Economics
Areas of study in economics
Economics is usually divided into two main branches:
-
Microeconomics, which examines the economic behaviour of
individual actors such as firms, households, and individuals, with a
view to understand decision making in the face of scarcity and the
allocation consequences of these decisions.
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 theoretical and evidential support in microeconomics.
Economics can also be divided into numerious subdisciplines that do
not always fit neatly into the macro/micro categorization. Some of
these subdisciplines include: international economics, labour
economics, welfare economics, resource economics, environmental
economics, managerial economics, financial economics, urban economics,
and spatial economics.
There are also methodologies used by economists whose underlying
theories are important.
Other subdivisions are possible.
Finance
has traditionally been considered a part of economics – as its body of
results emerges naturally from microeconomics – but has today
effectively established itself as a separate, though closely 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. See
political economy for the study of economics in the context of
political science. The most prevalent political economy is loosely
called
capitalism.
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; directly by government control, indirectly by
regulation that induces market participants to act in a manner
consistent with optimal welfare, or by creating 'missing' markets to
enable efficient trading where none had previously existed. This is
studied in the field of
collective action.
Mainstream economics centers around the relationship between supply
and demand. Supply can be said to be the amount of a given
commodity available at a give price, and demand can be said to be
the amount of a commodity that would be purchased at a given price.
Mainstream economic theory centers on creating a series of supply and
demand relationships, describing them as equations, and then adjusting
for factors which produce "stickiness" between supply and demand.
Analysis is then done to see what "trade offs" are made in the
"market" which is the negotiation between sellers and buyers. Analysis
is done as to what point the ability of sellers to sell becomes less
useful than other opportunities. This is related to "marginal" costs -
or the price to produce the last unit that can be sold profitably,
versus the chance of using the same effort to engage in some other
activity.
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. In particular the nature of money, supply and
whether price reflects available information are areas of dispute. See
below for further discussion.
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, for which
Daniel Kahneman won a Nobel Prize in 2002. An example is the
growing field of
behavioral finance which combines previous theory with
cognitive psychology.
Economic language and reasoning
Economics relies on rigorous styles of argument more than other
social sciences. This is at least, the purported ideal of
professionals in the field. Economic methodology has several
interacting parts;
- Collection of economic data. This data consists of collecting
measurable values of price, and changes in price, for measurable
commodities. For example the cost to hire a worker for a week, or
the cost of a particular commodity, and how much is typically used.
- Formulation of
models of economic relationships, for example, the relationship
between the general level of prices and the general level of
employment. This includes observable forms of economic activity:
money, consumption, preferences, buying, selling, prices etc. Some
of the models are simple
accounting models, while others postulate specific kinds of
economic behavior, such as utility or profit maximization. An
example of a model which illustrates both of these aspects, is the
classical mathematical formulation of the
Keynesian system involving the
consumption function and the
national income identity. In this article we will refer to such
models as formal models although they are not formal in the
sense of
formal logic.
- Production of Economic statistics. Taking the data collected,
and applying the model being used to produce a representation of
economic activity. For example the "general price level" is
theoretical idea common to macroeconomic models. The specific
inflation rate involves taking measurable prices, and a model of how
people consume, and calculating what the "general price level" is
from the data within the model. For example suppose that gasoline
costs 1 euro a liter, to calculate the price level would require a
model of how much gasoline an average person uses, and what fraction
of their income is devoted to this - but it also requires having a
model of how people use gasoline, and what other goods they might
substitute for it, which requires a model.
- Reasoning within economic models. This process of reasoning (see
the articles on
informal logic,
logical argument,
fallacy) may or may not involve advanced mathematics. For
instance, an established (though possibly unexamined) tradition
among economists is to reason about economic variables in
two-dimensional graphs in which curves representing relations
between the axis variables are parametrized by various indices. A
good example of this type of reasoning is exhibited by
Paul Krugman's online essay, There's something about macro.
See also the article
IS/LM model. One critical analysis of economic reasoning is
studied in
Paul Samuelson's thesis, Foundations of Economic Analysis:
he identifies a class of assertions called operationally
meaningful theorems which are those that can be meaningfully
formulated within an economic model. As usual in science, the
conclusions obtained by reasoning have a predictive as well as
confirmative (or dismissive) value. An example of the predictive
value of economic theory is a prediction as to the effect of current
deficits on interest rates 10 years into the future; An example of
the confirmative value of economic theory would be confirmation (or
dismissal) of theories concerning the relation between marginal tax
rates and the deficit.
Formal modelling is motivated by general principles of consistency
and completeness.
Formal modelling has been adopted to some extent by all branches of
economics. It is not the identical to what is often referred to as
mathematical economics; this includes, but is not limited to, an
attempt to set
microeconomics, in particular general equilibrium on solid
mathematical foundation. Some reject mathematical economics: The
Austrian School of economics believes that anything beyond simple
logic is often unnecessary and inappropriate for economic analysis. In
fact, the entire empirical-deductive framework sketched in this
section may be rejected outright by this school. However, we believe
the framework sketched here represents accurately the current
predominant view of economics.
Development of economic thought
Modern economic thought is usually said to have begun with
Adam Smith in the late
18th century, although earlier thinkers such as the Spanish
Scholastics and the
physiocrats made important contributions. 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.
The central idea promoted by Smith was that the competition between
various suppliers and buyers would produce the best possible
distribution of goods and services, because it would encourage
individuals to specialize and improve their capital, so as to produce
more value with the same labor. As with its contemporaneous idea of
evolution, it rests on the belief that large systems can be
self-regulating by the activity of their parts, without specific
direction. Smith's formulation is called the "invisible hand" and is
still the centerpiece of
market
economics, and
capitalism in particular.
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 19th and
20th centuries. 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 in some contexts 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 diverged from microeconomics 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. the majority of economic theory centers around
systems where goods are exchanged in the
market
- where buyers and sellers seek to maximize their results by trading.
The dominant form of
market
economics focuses on societies where property is owned by individuals,
money has a rational basis, and profit comes from utilizing labor and
capital to produce goods to be sold in the market - or
capitalism. However, economic theory is also applied to markets
where the control of capital is in the hands of the state or society,
which include
socialism and
mercantilism, and to societies where the allocation of resources
is not through the market, but through political mechanisms, generally
referred to as command economies, which includes
communism and other forms of
totalitarianism. Many economists assert that it is impossible to
avoid the "Invsible Hand" of the Market, and hence all societies can
be modelled through market dynamics, though this viewpoint has
vehement opponents across the political spectrum.
The development of economics as a field of study is closely related
to the rise of capital as the primary determining factor of production
and trading, hence its most detailed and precise work has dealt with
the institutions belonging to market societies, and most specifically
to capitalist and socialist societies. 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 - that is 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.
The study of
risk has
been influential, which viewed variations in price over time as more
important than actual price. This particularly applies to financial
economics where risk-return tradeoffs are the crucial decisions to be
made.
The most important area of growth has been in the study of
information and decision. Examples of this school include the work of
Joseph Stiglitz. Problems of asymmetric information and moral
hazard, both based around information economics, profoundly affect
modern economic dilemmas like executive stock options, insurance
markets, and third-world debt relief.
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)
Another infant branch of economics is
neuroeconomics. This combines neuroscience, economics, and
psychology to study how we make choices.
