In the beginning
Adam Smith, author of The Wealth of Nations (1776), generally regarded as initiating modern economics.
Adam Smith, author of The Wealth of Nations (1776), generally regarded as initiating modern economics.
Although discussions about production and distribution have a long history, economics in its modern sense is conventionally dated from the publication of Adam Smith's The Wealth of Nations in 1776.[7] In this work Smith describes the subject in these practical and exacting terms:
Political economy, considered as a branch of the science of a statesman or legislator, proposes two distinct objects: first, to supply a plentiful revenue or product for the people, or, more properly, to enable them to provide such a revenue or subsistence for themselves; and secondly, to supply the state or commonwealth with a revenue sufficient for the public services. It proposes to enrich both the people and the sovereign.
Smith referred to the subject as 'political economy', but that term was gradually replaced in general usage by 'economics' after 1870.
Microeconomics
Main article: Microeconomics
Microeconomics examines the economic behavior of agents (including individuals and firms) and their interactions through individual markets, given scarcity and government regulation. A given market might be for a product, say fresh corn, or the services of a factor of production, say bricklaying. The theory considers aggregates of quantity demanded by buyers and quantity supplied by sellers at each possible price per unit. It weaves these together to describe how the market may reach equilibrium as to price and quantity or respond to market changes over time. This is broadly termed demand-and-supply analysis. Market structures, such as perfect competition and monopoly, are examined as to implications for behavior and economic efficiency. Analysis often proceeds from the simplifying assumption that behavior in other markets remains unchanged, that is, partial-equilibrium analysis. General-equilibrium theory allows for changes in different markets and aggregates across all markets, including their movements and interactions toward equilibrium.
Macroeconomics
Main article: Macroeconomics
Macroeconomics examines the economy as a whole "top down" to explain broad aggregates and their interactions. Such aggregates include national income and output, the unemployment rate, and price inflation and subaggregates like total consumption and investment spending and their components. It also studies effects of monetary policy and fiscal policy. Since at least the 1960s, macroeconomics has been characterized by further integration as to micro-based modeling of sectors, including rationality of players, efficient use of market information, and imperfect competition.[10] This has addressed a long-standing concern about inconsistent developments of the same subject.[11] Analysis also considers factors affecting the long-term level and growth of national income within a country and across countries.
Related fields, other distinctions, and classifications
Recent developments closer to microeconomics include behavioral economics and experimental economics. Fields bordering on other social sciences include economic geography, economic history, public choice, cultural economics, and institutional economics.
Another division of the subject distinguishes two types of economics. Positive economics ("what is") seeks to explain economic phenomena or behavior. Normative economics ("what ought to be," often as to public policy) prioritizes choices and actions by some set of criteria; such priorities reflect value judgments, including selection of the criteria.
Another distinction is between mainstream economics and heterodox economics. One broad characterization describes mainstream economics as dealing with the "rationality-individualism-equilibrium nexus" and heterodox economics as defined by a "institutions-history-social structure nexus."
The JEL classification codes of the Journal of Economic Literature provide a comprehensive, detailed way of classifying and searching for economics articles by subject matter. An alternative classification of often-detailed entries by mutually-exclusive categories and subcategories is The New Palgrave: A Dictionary of Economics.
Mathematical and quantitative methods
Economics as an academic subject often uses geometric methods, in addition to literary methods. Other general mathematical and quantitative methods are also often used for rigorous analysis of the economy or areas within economics. Such methods include the following.
Mathematical economics
Main article: Mathematical economics
Mathematical economics refers to application of mathematical methods to represent economic theory or analyze problems posed in economics. It uses such methods as calculus and matrix algebra. Expositors cite its advantage in allowing formulation and derivation of key relationships in an economic model with clarity, generality, rigor, and simplicity.[16] For example, Paul Samuelson's book Foundations of Economic Analysis (1947) identifies a common mathematical structure across multiple fields in the subject.
Econometrics
Main article: Econometrics
Econometrics applies mathematical and statistical methods to analyze data related to economic models. For example, a theory may hypothesize that a person with more education will on average earn more income than person with less education holding everything else equal. Econometric estimates can estimate the magnitude and statistical significance of the relation. Econometrics can be used to draw quantitative generalizations. These include testing or refining a theory, describing the relation of past variables, and forecasting future variables.
Development and growth economics
Main articles: Economic growth and Development economics
Chart of World GDP per capita by region over the last 2000 years. GDP per capita is a convenient summary measure of long-term economic development.
Chart of World GDP per capita by region over the last 2000 years. GDP per capita is a convenient summary measure of long-term economic development.
Growth economics studies factors that explain economic growth – the increase in output per capita of a country over a longer period of time. The same factors are used to explain differences in the level of output per capita between countries, Much-studied factors include the rate of investment, population growth, and technological change. These are represented in theoretical and empirical forms (as in the neoclassical growth model) and in growth accounting. At a more specific level, development economics examines economic aspects of the development process in relatively low-income countries with a focus on methods of promoting economic growth. Approaches in development economics frequently incorporate social and political factors to devise particular plans.
Economic systems
Main article: Economic system
Economic systems is the branch of economics that studies the methods and institutions by which societies determine the ownership, direction, and allocaton of economic resources. An economic system of a society is the unit of analysis. Among contemporary systems at different ends of the organizational spectrum are socialist systems and capitalist systems, in which most production occurs in respectively state-run and private enterprises. In between are mixed economies. A common element is the interaction of economic and political influences, broadly described as political economy. Comparative economic systems studies the relative performance and behavior of different economies or systems.
Environmental economics
Main article: Environmental economics
Environmental economics is concerned with issues related to degradation, enhancement, or preservation of the environment. In particular, public bads from production or consumption, such as air pollution, can lead to market failure. The subject considers how public policy can be used to correct such failures. Policy options include regulations that reflect cost-benefit analysis or market solutions that change incentives, such as emission fees or redefinition of property rights.
Financial economics
Main article: Financial economics
Financial economics, often simply referred to as finance, is concerned with the allocation of financial resources in an uncertain (or risky) environment. Thus, its focus is on the operation of financial markets, the pricing of financial instruments, and the financial structure of companies.
Game theory
Main article: Game theory
Game theory is a branch of applied mathematics that studies strategic interactions between agents. In strategic games, agents choose strategies that will maximize their payoff, given the strategies the other agents choose. It provides a formal modeling approach to social situations in which decision makers interact with other agents. Game theory generalizes maximization approaches developed to analyze markets such as the supply and demand model. The field dates from the 1944 classic Theory of Games and Economic Behavior by John von Neumann and Oskar Morgenstern. It has found significant applications in many areas outside economics as usually construed, including formulation of nuclear strategies, ethics, political science, and evolutionary theory.
Industrial organization
Main article: Industrial organization
Industrial organization studies the strategic behavior of firms, the structure of markets and their interactions. The common market structures studied include perfect competition, monopolistic competition, various forms of oligopoly, and monopoly.
Information economics
Main article: Information economics
Information economics examines how information (or a lack of it) affects economic decision-making. An important focus is the concept of information asymmetry, where one party has more or better information than the other. The existence of information asymmetry gives rise to problems such as moral hazard, and adverse selection, studied in contract theory. The economics of information has relevance in many fields, including finance, insurance, contract law, and decision-making under risk and uncertainty.
International economics
Main articles: International trade and International finance
International trade studies the determinants of the flow of goods and services across international boundaries. International finance is a macroeconomic field which examines the flow of capital across international borders, and the effects of these movements on exchange rates. Increased trade in goods, services and capital between countries is a major effect of contemporary globalization.
Labour economics
Main article: Labour economics
Labour economics seeks to understand the functioning of the market and dynamics for labour. Labour markets function through the interaction of workers and employers. Labour economics looks at the suppliers of labour services (workers), the demanders of labour services (employers), and attempts to understand the resulting patterns of wages and other labour income and of employment and unemployment, Practical uses include assisting the formulation of full employment of policies.
Law and economics
Main article: Law and Economics
Law and economics, or economic analysis of law, is an approach to legal theory that applies methods of economics to law. It includes the use of economic concepts to explain the effects of legal rules, to assess which legal rules are economically efficient, and to predict what the legal rules will be. A seminal article by Ronald Coase published in 1961 suggested that well-defined property rights could overcome the problems of externalities.
Public finance
Main article: Public finance
Public finance is the field of economics that deals with budgeting the revenues and expenditures of a public sector entity, usually government. The subject addresses such matters as tax incidence (who really pays a particular tax), cost-benefit analysis of government programs, effects on economic efficiency and income distribution of different kinds of spending and taxes, and fiscal politics. The latter, an aspect of public choice theory, models public-sector behavior analogously to microeconomics, involving interactions of self-interested voters, politicians, and bureaucrats.
Welfare economics
Main article: Welfare economics
Welfare economics is a branch of economics that uses microeconomic techniques to simultaneously determine the allocative efficiency within an economy and the income distribution associated with it. It attempts to measure social welfare by examining the economic activities of the individuals that comprise society.
Economic concepts
Supply and demand
Main article: Supply and demand
The supply and demand model describes how prices vary as a result of a balance between product availability and demand. The graph depicts an increase (that is, right-shift) in demand from D1 to D2 along with the consequent increase in price and quantity required to reach a new equilibrium point on the supply curve (S).
The supply and demand model describes how prices vary as a result of a balance between product availability and demand. The graph depicts an increase (that is, right-shift) in demand from D1 to D2 along with the consequent increase in price and quantity required to reach a new equilibrium point on the supply curve (S).
The theory of demand and supply is an organizing principle to explain prices and quantities of goods sold and changes thereof in a market economy. In microeconomic theory, it refers to price and output determination in a perfectly competitive market. This has served as a building block for modeling other market structures and for other theoretical approaches.
For a given market of a commodity, demand shows the quantity that all prospective buyers would be prepared to purchase at each unit price of the good. Demand is often represented using a table or a graph relating price and quantity demanded (see boxed figure). Demand theory describes individual consumers as "rationally" choosing the most preferred quantity of each good, given income, prices, tastes, etc. A term for this is 'constrained utility maximization' (with income as the "constraint" on demand). Here, 'utility' refers to the (hypothesized) preference relation for individual consumers. Utility and income are then used to model hypothesized properties about the effect of a price change on the quantity demanded. The law of demand states that, in general, price and quantity demanded in a given market are inversely related. In other words, the higher the price of a product, the less of it people would be able and willing to buy of it (other things unchanged). As the price of a commodity rises, overall purchasing power decreases (the income effect) and consumers move toward relatively less expensive goods (the substitution effect). Other factors can also affect demand; for example an increase in income will shift the demand curve outward relative to the origin, as in the figure.
Supply is the relation between the price of a good and the quantity available for sale from suppliers (such as producers) at that price. Supply is often represented using a table or graph relating price and quantity supplied. Producers are hypothesized to be profit-maximizers, meaning that they attempt to produce the amount of goods that will bring them the highest profit. Supply is typically represented as a directly proportional relation between price and quantity supplied (other things unchanged). In other words, the higher the price at which the good can be sold, the more of it producers will supply. The higher price makes it profitable to increase production. At a price below equilibrium, there is a shortage of quantity supplied compared to quantity demanded. This pulls the price up. At a price above equilibrium, there is a surplus of quantity supplied compared to quantity demanded. This pushes the price down. The model of supply and demand predicts that for a given supply and demand curve, price and quantity will stabilize at the price that makes quantity supplied equal to quantity demanded. This is at the intersection of the two curves in the graph above, market equilibrium.
For a given quantity of a good, the price point on the demand curve indicates the value, or marginal utility to consumers for that unit of output. It measures what the consumer would be prepared to pay for the corresponding unit of the good. The price point on the supply curve measures marginal cost, the increase in total cost to the supplier for the corresponding unit of the good. The price in equilibrium is determined by supply and demand. In a perfectly competitive market, supply and demand equate cost and value at equilibrium.
Demand and supply can also be used to model the distribution of income to the factors of production, including labour and capital, through factor markets. In a labour market for example, the quantity of labour employed and the price of labour (the wage rate) are modeled as set by the demand for labour (from business firms etc. for production) and supply of labour (from workers).
Demand and supply are used to explain the behavior of perfectly competitive markets, but their usefulness as a standard of performance extends to any type of market. Demand and supply can also be generalized to explain macroeconomic variables in a market economy, for example, quantity of total output and the general price level.
Prices and quantities
Main articles: Price and Prices and quantities
Even a currency has a price, its exchange rate in currency markets. Its determination by supply and demand is an important issue in international trade.
Even a currency has a price, its exchange rate in currency markets. Its determination by supply and demand is an important issue in international trade.
In supply-and-demand analysis, price, the going rate of exchange for a good, coordinates production and consumption quantities. Price and quantity have been described as the most directly observable characteristics of a good produced for the market.[42] Supply, demand, and market equilibrium are theoretical constructs linking price and quantity. But tracing the effects of factors predicted to change supply and demand -- and through them, price and quantity -- is a standard exercise in applied microeconomics and macroeconomics. Economic theory can specify under what circumstances price demonstrably serves as an efficient communication device to regulate quantity. A real-world counterpart might attempt to measure how much variables that increase supply or demand change price and quantity.
Elementary demand-and-supply theory predicts equilibrium but not the speed of adjustment for changes of equilibrium due to a shift in demand or supply. In many areas, some form of "price stickiness" is postulated to account for quantities, rather than prices, adjusting in the short run to changes on the demand side or the supply side. This includes standard analysis of the business cycle in macroeconomics. Analysis often revolves around causes of such price stickiness and their implications for reaching a hypothesized long-run equilibrium. Examples of such price stickiness in particular markets include wage rates in labour markets and posted prices in markets deviating from perfect competition.
Another area of economics considers whether markets adequately take account of all social costs and benefits. An externality is said to occur where there are significant social costs or benefits from production or consumption that are not reflected in market prices. For example, air pollution may generate a negative externality, and education may generate a positive externality (less crime, etc.). Governments often tax and otherwise restrict the sale of goods that have negative externalities and subsidize or otherwise promote the purchase of goods that have positive externalities in an effort to correct the price distortions caused by these externalities.
Marginalism
Main article: Marginalism
Marginalist economic theory, such as above, describes consumers as attempting to reach a most-preferred position, subject to constraints, including income and wealth. It describes producers as attempting to maximize profits subject to their own constraints (including demand for goods produced, technology, and the price of inputs). Thus, for a consumer, at the point where marginal utility of a good, net of price, reaches zero, further increases in consumption of that good stop. Analogously, a producer compares marginal revenue against marginal cost of a good, with the difference as marginal profit. At the point where the marginal profit reaches zero, further increases in production of the good stop. For movement to equilibrium and for changes in equilibrium, behavior also changes "at the margin" -- usually more-or-less of something, rather than all-or-nothing.
Related conditions and considerations apply more generally to any type of economic system, whether market-based or not, where there is scarcity.[46] Scarcity is defined by the amount of producible or exchangeable goods, whether needed or desired, exceeding feasible production. The conditions are in the form of constraints on production from finite resources available. Such resource constraints describe a menu of production possibilities. For consumers or other agents, production possibilities and scarcity are posited to imply that, even if resources are fully utilized, there are trade-offs, whether of radishes for carrots, non-work time for money income, private goods for public goods, or present consumption for future consumption. The marginalist notion of opportunity cost is a device to measure the size of the trade-off between competing alternatives. Such costs, reflected in prices of a market economy, are used for analysis of economic efficiency or for predicting responses to disturbances in a market economy. In a centrally planned economy, comparable shadow-price relations must be satisfied for the efficient use of resources in meeting production objectives. At this level, marginalism can be used as a tool for modeling not only individual agents or markets but different economic systems and broad allocations of output in relation to variables that affect them.
Economic reasoning
Economics as a contemporary discipline relies on rigorous styles of argument. Objectives include formulating theories that are simpler, more fruitful, and more reliable in their explanatory power than other theories.[49] Often analysis begins with a simple model to isolate relations of a variable to be explained. Complications may be impounded in a ceteris paribus ("other things equal") assumption. For example, the quantity theory of money hypothesizes a positive relationship between the price level and the money supply, ceteris paribus. The theory can be tested using economic data, such as a price index for GDP and a measure of the money supply, say currency plus bank deposits. Econometric methods can allow for the influence of competing explanations and attempt to adjust for noise from other variables in the absence of a controlled experiment. More recently, the use of experimental methods in economics has greatly expanded, challenging a historically-noted differentiating feature of some natural sciences from economics.
Expositions of reasoning within economic models often use two-dimensional graphs to represent theoretical relationships. At a higher level of generality, Paul Samuelson's treatise Foundations of Economic Analysis (1947) showed how to apply mathematical methods to examine the class of assertions called operationally meaningful theorems in economics, which are theorems that can conceivably be refuted by empirical data. Such assertions permit testing of a theory.
Some reject mathematical economics. Thus, in the Austrian school of economics it is argued that anything beyond simple logic is likely unnecessary and inappropriate for economic analysis. Still, economics has undergone a thorough, cumulative formalization of concepts and methods, including for use in the hypothetico-deductive method of explaining real-world phenomena. An example of the latter is the extension of microeconomic analysis to seemingly non-economic areas, sometimes called economic imperialism.
Classical economics
Main article: Classical economics
Publication of Adam Smith's The Wealth of Nations in 1776, has been described as "the effective birth of economics as a separate discipline."
The book identified land, labor, and capital as the three factors of production and the major contributors to a nation's wealth. In Smith's view, the ideal economy is a self-regulating market system that automatically satisfies the economic needs of the populace.He described the market mechanism as an "invisible hand" that leads all individuals, in pursuit of their own self-interests, to produce the greatest benefit for society as a whole. Smith incorporated some of the Physiocrats' ideas, including laissez-faire, into his own economic theories, but rejected the idea that only agriculture was productive.
In his famous invisible-hand analogy, Smith argued for the seemingly paradoxical notion that competitive markets tended to advance broader social interests, although driven by narrower self-interest. The general approach that Smith helped initiate was called political economy and later classical economics. It included such notables as Thomas Malthus, David Ricardo, and John Stuart Mill writing from about 1770 to 1870.
While Adam Smith emphasized the production of income, David Ricardo focused on the distribution of income among landowners, workers, and capitalists. Ricardo saw a conflict between landowners on the one hand and labor and capital on the other. He posited that the growth of population and capital, pressing against a fixed supply of land, pushes up rents and holds down wages and profits.
Thomas Robert Malthus used the idea of diminishing returns to explain low living standards. Population, he argued, tended to increase geometrically, outstripping the production of food, which increased arithmetically. The force of a rapidly growing population against a limited amount of land meant diminishing returns to labor. The result, he claimed, was chronically low wages, which prevented the standard of living for most of the population from rising above the subsistence level.
Malthus also questioned the automatic tendency of a market economy to produce full employment. He blamed unemployment upon the economy's tendency to limit its spending by saving too much, a theme that lay forgotten until John Maynard Keynes revived it in the 1930s.
Coming at the end of the Classical tradition, John Stuart Mill parted company with the earlier classical economists on the inevitability of the distribution of income produced by the market system. Mill pointed to a distinct difference between the market's two roles: allocation of resources and distribution of income. The market might be efficient in allocating resources but not in distributing income, he wrote, making it necessary for society to intervene.
Value theory was important in classical theory. Smith wrote that the "real price of every thing ... is the toil and trouble of acquiring it" as influenced by its scarcity. Smith maintained that, with rent and profit, other costs besides wages also enter the price of a commodity. Other classical economists presented variations on Smith, termed the 'labour theory of value'. Classical economics focused on the tendency of markets to move to long-run equilibrium.
Historic definitions of economics
This section extends the discussion of the definitions of Economics at the beginning of the article.
Wealth definition
Some early definitions of political economy were succinctly related to wealth, which was broadly construed. Adam Smith defined the subject as simply the "Science of wealth." Smith offered another definition, "the Science relating to the laws of production, distribution and exchange." Wealth was defined as the specialization of labour which allowed a nation to produce more with its supply of labour and resources. This definition divided Smith and Hume from previous definitions which defined wealth as gold. Hume argued that gold without increased activity only serves to raise prices.
John Stuart Mill defined economics as "the practical science of production and distribution of wealth"; this definition was adopted by the Concise Oxford English Dictionary even though it does not include the vital role of consumption. For Mill, wealth is defined as the stock of useful things.
Definitions of the subject in terms of wealth emphasize production and consumption. This emphasis was charged by critics as too narrow a focus in placing wealth to the forefront and man in the background. For example, John Ruskin referred disparagingly to political economy as "the science of getting rich" and a "bastard science.
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