What are the 50 most important economic theories of the last century?

Thats the question a publisher

recently asked me to ponder for a book they are developing.
Ive noodled on this over the past week and have some initial ideas. But I would be remiss if I didnt solicit
suggestions from my insightful readers.
So, what do you think have been the most important economic theories over the past century?
To spark your thinking, here are some very preliminary ideas, albeit without much respect for the publishers
century limitation. (Apologies for the higher-than-usual amount of jargon and economic short-hand.)

I think the items in the first list are more likely to make the cut than those in the second list. There is otherwise
no importance to the ranking.

25 Theories To Get You Started
1. Supply and Demand (Invisible Hand)
2. Classical Economics
3. Keynesian Economics
4. Neoclassical Synthesis (Keynesian for near-term macro; Classical for micro and long-term macro)
5. Neo-Malthusian (Resource Scarcity)
6. Marxism
7. Laissez Faire Capitalism
8. Market Socialism
9. Monetarism
10. Solow Model (growth comes from capital, labor, and technology)
11. New Growth Theory (Romer & endogenous growth)
12. Institutions and Growth (rule of law, property rights, etc.)
13. Efficient Markets Hypothesis
14. Permanent Income / Life Cycle Hypothesis
15. Rational Expectations
16. Rational Choice Theory
17. Something Behavioral (e.g., Prospect Theory)
18. Adverse Selection and the Lemons Problem
19. Moral Hazard
20. Tragedy of the Commons
21. Property Rights as a solution to the Tragedy of the Commons
22. Game Theory (e.g., Prisoners Dilemma)
23. Comparative Advantage
24. New Trade Theory
25. The Trilemma (exchange rates, capital flows, and monetary policy)

37 More Theories
1. Washington Consensus
2. Financial Accelerator
3. Theory of Independent Central Banks
4. Bagehot Theory of Central Bank Lending
5. Creative Destruction (Schumpeter)
6. Ricardian Equivalence
7. Dynamic Consistency
8. Diversification and Investment Portfolio Design
9. Capital Asset Pricing Model
10. Option Valuation (Black-Scholes et al.)
11. Austrian Economics
12. Speculative Bubbles (e.g., Minsky)
13. Liquidationist View of Downturns
14. Time Value of Money (incredibly important but very old)
15. Public Choice / Economic Theory of Regulation (politicians and government workers as self-interested
maximizers)
16. Arrows Impossibility Theorem
17. Welfare Theorems
18. Veblen and Conspicuous Consumption
19. Polluter Pays Principle (e.g., Piouvian Taxes)
20. Offsetting Behavior (e.g., people drive safe cars more aggressively)
21. Heckscher-Ohlin Trade Theory
22. Optimal currency areas
23. Exchange Rates and Purchasing Power Parity
24. Mercantilism
25. Rubinomics
26. Supply-side Economics
27. Laffer Curve
28. Phillips Curve
29. Theories of Economic Geography
30. Fisher Theory of Interest Rates
31. Liquidity Traps
32. Resource Curse (Dutch Disease)
33. Exchange Rate Overshooting (Dornbusch)
34. Auctions
35. Mechanism Design
36. Principal-Agent Theory (e.g., separation of management and ownership)
37. Theory of Optimal Taxation (e.g., broad base, low rate, tax less-elastic activities)

I could go on, but you get the idea. As the list illustrates, there are nuances about what constitutes a theory
some try to describe how the world works, and others try to describe how it should work. And, of course, they
vary widely in how well they accomplish those goals. There are certainly economic theories that are wrong, but
nonetheless deserve to be on the list.
As the list may suggest, I am a mainstream economist with a U.S. focus, so my first round of brainstorming
undoubtedly overlooks some worthy non-U.S. theories or less orthodox theories. (And I probably overlooked
some mainstream ones too!)

What is Classical Economics?

While macroeconomics as a discipline may have started with Keynes, he was not the first to think about issues
involving the economy as a whole. Economics usually labels those thinkers classical (or neoclassical)
economists. These included Alfred Marshall, William Stanley Jevons, Arthur Cecil Pigou, John Bates Clark,
Irving Fisher, and Knut Wicksell. The Classical economists believed in free market efficiency given a series of
assumptions known as the First Welfare Theorem. The conditions of this theorem are that there is perfect
information in the market, zero transaction costs, a large number of buyers and sellers, no externalities, and all
transactions of voluntary. According to the classical school of thought, free markets functioned better than
regulated markets as long as the conditions of the First Welfare Theorem held.
Macro is aggregated Micro

The classical economists did not differentiate between macroeconomic and microeconomic theory. They used
their understanding of (micro)economic theory to analyze both micro and macroeconomic phenomena.
Classical economists conceived of the macroeconomy as no more than aggregated microeconomics. Thus,
what we now conceive of as aggregate supply was simply the sum of each firms production decision.
Similarly, aggregate demand was the sum of all individual demand curves.

Gerard Debreu, in his 1957 book, Theory of Value proved the existence of a general competitive equilibrium.
That is, if all markets are perfectly competitive, all firms maximize profits, and all individuals maximize utility,
there is a set of prices at which all markets will be in equilibrium. This is the macroeconomic model of the
Classical economists, and for this, Debreu won the 1984 Nobel Prize.

One topic that the classicals did recognize as being economy-wide was business cycles. However, classical tools
to analyze business cycles were rather primitive by modern standards. Another topic was inflation, or the rate
of change of the aggregate level of prices.
Focus on the Supply Side

Classical economics focused on the supply side of the economy. Specifically, Jean Baptiste Says Law
dominated classical economic thought: Supply creates its own demand. Say meant that production creates
income that provides enough purchasing power to purchase all the goods being produced, no more and no
less. One hundred dollars worth of goods produced creates one hundred dollars worth of income. The critical
assumption in this theory is that there is no hoarding. All income is either spent or saved. All saving is
invested so that all income stays in circulation. In this model, excess supply in one market must be balanced
with excess demand in another; there can be no such thing as economy-wide excess supply. This conclusion is
known as Walras law. A shift in relative demand will result in changes in relative prices; if one good is more
desirable it will rise in price, while less desirable goods will fall in price. The aggregate price level will not
change.
Analysis starts with the Labor Market

The classical view of the economy begins with the labor market. Profit maximizing firms hire labor up to the
point where the marginal revenue product, or the additional revenue gained from one extra unit of labor,
equals the wage rate. (In real terms, the real demand for labor is its marginal productivity. The real demand
equals the real wage, that is, the nominal wage divided by the price level.)

Given the supply of labor, the wage rate will adjust to insure full employment.
Analysis proceeds to the Product Market

Equilibrium employment thus served as the source of aggregate supply. Given the equilibrium level of
employment, the aggregate production function determines the equilibrium left of output.
Thrift & Enterprise determine the Composition of GDP

There are two key parameters or behavioral coefficients in the Classical model: thrift and enterprise. Thrift can
be thought of as economic agents propensity to save, and is based on their willingness to defer present for
future consumption. Enterprise can be thought of as their propensity to invest, which is dependent on the
availability of investment opportunities or the rate of return on capital. Thrift and enterprise are fixed in the
short run; changes in either and have no effect on the level of GDP, only on its composition.

[ Insert graph of Loanable Funds model? Attributed to D.H. Robertson ]

For example, if there was an autonomous increase in saving (an increase in thrift), the real interest rate
would decrease as the supply of loanable funds increased. The lower interest rates would induce
entrepreneurs to borrow the extra saving. Thus, if GDP is the sum of consumption (C) and Investment (I),
and C decreases (as saving increases), I increases by the same amount, and GDP stays exactly the same. As
another example, suppose there is some technological improvement that causes an increase in the rate of
return on investment (an increase in enterprise). The desired increase in investment translates to an
increase in demand for loanable funds, leading to a higher real interest rate. The higher interest rate induces
an increase in saving to finance the investment. As a result, consumption decreases and investment increases,
while overall output stays the same.
The Classical Dichotomy Segments the Economy into Real & Financial Sides

The Classical analysis of the macro-economy led to what is now known as the classical dichotomy. The
economy has two sides, real and financial. The real side includes the real variables in the economy, including
output and employment, while the financial side includes all nominal factors of the economy, such as the
aggregate price level and nominal interest rates. The notion of a dichotomy means that nominal factors only
influence financial side of the economy, never the real side. As we noted above, real variables are determined
entirely on the supply side of the economy: employment is determined in the labor market, and output is
determined by the aggregate production function.




Classical AD-AS Diagram

Classical AD-AS Diagram
This implies a vertical aggregate supply curve based on the available resources, with factor prices adjusting so
that all resources are fully employed, and output prices adjusting for all goods and services to be purchased.
As a consequence, aggregate demand has no effect on the levels of output or employment. The only way to
change output or employment is either an increase in the supply of labor or an increase in labor productivity,
which would shift the aggregate supply curve to the right.

This is easy to see in the labor market. Since employment is defined by the intersection between labor
demand and labor supply, and both are multiplicatively functions of the price level, an increase in aggregate
demand raises both labor supply and labor demand proportionately, so that AD has no effect on the
equilibrium level of employment and thus none on real GDP.
Quantity Theory of Money

The Classical view of aggregate demand was the Quantity Theory of Money. The Quantity Theory is, based on
the equation of exchange: MV = PQ, where M is the supply of money, V is the velocity of money (the average
number of times a dollar is spent in a year), P is the aggregate price level and Q is real GDP. The equation of
exchange is an identity, but the classicals reinterpreted it as a behavioral relationship as follows: Let M
represent money demand (MD). Then MD=(1/V)PQ or MD=kPQ where k=1/V.

This means that the demand for money, MD is proportional to nominal GDP (PxQ) or income. An increase in
real income (Q) means that people spend more, so they need to hold more money, which means the demand
for money increases. Also, if the price level increases the demand for money similarly increases, because
people must carry more cash to have equivalent purchasing power.

The model is completed by adding the equilibrium condition that MS=MD.

Consider an increase in money supply so that MS>MD. Since velocity was assumed to be constant, and since
output (Q) was at potential, the resulting increase in spending can only increase the price level.

Graphically, the increased money supply shifts aggregate demand curve to the right, increasing the price level.
But this change only affects nominal factors, not any real factors. Because the classical economists assumed
that labor was always at full employment, there are no labor resources that could be devoted increasing
output, as indicated by the inelastic aggregate supply curve.

On the other hand, inflation must be caused by increases in the money supply. The solution is simplethe
monetary authorities need to rein in money creation.

The Quantity Theory of Money was later reinterpreted by Milton Friedman and the Monetarists. See Chapter
#.
Economy-wide Unemployment isnt likely

In classical thought, the labor market determines employment. At the equilibrium wage rate, everyone who
wants a job will have one. Unemployment was believed to be caused by people choosing not to work for low
wages. Unemployment occurring in one sector of the economy was the result of a change in consumer
demand away from that sectors products towards another sectors products. The result should be lower
wages in the former sector and rising wages in the latter. Over time, labor should migrate from the former to
the latter. Unemployment then is a sectoral problem and exists when people choose not to work for low
wages or when they choose not to migrate.

Widespread unemployment simply should not occur, according to classical theory. If it did, the cause must be
sticky wageswages that dont adjust downward, due to market imperfections such as unions. Labor
unions interfere with the economys movement towards full employment because they push up wages and
make workers less willing to relocate for new work. Over time though, unemployment should disappear.
Classical Views on Fiscal Policy

Classical economists conceived of fiscal policy in much more limited terms than it is viewed today. The notion
of discretionary policy was not widely accepted, since the only responsible fiscal policy was a balanced budget.
Thus, expansionary fiscal policy, for example increasing government spending without increasing taxes to
stimulate the economy, was not generally considered by policy makers. Since the economy was assumed to be
at potential output, an expansionary policy could only lead to higher prices. (Later, the Monetarists would
interpret this as leading to complete crowding-out.) Similarly, an increase in net exports would only change
the composition of output towards export goods and away from domestically consumed goods (C & I). Again,
there is no effect on the level of GDP.
Conclusions

[ The Classical school was the primary school of thought in economics until the 1930's and the time of the
Great Depression. The shortcomings of the Classical school became extremely evident when its practitioners
were unable to explain the extraordinary decline in economic activity and increase in unemployment during
the 1930s. The Classicals were mostly criticized for being unable to see the importance of the short-run
changes that were taking place. Their models which held many variables fixed and focused on the supply side
of the economy could not give a viable answer for what was happening. This brought about a great deal of
criticism from many analysts and cast the entire economics discipline in a bad light, much like what happened
after the Great Recession of 2007-09. Nonetheless, Classical economics is the jumping off point for
understanding all modern macroeconomic theories, since in one way or another they change or relax the
assumptions first discussed in the Classical school of thought to derive a more realistic model.