Economics is a social science that studies human behavior as a relationship between ends and scarce means which have alternative uses (Lionell Robbins, 1935). That is, economics is the study of the trade-offs involved when choosing between alternate sets of decisions.
Understanding choice by individuals and groups is thus 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. In a market setting, scarcity is often quantified by price
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 related to much of modern economics.
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.
Aspects receiving particular attention in economics are resource allocation, trade, and competition.
The word economy comes from the Greek oiko- for "house" and nomos for "laws" or "norms". Originally, economics was known as political economy, while the term economics was coined around 1870 and popularized by Alfred Marshall. Note that the word economist predated economics.
Areas of study in economics
Economics is usually divided into two main branches:
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
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. Computational economics relies on mathematical methods, including econometrics.
Other subdivisions are possible. Finance
has traditionally been considered a part of economics, but has today
effectively established itself as a separate, though closelty related,
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, 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.
Mainstream economics does not assume a priori that markets are
preferable to other forms of social organization. In fact, much
analysis is devoted to cases where so-called 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 a given individual's
irrationality is canceled out in the aggregate) and tends to produce
tractable results. However, this framework ("homo economicus")
has for decades been understood as a handy approximation (e.g., see
Herbert Simon's model for "bounded rationality," which was awarded a
Nobel Prize in 1978). More recently, irrational behavior and imperfect
information have increasingly been the subject of formal modelling
(often referred to as behavioral economics), resulting in additional
Nobel Prizes in economics. An example is the growing field of behavioral finance which combines previous theory with cognitive psychology.
Economics often 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 borrows much from philosophy, especially logic.
Formal modelling has been adopted to some extent 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 often unnecessary and 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.
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 was the most widely adhered-to
critique of market economics during much of the 20th century. The
Marxist paradigm of economics is not generally held in high regard by
market economists, though some concepts from his work are occasionally
used in mainstream contexts, particularly in labor economics and in political economy. The term Marxian
is less used nowadays, being often used to describe work which accepts
concepts from his work but does not necessarily subscribe to the
political thrust of Marxist thought.
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 neoclassical school was challenged by 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
By far the most influential was the study of risk,
which viewed variations in price over time as more important than
actual 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)
In its infancy is the application of non-linear dynamics to economic theory, as well as the application of evolutionary psychology. So far the most visible work has been in the area of applying fractals to market analysis, particularly arbitrage. (See Complexity in Economics)
Economics in the context of Western thought
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
This view, that the primary trade-off involved in economics is between
time and money, has several challengers. 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 Ronald 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 emphasises that the decision-making process itself is costly.
Marxist economics generally denies the trade-off of time for money. In
the Marxist view, concentrated control over the means of production is
the basis for the allocation of resources among classes. 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 and also see Pigovian taxes.
Not all economics study accepts this paradigm, and, instead, there is a
seven decade old tradition of viewing economic relationships as being
based on the scarcity of energy, rather than price, as the central
feature of economics.
It could be argued that 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,
Ricardo 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 and the closely related cost-of-production theory of value dominates the work of most classical economists, but they are 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 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 (See social cost). From this flows arguments over such economic terms as moral hazard.
Economics and other disciplines
There is some degree of 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.
This leads to one of the most hotly debated areas in economic policy:
namely the effect and efficacy of welfare policies. This is viewed as a
failure to respect economics reasoning by libertarians,
who argue that redistribution of wealth is morally and economically
wrong. And viewed as a failure of economics to respect society by socialists, who argue that disparities of wealth should not have been allowed in the first place. 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 a basic
disagreement with the terminology or paradigm of market economics.
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.
- Microeconomics -- Supply and Demand -- Consumer Theory -- Production theory -- General equilibrium -- Industrial organization -- Financial economics -- Public finance -- International trade -- Labor economics -- Development economics -- Environmental economics -- Evolutionary economics -- Welfare economics -- Public choice theory -- Public goods -- Economic geography -- Network effect -- Transport economics -- Health economics
- Macroeconomics -- Stabilisation policy -- Economic growth -- Purchasing power parity -- supply side economics -- Gold standard
- Econometrics -- Game Theory -- Mathematical economics
- Related fields
- History of economic thought -- Political economy -- Political science -- Finance -- Operations research -- Home economics -- Economic anthropology
- 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
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