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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 relationships.

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 microeconomics.

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, discipline.

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.

Economic assumptions

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.

Economic language

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 exchange.

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 convenience".

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.

Value Theory

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.

See also

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

Finding related topics

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[email protected] - October 17th, 2004
illustrate with example the meaning of "scale of preference"
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Anonymous - February 27th, 2009
write brief notes on the following terms:- 1. Scarcity 2. Opportunity cost 3. Factors of Production
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daycolbey - March 17th, 2009
u need extinction
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