The study of economics is driven by theories of economic behavior and economic performance, which have developed along the lines of the classical ideas, the Marxist idea, or a combination of both. In the process, various models were developed, each trying to explain such economic phenomena as wealth creation, value, prices, and growth from a separate intellectual and cultural setting, each considering certain variables and relationships more important than others. Within the aforementioned historical framework, economics has followed a trajectory that is characterized by a multiplicity of doctrines and schools of thought, usually identifiable with a thinker or thinkers whose ideas and theories form the foundation of the doctrine.
Classical economic doctrine descended from Adam Smith and developed in the nineteenth century. It asserts that the power of the market system, if left alone, will ensure full employment of economic resources. Classical economists believed that although occasional deviations from full employment result from economic and political events, automatic adjustments in market prices, wages, and interest rates will restore the economy to full employment. The philosophical foundation of classical economics was provided by John Locke's (1632–1704) conception of the natural order, while the economic foundation was based on Adam Smith's theory of self-interest and Jean-Baptiste Say's (1767–1832) law of the equality of market demand and supply.
Classical economic theory is founded on two maxims. First, it presupposes that each individual maximizes his or her preference function under some constraints, where preferences and constraints are considered as given. Second, it presupposes the existence of interdependencies—expressed in the markets—between the actions of all individuals. Under the assumption of perfect and pure competition, these two features will determine resource allocation and income distribution. That is, they will regulate demand and supply, allocation of production, and the optimization of social organization.
Led by Adam Smith and David Ricardo with the support of Jean-Baptiste Say and Thomas Robert Malthus (1766–1834), the classical economists believed in Smith's invisible hand, self-interest, and a self-regulating economic system, as well as in the development of monetary institutions, capital accumulation based on surplus production, and free trade. They also believed in division of labor, the law of diminishing returns, and the ability of the economy to self-adjust in a laissez-faire system devoid of government intervention. The circular flow of the classical model indicates that wages may deviate, but will eventually return to their natural rate of subsistence.
Because of the social cost of capitalism as proposed by classical economics and the industrial revolution, socialist thought emerged within the classical liberal thought. To address the problems of classical capitalist economics, especially what he perceived as the neglect of history, Karl Marx (1818–1883), a German economic, social, and political philosopher, in his famous book titled Das Kapital or Capital (1867–1894) advanced his doctrine of dialectical materialism. Marx's dialectics was a dynamic system in which societies would evolve from primitive society to feudalism to capitalism to socialism and to communism. The basis of Marx's dialectical materialism was the application of history derived from Georg Wilhelm Friedrich Hegel (1770–1831), which maintained that history proceeds linearly by the triad of forces or dialectics called thesis, antithesis, and synthesis. This transition, in Marx's view, will result from changes in the ruling and the oppressed classes and their relationship with each other. He then envisaged conflict between forces of production, organization of production, relations of production, and societal thinking and ideology.
Marx predicts capitalist cycles that will ultimately lead to the collapse of capitalism. According to him, these cycles will be characterized by a reserve army of the unemployed, falling rate of profits, business crises, increasing concentration of industry into a few hands, and mounting misery and alienation of the proletariat. Whereas Adam Smith and David Ricardo had argued that the rational and calculating capitalists in following their self-interest promote social good, Marx argued that in rationally and purposefully pursuing their economic advantage, the capitalists will sow the seeds of their own destruction.
The economic thinking or school of economic thought that originated from Marx became known as Marxism. As the chief theorist of modern socialism and communism, Marx advocated fundamental revolution in society because of what he saw as the inherent exploitation of labor and economic injustice in the capitalist system. Marxist ideas were adopted as the political and economic systems in the former Soviet Union, China, Cuba, North Korea, and other parts of the world.