are doing that thing, and the best, people are best at doing something else are doing that thing, ooh, that's specialization, right? And division of labor. If you're a teacher, teach, you know? If you're an accountant, count up, you know, the bills. If you are a lawyer, be a lawyer. If you're a medical doctor, do the surgery. But let's not have the teacher doing the surgery, right? So, division of labor, specialization, right? And what the visible hand was, was that if the government would get his hand out of the marketplace, those things would take care of themselves. And the reason that would happen is based on two fundamental ideas that you're going to have to have in your head throughout your studies of economics. And that is that, check it, consumers maximize their utility. Utility is an economic way of saying happiness. I'm happy because I bought new shoes. I'm happy because I have a new shirt. I'm happy because I have a new iPad, right? Utility, right? So, consumer's utility and combined with producer's interest in what? Maximizing their profits. And therefore, the market will self-regulate, which means that there's no hand. The hand is invisible. And as a result of that, the best allocation of resources in a market will happen. What does that mean? Okay. If this Montay cup costs $5 to make, put it over here. Here's the producer. It costs $5 to make. I'm over here, right? I look at that. I'm like, ooh, I like that. I'm going to buy it. And I'm thinking in my head, I'll buy it for $10, you know? And this person over here, no, I'll buy it for like, no, the other way around. I'd pay like, you know, I don't know, $8 for that, right? And the seller, the producer is like, wow, I want to sell this for $10 because I want to make double, right? And I come up there and I say, hey, you know what? I would love to buy that for $8, right? And the person says, well, you know what? No, actually, you know, I want $10. And then we decide on a price of $9. Oh, what did we do? We established that the value of this, not because the government was involved, but I wanted the thing, right? The producer's maximizing profit. I'm maximizing my utility, which means I pay the lowest price possible for something that I want. I really wanted to pay $8, but I paid $9. The producer really wanted $10, but they got $9. And therefore, the system itself fixed itself. And if you can't sell Mate cups for $9, then you're going to go out of business. And so the market is what's called self-regulating or self-writing. And that's not without any of the government getting involved. Okay? Those are the transformative thoughts of Adam Smith. Okay. So what did he say? He also said, and check this out, free trade is the key to the prosperity of nations, not mercantilism, not tariffs on imports, right? But free trade. So he was an advocate of free trade over protectionism. And he believed and he sort of coined this phrase of laissez-faire economics, which is where the economy functions as freely as possible from the intervention of the government. And what is the economy? Consumption, production, and trade happens as freely as possible. No government intervention, right? No government intervention. What's government intervention? Taxes on things, sales taxes, income taxes, tariffs on things coming in and out of a country. So what he said is the best outcome will be if producers maximize their profits, and consumers maximize their utility, their happiness, it'll arrive at the best market prices for all the things. It'll make more things produced at a lower price. Okay? That is the overall understanding of classical economics. It comes from Adam Smith. And the one last thing, and a lot of people forget this about Adam Smith, is this. The government in his mind does have a role to play. But that role is in defense, armies, defending a country, education of the people, infrastructure, bridges, roads, airports, deepwater ports, electricity, cell service, those things, rule of law, and the punishment of crime. And this last part is really important. The rule of law in economics is critical. And if you live in a country, or if you've traveled to countries that are underdeveloped, it could be for a lot of reasons. I lived in Nicaragua for four years. And the thing about Nicaragua is there's no rule of law. And what that means is the people in power are also the people that control the legal system. The politicians control the legal system. It's a very corrupt place. I love that country. I left a piece of my heart in Nicaragua. I love that place. But the reason why it hasn't developed economically is a result of the parental, the government's abuse of the country by not following the rules. If you look at the most prosperous countries on this planet, they are places where rule of law is in place. All of Western Europe, the United States, Australia, New Zealand, Japan, South Korea, Singapore, those places are the wealthiest nations on this planet. And it's because the government itself is providing the infrastructure, the education, the rule of law, punishing crime, holding people accountable. And as a result of that, economies can flourish, or economics can flourish. Then people become able to participate in the economic system. And as a result of that, they become wealthier, and it multiplies throughout the generations. And there we have it, my friends, an overall look at the beginning of the story of modern day economics, which is the classical view. And it started in 1776, with our good friend Adam Smith. And now my friends, we're rolling on to the next video.