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One of the uses of economics is to explain how economies work and what the relations are between economic players in the larger society. Methods of economic analysis have been increasingly applied to fields that involve people (officials included) making choices in a social context, such as crime [1], education [2], the family, health, law, politics, religion [3], social institutions, and war [4].
In the beginning . . .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. In this work Smith defines the subject in practical terms:
Smith referred to the subject as 'political economy', but that term was gradually replaced in general usage by 'economics' after 1870. Areas of study
Since at least the 1960s, macroeconomics has been characterized by further micro-based modeling as to rationality of players and efficient use of market information. Today a consensus view is that good macroeconomics has solid microeconomic motivation as to theory and evidence. The vast majority of economic theory is in terms of either macro or micro economics. However, a few authors (for example, Kurt Dopfer, Stuart Holland and Markos Mamalakis[3]) also argue that 'mesoeconomics', which considers the intermediate level of economic organization such as markets and other institutional arrangements, should be considered an additional branch of economic study.[3] Mamalakis claims that mesoeconomics "unifies and reconciles the macro and micro approaches"[3] and is a "richer" way of studying the dynamics of economics than the two traditional models. In an article published in 1996, Mamalakis claimed that in Latin America the mesoeconomic approach is the key to understanding the poverty and inequality that has persisted over two centuries despite the adoption of various different economic systems.[4] George Ainslie has proposed a theory of an individual as a collection of actors, based on experiments in consumer psychology. Picoeconomic thinking argues that behavioral economics provides evidence an even greater level of disaggregation that reduces the individual consumer's behavior to the psychological components that drive that behavior. Another division of the subject distinguishes positive economics, which seeks to predict and explain economic phenomena ("what is"), from normative economics ("what ought to be"), which orders choices and actions by some criterion; such orderings necessarily involve value judgments, including selection from criteria. Another more recent trend, closer to microeconomics, is to use social psychology concepts (behavioral economics) and methods (experimental economics) to understand deviations from the predictions of neoclassical economics. Economic history is the study of economic change, and of economic phenomena in the past. Financial economics has traditionally been considered a part of economics, as its body of results emerges naturally from microeconomics. However, today Finance effectively established itself as a separate, though closely related, discipline. Economics can also be divided into numerous sub disciplines including: international economics, development economics, labor economics, environmental economics, industrial organization, public finance, economic psychology, economic sociology, institutional economics, economic geography, information economics and economics of security. The JEL classification codes 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 (1987).[5] TechniquesSpecialized techniques may be used in the subject. These include the following
Another important technique is national (or social) accounting, which summarizes economic activity for a nation (or other geographic area). Specifically, the national accounts are double-entry accounting systems that provide detailed underlying measures of such information. These include national income and product accounts, balance sheets, accounts of capital accumulation and finance, and input-output tables.[7] Language and reasoningEconomics relies on rigorous styles of argument. Economic methodology has several interacting parts:
1) Identity equations are used to explain how certain economic values are calculated. An example is the relationship of the quantity theory of money as expressed in Irving Fisher's theory of the price level, which is shown by the equation of exchange <math>M \cdot V = P \cdot Q</math>. This is often used to find how fast money circulates in the economy and can be considered an accounting measure. Another example is national income. Identity equations are tautological in that the purpose is to define rather than to explain. 2) Descriptive equations are used to describe how an economic agent behaves. For example, utility and budget equations describe the desires and limitations of consumers. When combined, these yield demand equations which describe the quantities of product consumers will seek to purchase at various prices. Similarly, profit and production equations describe the desires and limitations of firms. When combined, these yield supply equations. Combining demand and supply equations yields equilibrium equations that describe the prices and quantities that will prevail in the markets. This article will refer to such models as formal models, although they are not formal in the sense of formal logic. Economists often formulate very simple models in order to define the impact of just one variant changing. This is called the ceteris paribus ("other things equal") assumption, meaning that all other things are assumed not to change during the period of observation: for example, "If the price of movie tickets rises, ceteris paribus the demand for popcorn falls." However, it is possible with the use of econometric methods to determine one relationship while removing much of the noise caused by other variables.
Formal modeling, which has been adapted to some extent by all branches of economics, is motivated by general principles of consistency and completeness. It is not 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 foundations. 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 that school. However, the framework sketched here accurately represents the current predominant view of economics. Many mainstream economists feel that the combination of rigorous theory and empirical data ultimately gives the best understanding of real-world phenomena. Towards this end, economics has undergone a massive formalization of its ideas, concepts and methods. According to critics, sometimes to the detriment of its real-world relevance. This creates a tension in the profession on what economists should do. The traditional Chicago School, with its emphasis on economics being an empirical science aimed at explaining real-world phenomena, has insisted on the power of price theory as the tool of analysis. On the other hand, some economic theorists have formed the view that a consistent economic theory may be useful even if at present no real world economy bears out its prediction. Schools of thoughtModern mainstream economicsMainstream economics begins with the premise that resources are scarce and that it is necessary to choose between competing alternatives. That is, economics deals with tradeoffs. With scarcity, choosing one alternative implies forgoing another alternative—the opportunity cost. The opportunity cost creates an implicit price relationship between competing alternatives. In addition, in both market oriented and planned economies, scarcity is often explicitly quantified by price relationships. Alfred Marshall in the late 19th century informally described economics as "the study of man in the ordinary business of life". Understanding choices by individuals and groups is central. Economists believe that incentives and desires play an important role in shaping decision making. Concepts from the Utilitarian school of philosophy are used as analytical concepts within economics, though economists appreciate that society may not adopt utilitarian objectives. One example of this is the idea of a utility function, which is assumed to represent how economic agents rank the choices given to them. The utility function ranks available choices from best to worst, and the agent gradually learns to choose the best-ranked choice in the feasible set of his alternatives. On a microeconomic level, some economists extend economic analysis to all personal decisions. An alternative can be thought of as a vector where the entries are answers not only to questions like "How many eggs should I buy?", but also "How many hours should I spend with my kids?" and "Which candidate should I vote for?" Modern mainstream economics builds primarily on neoclassical economics, which began to develop in the late 1800s and models choices made in the allocation of scarce resources. Mainstream economics also acknowledges the existence of market failure and some insights from Keynesian economics. It looks to game theory and asymmetric information to solve problems on a microeconomic level. Many important insights on collective behavior (for example, emergence of organizations) have been incorporated from institutional economics via new institutionalism. Alternative approachesNeoclassical economics as part of a Neo-classical synthesis with Keynesian macro-economics is the dominant form of economics used today, and is the main source of theory for mainstream economists. It is often referred to by its critics as Orthodox Economics. The more specific definition this approach implies was captured by Lionel Robbins in 1932: "the science which studies human behavior as a relation between scarce means having alternative uses." Scarcity means that available resources are insufficient to satisfy all wants and needs; if there is no scarcity and no alternative uses of available resources, then there is no economic problem. There are various forms of heterodox economics, as well as schools of thought which, while part of the mainstream, are at variance with the main emphasis on micro-economic formalism. Others, while they have academic or institutional followings are less used by mainstream economists. These include institutional economics, Marxist economics, socialism, and green economics.
Famous schools or trends of thought referring to a particular style of economics practiced at and disseminated from well-defined groups of academicians that have become known worldwide, may be generally summarized as follows:
Economics and ecologyAnother premise is that economics fits within a finite ecosystem where there are at least some abundant resources. For instance, when fueling a fire, people are usually concerned with finding the wood, and not with finding the air to burn it with. Traditional economics explicitly does not deal with free or abundant natural inputs. One criticism is that it often conflicts with ecology's view of what affects what. Ecological economics attempts to address this criticism by calculating the financial contribution of nature's services, adding environmental considerations such as biodiversity to traditional list of human wants and needs, and proposing policy tools to address the negative impacts of economic growth on the environment. Green economics is a closely related field which views the human economy as a subset of the larger ecosystem. Alternative definitionsThis section extends the discussion of the definitions of Economics at the beginning of the article. Wealth definitionThe earliest definitions of political economy were simple, elegant statements defining it as the study of wealth. The first scientific approach to the subject was inaugurated by Aristotle, whose influence is still recognized, inter alia, today by the Austrian School. Adam Smith, author of the seminal work The Wealth of Nations and regarded by some as the 'father of economics', defines economics simply as "The science of wealth."[11] Smith offered another definition, "The Science relating to the laws of production, distribution and exchange."[11] Wealth was defined as the specialization of labor which allowed a nation to produce more with its supply of labor and resources. This definition divided Smith and Hume from previous definitions which defined wealth as gold. Hume argued that gold without increased activity simply serves to raise prices.[12] 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.[13] Definitions in terms of wealth emphasize production and consumption. The accounting measures usually used measure the pay received for work and the price paid for goods, and do not deal with the economic activities of those not significantly involved in buying and selling (for example, retired people, beggars, peasants). For economists of this period, they are considered non-productive, and non-productive activity is considered a kind of cost on society. This interpretation gave economics a narrow focus that was rejected by many as placing wealth in the forefront and man in the background; John Ruskin referred to political economy as a "bastard science"[14] and "the science of getting rich."[15] Welfare definitionLater definitions evolved to include human activity, advocating a shift toward the modern view of economics as primarily a study of man and of human welfare, not of money. Alfred Marshall in his 1890 book Principles of Economics wrote, "Political Economy or Economics is a study of mankind in the ordinary business of Life; it examines that part of the individual and social action which is most closely connected with the attainment and with the use of material requisites of well-being."[16] The welfare definition was still criticized as too narrowly materialistic. It ignores, for example, the non-material aspects of the services of a doctor or a dancer. A theory of wages which ignored all those sums paid for immaterial services was incomplete. Welfare could not be quantitatively measured, because the marginal significance of money differs from rich to the poor (that is, $100 is relatively more important to the well-being of a poor person than to that of a wealthy person). Moreover, the activities of production and distribution of goods such as alcohol and tobacco may not be conducive to human welfare, but these scarce goods do satisfy innate human wants and desires. Marxist economics still focuses on a welfare definition. In addition, several critiques of mainstream economics begin from the argument that current economic practice does not adequately measure welfare, but only monetized activity, which is an inadequate approximation of welfare. Scarcity definitionScarcity suggests all things in the world are in finite supply. People therefore have to make choices. Scarcity too has its critics. It is most amenable to those who consider economics a pure science, but others object that it reduces economics merely to a valuation theory. It ignores how values are fixed, prices are determined and national income is generated.[citation needed] It also ignores unemployment and other problems arising due to abundance. This definition cannot apply to such Keynesian concerns as cyclical instability, full employment, and economic growth. The focus on scarcity continues to dominate neoclassical economics, which, in turn, predominates in most academic economics departments. It has been criticized in recent years from a variety of quarters, including institutional economics and evolutionary economics and surplus economics. Core conceptsValueThe concept of value is central to economics. An observable measure of it is market price. Image:Us-gold-certificate-1922.jpg Representative money like this 1922 US $100 gold note could be exchanged by the bearer for its face value in gold. Adam Smith defined labor as the underlying source of value,[11] and the "labor theory of value" underlies the work of Karl Marx, David Ricardo and many other classical economists. This theory argues that a good or service is worth the labor that it takes to produce. For most, this value determines a commodity's price. This labor theory of price and the closely related cost-of-production theory of value dominates the work of most classical economists, but those theories are far from the only accepted basis for "value". For example, Austrian School economists use the marginal theory of value. Neoclassical economics, as in John R. Hicks's book Value and Capital, distinguishes value (as determined on the demand side) from cost (on the supply side), with price determined by supply and demand.[17] In a competitive market, demand and supply interact to determine price and equate cost and value. Economic analysis considers not only the allocation of output for different uses but the distribution of income to the factors of production, including labour and capital, through factor markets. Supply and demandImage:Supply-demand-right-shift-demand.svg The supply and demand model describes how prices vary as a result of a balance between product availability and demand. The graph depicts a 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). In microeconomic theory supply and demand attempts to describe, explain, and predict the price and quantity of goods sold in perfectly competitive markets. It is one of the most fundamental economic models, ubiquitously used as a basic building block in a wide range of more detailed economic models and theories. To define, demand is the quantity of a product that a consumer or buyer would be willing and able to buy at any given price in a given period of time. Demand is often represented as a table or a graph relating price and quantity demanded. Most economic models assume that consumers make rational choices about how much to buy in order to maximize their utility - they spend their income on the products that will give them the most happiness at the least cost. The law of demand states that, in general, price and quantity demanded are inversely related. In other words, the higher the price of a product, the less of it consumers will buy. Supply is the quantity of goods that a producer or a supplier is willing to bring into the market for the purpose of sale at any given price in a given period of time. Supply is often represented as a table or a graph relating price and quantity supplied. Like consumers, producers are assumed to be utility-maximizing, attempting to produce the amount of goods that will bring them the greatest possible profit. The law of supply states that price and quantity supplied are directly proportional. In other words, the higher the price of a product, the more of it producers will create. The theory of supply and demand is crucial to explaining the market economy in that it explains the mechanisms by which prices and levels of production are set. PriceIn order to measure the ebb and flow of supply and demand, a measurable value is needed. The oldest and most commonly used is price, or the going rate of exchange between buyers and sellers in a market. 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.[11] A great deal of economic theory is based around prices and the theory of supply and demand. In economic theory, the most efficient form of communication comes about when changes to an economy occur through price, such as when an increase in supply leads to a lower price, or an increase in demand leads to a higher price. Image:Moneybillscoins3.jpg Exchange rates are determined by the relative supply and demand of different currencies — an important issue in international trade. In many practical economic models, some form of "price stickiness" is incorporated to model the fact that prices do not move fluidly in many markets. Economic policy often revolves around arguments about the cause of "economic friction", or price stickiness, and which is, therefore, preventing the supply and demand from reaching equilibrium. Another area of economic controversy is about whether price measures the value of a good correctly. In mainstream market economics, where there are significant scarcities not factored into price, there is said to be an externalization, which is a cost or benefit to actors other than the buyer and seller, of which many examples exist, including pollution (a cost to others) and education (a benefit to others). Market economics predicts that scarce goods which are under-priced because of externalities are over-consumed (See social cost), and that scarce goods that are over-priced are under-consumed. This leads into public goods theory. 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 distortion in price caused by these externalities. ScarcityNeoclassical economics is characterized by maximization (leisure time, wealth, health, other sources of happiness - all commonly reduced to the concept of utility) subject to constraints. These constraints - or scarcity - inevitably define a trade-off. For example, one can have more money by working harder, but less time (there are only so many hours in a day, so time is scarce). One can have more radishes only at the expense of, for example, fewer carrots (you only have so much land on which to grow food - land is scarce). All economies in the world face scarcity Scarcity is defined as: when the price is zero, the quantity demanded exceeds the quantity supplied. Price is a measure of relative scarcity. If all other market variables are held constant. When the price is rising, this indicates the commodity is becoming relatively more scarce. When the price is falling, this indicates the commodity is becoming relatively less scarce. Adam Smith considered, for example, the trade-off between time, or convenience, and money. He discussed how a person could live near town, and pay more for rent of his home, or live farther away and pay less, "paying the difference out of his convenience".[11] MarginalismIn marginalist economic theory, the price level is determined by the marginal cost and marginal utility. The price of all goods will be the cost of making the last one that people will purchase, and the price of all the employees in a company will be the cost of hiring the last one the business needs. Marginalism looks at decisions based on "the margins", what the cost to produce the next unit is, versus how much it is expected to return in profit. When the marginal return of an action reaches zero, the action stops. Marginal utility is how much more happiness or use a person receives from a purchase in contrast with buying less. Marginal rewards are often subject to diminishing returns: Less reward is obtained from more production or consumption. For example, the 10th bar of chocolate that a person consumes does not taste as good as the first, and so brings less 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. 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. Marginalism states that when the profit from the next unit will be zero, that unit will not be produced. This is often termed the marginal revolution in economic thought. The marginalist theory of price level runs counter to the classical theory of price being determined by the amount of labor congealed in a commodity. Development of economic thoughtImage:AdamSmith.jpg Adam Smith, generally regarded as the Father of Economics, author of An Inquiry into the Nature and Causes of the Wealth of Nations, commonly known as The Wealth of Nations. The term economics was coined around 1870 and popularized by influential "neoclassical" economists such as Alfred Marshall (Welfare definition), as a substitute for the earlier term political economy, which referred to "the economy of polities" – competing states.[citation needed] The term political economy was used through the 18th and 19th centuries, with Adam Smith, David Ricardo and Karl Marx as its main thinkers and which today is frequently referred to as the "classical" economic theory. Both "economy" and "economics" are derived from the Greek oikos- for "house" or "settlement", and nomos for "laws" or "norms". Economic thought may be roughly divided into three phases: premodern (Greek, Roman, Arab), early modern (mercantilist, physiocrats) and modern (since Adam Smith in the late 18th century). Systematic economic theory has been developed mainly since the birth of the modern era. Joseph Schumpeter specifically credits the development of the scientific study of economics to the Late Scholastics, particularly those of 15th and 16th century Spain (see his History of Economic Analysis). There have been different and competing schools of economic thought pertaining to capitalism from the late 18th Century to the present day. Important schools of thought include Mercantilism, Kameralism, physiocracy, classical economics, Manchester school, Austrian school, Marxian economics, and Chicago school. Within macroeconomics there is, in general order of their appearance in the literature; classical economics, Keynesian economics, neo-classical synthesis, post-Keynesian economics, monetarism, new classical economics, and supply-side economics. New alternative developments include evolutionary economics, dependency theory, and world systems theory. Criticism and contrarian perspectivesIs economics a science?One of the marks of a science is the use of a scientific method and the ability to establish hypotheses and make predictions which can then be tested with data and where the results are repeatable by others. Unlike some natural scientists and in a way similar to what happens in other social sciences, it is difficult for economists to conduct formal experiments due to moral and practical issues involved with human subjects. Experimentation, however, has been conducted in a number of applied fields in economics: this includes the sub-fields of experimental economics and consumer behavior, focused on experimentation using human subjects; and the sub-field of econometrics, focused on testing hypotheses when data are not generated via controlled experimentation. The status of social sciences as an empirical science has been a matter of debate in the 20th century, see Positivism dispute.[18] Unlike the natural sciences, economics yields no natural laws or universal constants due to its reliance on non-physical arguments, so this has led some critics, like Dick Richardson, Ph.D., Professor of Integrative Biology at the University of Texas at Austin, to argue economics is not a science.[19] In general, economists reply that while this aspect presents serious difficulties, they do in fact test their hypotheses using statistical methods such as econometrics and data generated in the real world. [20] The field of experimental economics has seen efforts to test at least some predictions of economic theories in a simulated laboratory setting – an endeavor which earned Vernon Smith the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel in 2002. Criticisms of economic theory and practiceEconomics has been criticized for its reliance on unrealistic, unobservable, or unverifiable assumptions. One response to this criticism has been that the unrealistic assumptions result from abstraction from unimportant details, and that such abstraction is necessary in a complex real world. Rather than unrealistic assumptions compromising the epistemic worth of economics, such assumptions are essential for economic knowledge. One study has termed this explanation the "abstractionist defense". The study concludes that that this "abstractionist defense" does not invalidate the criticizism of the unrealistic assumptions.[21] However, it is important to note that while one school does have a majority in the field, there is far from a consensus on all economic issues and multiple alternative fields claim to have more empirically-justified insights. Economics is a field of study with various schools and currents of thought. As a result, there exists a considerable distribution of opinions, approaches and theories. Some of these reach opposite conclusions or, due to the differences in underlying assumptions, contradict each other.[22][23] Criticism on several topics in economics can be found elsewhere, in both general and specialized literature (for example, general equilibrium, Pareto efficiency, marginalism, behavioral finance, behavioral economics, feminist economics, Keynesian economics, monetarism, endogenous growth theory, comparative advantage, Kuznets curve, Laffer curve, economic sociology, et al.). McCloskey critiqueAlthough the conventional way of connecting an economic model with the world is through econometric analysis, Professor Deirdre McCloskey cites many examples in which professors of econometrics were able to use the same data to both prove and disprove the applicability of a model's conclusions. She argues the vast efforts expended by economists on analytical equations is essentially wasted effort. Ethics and economicsThe relationship between economics and ethics is complex. Many economists consider normative choices and value judgments, like what needs or wants, or what is good for society, to be political or personal questions outside the scope of economics. Once a person or government has established a set of goals, however, economics can provide insight as to how they might best be achieved. Others see the influence of economic ideas, such as those underlying modern capitalism, to promote a certain system of values with which they may or may not agree. (See, for example, consumerism and Buy Nothing Day.) According to some thinkers such as John Syko, a theory of economics is also, or implies also, a theory of moral reasoning.[citation needed] The premise of ethical consumerism is that one should take into account ethical and environmental concerns, in addition to financial and traditional economic considerations, when making buying decisions. Effect on societySome would say that market forms and other means of distribution of scarce goods, suggested by economics, affect not just their "desires and wants" but also "needs" and "habits". Much of so-called economic "choice" is considered involuntary, certainly given by social conditioning, people have come to expect a 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. Libertarians view this as a failure to respect economic reasoning. They argue that redistribution of wealth is morally and economically wrong. socialists view it as a failure of economics to respect society. They argue that disparities of wealth should not have been allowed in the first place. This led to both 19th century labor economics and 20th century welfare economics before being subsumed into human development theory. The older term for economics, political economy, is still often used instead of economics, especially by certain economists such as Marxists. The use of this term often signals a basic disagreement with the terminology or paradigm of market economics. Political economy explicitly brings social political considerations into economic analysis and is therefore openly normative, although this can be said of many economic recommendations as well, despite claims to being positive. Some mainstream universities (many in the United Kingdom) have a "political economy" department rather than an "economics" department. 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. See alsoRelated topics
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