Classical macroeconomics comes from the economic theories of individuals over a wide time period. The most common period defined here stretches from Adam Smith to Alfred Marshall, or from 1750 to 1950 in terms of years. These economists had many common thoughts, including a natural supply and demand control, Say’s law to govern real gross domestic product (GDP), and flexible interest rates and wages. A key thought in classical macroeconomics is the ability of the free market to rule and govern itself. They saw government interaction as an unnecessary and unwanted actor.
Free markets tend to have a natural supply and demand. A frequent example in classical macroeconomics is the invisible hand. This theory states that the free market is able to discern the natural movement of resources when the production of new goods or services is necessary. For example, the current popular cooking utensil is the pot; heavy demand occurs when everyone wants a pot for cooking. If consumer demand changes to pans, however, the invisible hand shifts resources to companies making pans, meeting the demand for this new good.
Through the invisible hand, an economy typically meets both the supply and demand for individual goods and for its overall economy. Therefore, companies are able to allocate resources to those products that have the highest profits. Consumers spend money on those products that offer the best quality at the lowest cost. Where equilibrium does not exist, an adjustment occurs, and consumers lose interest or move to different products.
A common theory that describes these actions in classical macroeconomics is Say’s law. This law states that, when a national economy produces a specific amount of real GDP, the economy also generates sufficient income for purchasing the level of this real GDP. Hence, one large national supply and demand concept is at work. Increases and decreases of real GDP also result in changes to national income. Therefore, no excess or shortages should exist that cripple the economy. While an economic downturn or trough is possible through the business cycle, an upswing will occur once the economy begins positive GDP improvements.
Flexible interest rates and wages are two other elements that are defined in classical macroeconomics. When a nation allows the free market to define these elements, a market can help adjust its supply and demand for specific goods and services. For example, when the demand for business loans decrease, lenders should have the ability to lower interest rates in order to spur more loan creation. The same goes for wages. An economy that has the ability to change wages according to free market principles can control employment and lower unemployment figures.
