Economics

Economics is a social science which studies human activity in relation to meeting wants and desires through the lens of price relationships. Originally called "political economy", the word "economy" coming from the Greek "oiko-" for house and "nomos" for laws or norms, the derivation provided by Rousseau in 1755.

The term "economics" was coined around 1870 and was popularized by Alfred Marshall, and can be said to diverge from political economy in that it focuses more specifically on price relationships. For a fuller discussion of the differences, see political economy and value. Note that the word "economist" predated "economics".

Modern market economics was concisely defined by Lionell Robbins in 1935:

Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses.

That is, the study of the trade offs involved between alternate sets of decisions. The central questions of economic theory are then what resources are scarce, and how does one make choices between the alternatives.

The subject is said to be positive when it attempts to explain the consequences of different choices given a set of assumptions and normative when it prescribes a certain route of action.

Mainstream market economics focuses on the measurement of price, which are measurable quantities of the medium of exchange, generally money, which are involved in a transaction. Theories of value exist to explain the underlying quantities, if any, that price is said to measure. Divergences between price and actual outcomes occupy a large fraction of economic theory.

Aspects receiving particular attention in economics are resource allocation, trade, monetary policy and competition.

Table of contents

1 Areas of study in economics 2 Value Theory 3 Price 4 Basic Scarcity in Economic Theory 5 Economic assumptions 6 Economic language 7 Branches of economics and related subjects 8 Development of economic thought 9 Economics and other disciplines 10 See also 11 External links

Areas of study in economics

Economics is usually divided into two main branches:

• Microeconomics, which deals with the behaviour and interaction of individual agents and firms.
• Macroeconomics, which examines an economy as a whole with a view to understanding the interaction between economic aggregates such as national income, employment and inflation.

Attempts to join these two branches or to refute the distinction between them have been important motivators in much of recent economic thought, especially in the late 1970s and early 1980s. Today, the consensus view is arguably that good macroeconomics has solid microeconomic foundations i.e. its premises have support in microeconomics.

Increasingly some have argued that finance is to economics what engineering is to physics, and should be considered separately. Similarly, some have argued that computational economics should be regarded as separate, by analogy with the idea that physics should, as well, regard computational physics as separate from experimental physics and theoretical physics. These views have not yet gained general currency.

Within these major divisions there are specialized areas of study that try to answer questions on a broad spectrum of human economic activity (see below). There are also methodologies used by economists whose underlying theories are important. The most significant example may be econometrics, which applies statistical techniques to the study of economic data.

There has been an increasing trend for ideas and methods from economics to be applied in wider contexts. Since economics analysis focuses on decision making, it can be applied (with varying degrees of success) to any field where people are faced with alternatives - education, marriage, health, public policy, voting theory etc. Public Choice Theory studies how economic analysis can apply to those fields traditionally considered outside of economics. The areas of investigation in Economics therefore overlap with other social sciences, including political science and sociology.

Value Theory

Beneath an economic theory is a theory of value. Value can be defined as the underlying activity which economics describes and measures. It is what is "really" happening.

Adam Smith defined "labor" as the underlying source of value, and "the labor theory of value" underlies the work of Karl Marx, Riccardo and many other "classical" economists. The "labor theory of value" argues that a good or service is worth the labor that it takes to produce, and the abundance or scarcity of labor determines the price of a commodity. The labor theory of value dominates the work of most classical economists, but it is far from the only accepted basis for "value".

"Market theory" argues that there is no "value" separate from price, that the market incorporates all available information into price, and that so long as markets are open, that price and value are one and the same. This theory rests on the idea of the "rational economic actor".

Another set of theories rest on the idea that there is a basic external scarcity, and that "value" represents the relationship to that basic scarcity. Theories based on economics being limited by energy or based on a "gold standard" are of this type.

All of these value theories are used in current economic work.

Price

Price is the measurable quantities involved in an exchange. Price theory, therefore, charts the movement of measurable quantities over time, and the relationship between price and other measurable variables. In Adam Smith's Wealth of Nations this was the trade off between price and convenience. A great deal of mainstream market theory is centered around price pressures caused by imbalances in supply and demand.

Price curves, therefore, are the bulk of mainstream market economics and its modelling. Price is modelled as the intersection between curves, in the simplest form, a supply curve and a demand curve. In theory, but seldom in practice, prices are free to move along the curves to find the point of equilibrium. In almost every practical economic model, some form of "price stickiness" is incorporated to model the observed fact that prices do not move fluidly. Economic policy often revolves around arguments as to what is causing "economic friction", or price stickiness, and which is, therefore, preventing the supply and demand from reaching equilibrium.

Another area of economic controversy is on whether price measures value correctly. In mainstream market economics, where there are significant scarcities not factored into price, there is said to be an externalization of cost. Market economics predicts that scarce goods which are under-priced are over-consumed. From this flows arguments over such economic terms as moral hazard.

Basic Scarcity in Economic Theory

Because scarcity and decision are central to economic theory, the question of what is the basic trade off in economics is of central importance. In every economic theory, there is a basic exchange of two or more ultimately scarce commodities. For Adam Smith, it was defined as the trading of time, or convenience, for money. For example, a person could live near town, and pay more for rent or his domicile, or live farther away and pay less "paying the difference out of his convenience".

This view, that the primary trade off involved in economics is between time and money has some challenges. Each of these bases its view of scarcity on a different fundamental trade off.

A small number of economists prefer to define economics as the study of how and why people trade, this definition implies relative scarcity.

Information theory has been applied to economics since the work of Coase in the 1930's. However, with Herbert Simon and John von Neumann in the 1950's, it gathered a more specific formalism as part of game theory. This lead to their defining it as "the study of economic agents as processors of information." An influential text advancing this view is "Economics becomes a Cyborg Science",Mirowski 2002. This emphasises that the decision-making process, itself is costly. It started advancing due to use of the computer as analogy to the human brain and has progressed viewing a market through the lens of network theory. At some point, its adherents believe, computers will be fast enough for directly operationalising this definition in widespread Economics Simulation. (So called "Agent-Based Computational Economics")

Marxist economics, while it generally denies the trade off of time for money, presents a different scarce resource, namely power. In Marxist economics a scarce amount of control over the means of production is the basis for the allocation of resources among classes, and scarcity of any particular physical resource is subsidiary to the central question of power relationships embedded in the means of production.

The question of the environment is viewed, in the traditional economic framework, as being related to the externalization of costs. That is, market economics assumes that a good which is underpriced, is overconsumed. Externalization of cost, in this view, will be corrected by pricing the overconsumed resources which are being used, for example the work of Lester Thurow. Not all economics study accepts this paradigm, and, instead, there is a 7 decade old tradition of viewing economic relationships as being based on the scarcity of energy, rather than price, as the central feature of economics. The treatment of economics as a branch of biology seems self-evident to these critics of market economics, but it is not yet the accepted basis of either monetary systems or economic development, even though an increasing amount of attention is paid to energy cost issues in economics.

Economic assumptions

Understanding choice by individuals and groups is central in economics. With scarcity, choosing one alternative implies foregoing another alternative; economists refer to this as opportunity cost. For instance, learning one skill implies time not spent learning another. At an applied level this approach often requires an explicit modelling of the spectrum of choices available and thus implicitly those that are unavailable.

Economists believe that incentives and preferences (tastes) together play an important role in shaping decision making. Sometimes a preference relation can be represented by a utility function. Utilitarianism may be viewed as a philosophical basis of much of modern economics; (see goodness and value theory for other approaches to value).

Mainstream economics does not assume a priori that markets are preferable to other forms of social organization. To the contrary, much analysis is devoted to cases where market failures lead to resource allocation that is suboptimal by some standard. In such cases, economists may attempt to find policies that will avoid waste, either directly by government control or indirectly by regulation that forces market participants to act in a manner consistent with optimal welfare.

Despite the extreme controversy surrounding larger economic issues, there is significant agreement among mainstream economists on the fundamentals of the subject, especially as reflected in microeconomics as opposed to macroeconomics.

Much contemporary theory assumes that economic agents act rationally to optimize well-being given available information. This may sometimes be an acceptable approximation (for instance, if individual irrationality cancel each other out in the aggregate) and tends to produce tractable results. However, this framework ("homo economicus") is not accepted by all. More recently, irrational behavior and imperfect information have increasingly been the subject of formal modelling (often referred to as behavioral economics), resulting in some Nobel Prizes in economics. An example is the growing field of behavioral finance which combines traditional theory with cognitive psychology.

Economic language

Economics relies on formal styles of argument more than other social sciences. Formal modelling implies that conclusions follow rigorously by the laws of logic from the stated assumptions. It may involve advanced mathematical methods, but need not. Formal modelling is motivated by the belief that it encourages researchers to focus on essentials and makes exposition less prone to ambiguity. Modelling is also increasingly used in other social sciences, such as political science and philosophy.

Formal modelling has been adopted by all branches of economics. It is not the same as mathematical economics, which implies the application of advanced mathematical methods to study any given problem. Some reject mathematical economics: The Austrian School of economics believes that anything beyond simple logic is not only unnecessary but inappropriate for economic analysis.

Academic work sometimes requires years of training to be fully understandable. However, the basic ideas of economics can be taught with no more than simple arithmetic and graphs.

Branches of economics and related subjects

Economics may be broken down as follows:

Microeconomics

General equilibrium -- Industrial organization -- Financial economics -- Public finance -- International trade -- Labor economics -- Development economics -- Environmental economics -- Evolutionary economics -- Public choice theory -- Public goods -- Economic geography -- Network effect -- Transport economics -- Supply and Demand -- Consumer Theory -- Health economics

Macroeconomics

Stabilisation policy -- Economic growth -- Purchasing power parity -- supply side economics --Gold standard

Methodology

Econometrics -- Game Theory -- Mathematical economics

Development of economic thought

Modern economic thought is usually said to have begun with Adam Smith in the late 18th century. For an overview of precursors to Smith as well as an overview of schools that have developed later, see history of economic thought. Modern mainstream economics can be said to begin with Mills focusing of what was then called "political economy" on "wealth" which he defined exclusively in relation to the exchange value of objects, or what would now be called price. "Classical Economics" as the economic work of the period is called, forms the foundation of micro-economics.

In the 19th century, Karl Marx synthesized a variety of schools of thought involving the social distribution of resources, including the work of Adam Smith, as well as socialism and egalitarianism, and used the systematic approach to logic taken from philosopher Hegel to produce "Das Kapital". His work remains the most widely adhered to critique of market economics. The Marxist paradigm of economics is not generally held in high regard by most market economists, even though some of the concepts from his work are, from time to time, used in mainstream contexts, particularly in labor economics and in political economy. The term Marxian is increasingly used to describe work which accepts concepts from his work but does not necessarily subscribe to the political thrust of Marxist thought in some manner.

In the early 20th century, economics became increasingly statistical, and the study of econometrics became increasingly important. Statistical treatment of price, unemployment, money supply and other variables, as well as the compiling of these statistics, became more and more central to economic writing and disputes within the field of economics.

Macroeconomics began with Keynes in the 1920s, and was codified in the 1930s by Keynes and others, particularly John Hicks. It grew in popularity as a reaction to the Great Depression. Keynes had been an influential exponent of the importance of central banking and government involvement in economic affairs, as well as a critic of the political economy of the post World War I period. His "General Theory" encapsulated both criticisms of classical theory that had been levelled by Thorstein Veblen and others, as well a method for economic management of aggregate demand. For an overview of a number of competing schools, see macroeconomics.

Many economists use a combination of Neoclassical microeconomics and Keynesian macroeconomics. This combination, sometimes known as the Neoclassical synthesis, was dominant in Western teaching and public policy in the years following World War II and up to the late 1970s. The most influential school of this synthesis was monetarism formulated in the late 1940's and early 1950's by Milton Friedman and associated with the University of Chicago.

In principle, economics can be applied to any type of economic organization. However, it developed historically in market societies, and its most detailed and precise work has dealt with the institutions belonging to them. To what extent economics must be adjusted to be applied to earlier forms of social organization has been the source of discussion. Generally, mainstream economists mostly feel that the basic framework of economics is relevant and flexible enough to be applied to virtually any form of society. Marxist economics asserts that history is divided into eras which are determined by which two classes, which are struggling to control the means of production (slaves and masters, peasants and royalty, wage workers and capitalists), and that mainstream economics only applies to those societies which are "objectively" industrial, that is to say, societies which are capable of industrial production based on their own knowledge and resources. (See Marxism, particularly "The Hegelian Roots of Marxism")

In the late 20th Century three of the areas of study which are producing change in economic thinking are risk based rather than price based models, imperfect economic actors, and treating economics as a biological science, based on evolutionary norms rather than abstract exchange.

By far the most influential was the study of risk, which viewed variations in price over time as more important than actual price, this included Black-Scholes theory, GARCH and other innovations designed to seek solutions to time series outcomes, while seemingly unrelated the work of Amartya Sen focusing on price volatility as the cause of catastrophic events is rooted in the same notion that underlying scarcity is only part of the determiner of price.

While less influential, the study of information and decision has become central to attempts to unify microeconomic with macroeconomic theory, examples of this school include the work of Joseph Stiglitz.

Finally, there are a series of economic ideas rooted in the conception of economics as a branch of biology, including the idea that energy relationships rather than price relationships determine economic structure, and the use of fractal geometry to create economic models. (See Energy Economics)

Economics and other disciplines

There is to some degree in tension between economics and ethics, another of the most basic social sciences, which tends to avoid quantification and emphasize balances of rights. Modern economics deals with this tension explicitly - according to some thinkers a theory of economics is also, or implies also, a theory of moral reasoning. One way economists deal with this is to qualify discussions of economic choice by noting that "all else being equal..." referring to moral or social factors that are supposedly held equivalent for all choices that one might make. For exploration of this issue, see the moral purchasing article.

Another premise is that economics fits within a finite ecosystem where there are at least some abundant resources - for instance, when fueling a fire one is usually concerned with finding the wood, and not so much with finding the air to burn it with. Economics explicitly does not deal with free abundant inputs - one criticism is that it often conflicts with ecology's view of what affects what. Human beings are, according to ecologists, merely one species participating in a vast energy system on this planet - economy is a subset of ecology that deals with just one species' habits and wants. See nature's services for the economic view of ecology and green economics for the view wherein economics is a subset of ecology.

A third premise is that economics suggests market forms and other means of distribution of scarce goods that do not just affect "desires and wants" but also "needs" and "habits". Much of so-called economic "choice" is involuntary, certainly given the conditioning that people have to expect certain quality of life. Much of the welfare state that developed nations have built has no basis whatsoever in the study of economics in academia. This is viewed as a failure to respect economics by libertarians, and viewed as a failure of economics to respect society by socialists. This led to both 19th century labour economics and 20th century welfare economics before being subsumed into human development theory.

The debates above are all quite old. The term economics was coined in around 1870, and popularised by influential "neoclassical" economists such as Alfred Marshall. Prior to this the subject had been known as "political economy" and referred to "the economy of polities" - competing states. The older term is still often used instead of economics, especially by radical economists such as Marxists who strongly question assumptions of "mainstream" technical and quantitative economics. Use of this term often signals an intent to challenge or reframe economic assumptions about scarcity.

Some mainstream universities (such as the University of Toronto and many in the United Kingdom) have a political economy department rather than an economics department. Political economy explicitly brings political considerations into economic analysis and therefore tends to be more normative - for instance it would describe assumptions in common between green politics and green economics rather than assuming the latter objective.

See also

Related fields

History of economic thought -- Political economy -- Political science -- Accounting -- Finance -- Operations research -- Home economics

Selected topics

Economists -- The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel -- Communism -- Capitalism -- Coordinatorism -- Market economy -- Informal economy -- Freiwirtschaft -- Synthetic economies -- Participatory economics -- Natural capitalism -- Stock exchange -- economic indicator -- Regulation -- Deregulation -- Privatization

List of terms in urban economics

• List of things which are neither production nor consumption
• List of economics consultancies and think tanks
• Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel

External links

• A guide to several online economics textbooks
• OCED Statistics Organization For Co-operation and Economic Development Statistical site.
• Bureau of Labor Statistics American Labor Department's statistical division.
• World Bank's Data Web Page
• US Department of Commerce Economics Statistics
• World Lecture Hall Economics Section
• Essential Principles of Economics Text in Progress on Economics
• Economics Resources on the Net
• National Bureau of Economic Research Economics material from the organization that declares Recessions and Recoveries.
• The library of economics and liberty, a site with numerous articles and essays written by well-known economists
• Saint Louis Federal Reserve Gateway to the Federal Reserve, including working papers, links to lectures and other material.
• David Friedman's Price Theory Text Entire text on-line.
• Brief Introduction to Macroeconomics by Paul Krugman
• LibertyForums - Classical Liberal, Libertarian & Objectivist Discussion Board

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