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.
In economic theory, the price level is determined by the "marginal"
cost and "marginal" utility. Marginalism became increasingly important
in economic theory in the late 19th century, and is a tool which is
used to analyze how economic systems will react. The marginal cost of
a commodity is the cost to produce the last unit of it, the marginal
utility is the happiness gained from buying the last unit. Economic
theory uses marginalism to describe the "diminishing returns" from
consumption - the 10th candy bar doesn't taste as good as the first,
and so brings less "marginal utility". Marginal cost of production
divides costs into "fixed" costs which must be paid regardless of how
many of a commodity are produced, and "variable costs". The marginal
cost is the variable cost of the last unit, plus the percentage of
fixed costs. Marginalism states that when the profit from the next
unit will be zero, that unit will not be produced.
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". For example
neoclassical economists and
Austrian School economists prefer the
marginal theory of 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". This was orginally asserted by Mill.
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 economic theory is
based around prices and the theory of
supply and demand.
Supply and demand assume that the factors affecting the agents who
supply a particular commodity can be separated from those who wish to
sell it. Sellers have a quantity they would wish to sell at every
given price and a price for any quantity the wish to sell; buyers have
a quantity they will demand at any given price and a price that is
acceptable to them if they have to buy a particular quantity.
The market 'clears' at the point where all the supply and demand at
a given price balance. That is, the amount of a commodity available at
a given price equals the amount that buyers are willing to purchase at
that price. It is assumed that there is a process that will result in
the market reaching this point, but exactly what the process is in a
real situation is an ongoing subject of research. Markets which do not
clear will react in some way, either by a change in price, or in the
amount produced, or in the amount demanded. Graphically the situation
can be represented by two curves; one showing the price-quantity
combinations acceptable to buyers, or the
demand curve, one showing the combinations acceptable to sellers,
or the
supply curve. The market clears where the two are in equilibrium,
that is where the curves intersect. In a
general equilibrium model, all markets in all goods clear
simultaneously and the 'price' can be described entirely in terms of
tradeoffs with other goods. For a century the
Say's Law was believed in economic theory, which said that
markets, as a whole, would always clear.
In many practical economic models, some form of "price stickiness"
is incorporated to model the observed fact that in many markets 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). This leads into
public goods theory.
