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Economics

Economics is the social science that studies the production, distribution, and consumption of commodities.

The word "economics" is from the Greek words οἶκος [oikos], meaning "house, temple, hall, camp, nest" and νόμος [nomos], or "custom, law, convention" and hence literally means "rules of the household." Originally termed political economy, the term economics grew in popularity with the marginal revolution. While discussions about production and distribution date back to ancient laws, and to philosophers such as Plato, the field is generally considered to have been clearly separated from philosophy by the publication of Adam Smith's book, generally called The Wealth of Nations.

The field may be divided in several different ways, most commonly microeconomics vs macroeconomics. It may also be divided in positive (descriptive) vs. normative, mainstream vs. heterodox, and by subfield. Economics has many direct applications in business, personal finance, and government.

There has been an increasing trend for ideas and methods from economics to be applied in other fields. Economic analysis focuses on decision making, and has been applied to various fields where people are faced with alternatives – education, marriage, health, law, crime, war, and religion.

Areas of study in economics

One of the main purposes is to understand how economies work, and what the relations are between the main economic players and institutions.

Economics is usually divided into three main branches:

  • Microeconomics examines the economic behaviour of individual units, including businesses and households, and their interactions through markets, given scarcity and government regulation. Within microeconomics, general equilibrium theory aggregates across all markets, including their movements and interactions toward equilibrium.
  • Macroeconomics examines an economy as a whole "top down" with a view to understanding interactions between the broadest aggregates such as national income and output, employment and inflation and broad aggregates like total consumption and investment spending.
  • Econometrics is the application of statistical techniques to measuring economic phenomena.

Attempts to join the microeconomics and macroeconomics 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. In other words, its premises ought to have theoretical and evidential support in microeconomics. A few authors (for example, Kurt Dopfer and Stuart Holland) 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.[citation needed] Further, modern developments in consumer psychology suggest an even greater level of disaggregation one might call 'picoeconomics' that reduces the individual consumer's behavior to the psychological components that drive that behavior.

Economics can also be divided into numerous subdisciplines including: international economics, development economics, labor economics, environmental economics, industrial organization, public finance, economic psychology, economic sociology, institutional economics and economic geography. The JEL classification codes provide a comprehensive, detailed way of classifying economics articles by subject matter.

Another division of the subject distinguishes positive economics, which seeks to predict and explain economic phenomena, from normative economics, which orders choices and actions by some criterion; such orderings necessarily involve subjective value judgments.

There are also methodologies used by economists whose underlying theories are important.

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.

Economic language and reasoning

Economics relies on rigorous styles of argument. Economic methodology has several interacting parts:

  • Collection of economic data. This data consists of 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, such as money, consumption, preferences, buying, selling, and prices. Economics typically employs two types of equations:

1) Identity equations are used to explain how certain economic values are calculated. An example is the relationship of the quantity theory of money, which is shown by the equation of exchange.M*V=P*Q. 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"-assumption (All others equal), meaning that all other things are assumed not to change during the period of observation. Example: "If the price of movie tickets rises, ceteris paribus the demand for popcorn falls." However it is possible with the use of econometric method to determine one relationship while removing much of the noise caused by other variables.

  • 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 a 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 diesel fuel costs 1 euro a litre: To calculate the price level would require a model of how much diesel 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 diesel, and what other goods they might substitute for it.
  • Reasoning within economic models. This process of reasoning (see the articles on informal logic, logical argument, fallacy) sometimes involves 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 parameterized 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. Paul Samuelson's treatise, Foundations of Economic Analysis examines the class of assertions called operationally meaningful theorems in economics, which are those that can be conceivably refuted by empirical data.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, 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 economic thought
Modern mainstream economics

Mainstream 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.

Economics studies how individuals and societies seek to satisfy needs and wants through incentives, choices, and allocation of scarce resources. 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 "How long should I spend brushing my teeth?".

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 behaviour (for example, emergence of organizations) have been incorporated from institutional economics via new institutionalism.

It is sometimes referred to as the study of choice under conditions of scarcity. Another more simplified way of explaining economics is the study of how people or a society seek to satisfy their needs and wants.

Economics is a broad term given to the social science of how choices are made in face of limited resources. Various definitions include: "the study of people in the ordinary business of life", "the science which studies human behavior as a relationship between given ends and scarce means which have alternative uses", and the "study of how societies use scarce resources to produce valuable commodities and distribute them among different people".

Alternative approaches

Neoclassical 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 behaviour 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, which are less used by mainstream economists. These include institutional economics, Marxist economics, socialism, and green economics.

  • Classical economics: This was the original form of mainstream economics of the Eigthteenth and Nineteenth Centuries. Neoclassical economics descended from it.
  • Keynesian economics: This school has developed from the work of John Maynard Keynes and focused on macroeconomics in the short-run, particularly the rigidities caused when prices are fixed. It has two successors:
  • Post-Keynesian economics: An alternative school - one of the successors to the Keynesian tradition with a focus on macroeconomics. They concentrate on macroeconomic rigidities and adjustment processes, and research microfoundations for their models based on real-life practices rather than simple optimizing models. Generally associated with Cambridge, England and the work of Joan Robinson. (see Post-Keynesian economics)
  • New-Keynesian economics: The other school associated with developments in the Keynesian fashion. These researchers tend to share with other Neoclassical economists the emphasis on models based on microfoundations and optimizing behaviour but focus more narrowly on standard Keynesian themes such as price and wage rigidity. These are usually made to be endogenous features of these models, rather than simply assumed as in older style Keynesian ones. (see New-Keynesian economics)
    • Marxian economics: Descended from the work of Karl Marx, this school focuses on the labour theory of value and what Marx considered to be the exploitation of labour by capital.
    • Austrian economics: This school focuses on the role of the entrepreneur creating temporary market power and being the drive for economic growth.
    • Other alternatives: There are many types of economist, and many of them are considerably outside the mainstream. Socialist economics and green economics are two of the smaller schools.
    • Eclectic Economists: The term 'eclectic' means selecting and using what seems best from various sources, systems or schools of thought. Eclectic economists tend to economize to get an optimal result for the problem at hand. The assumption of utility can for example be used, not to imply that people really have such a utility, but as an efficient approximation. Such economists might be 'main stream' or neoclassical in one publication and do political economy in another publication.
    • Complexity economics: One of the most recent (dating from the late 1970s early 1980s) school of thoughts in modern economics. Complexity economics theories hold that the economy is a complex adaptive evolving system rather than a closed equilibrium system. Most studies in this new field were done by the Santa Fe Institue in New Mexico, USA.

    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:

    Austrian School
    Chicago School
    Freiburg School
    Keynesian economics
    Post-Keynesian economics
    School of Lausanne
    Stockholm school
    Economics and ecology

    Another premise is that economics fits within a finite ecosystem where there are at least some abundant resources. For instance, when fuelling 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 definitions of economics

    This section extends the discussion of the definition of Economics at the beginning of the article.

    Torianto S. Johnson states that "economics is the science of scarcity." "It is where our infinite wants meet our finite resources and choices must be made."

    Economics is the study of human choice behaviour. All of economics whether represented through articulation or empirically through mathematical means is essentially an analysis of the behaviour choices of human beings.

    Refer to Economics, Ninth Canadian edition 1997 by Richard Lipsey, Christopher Ragan and Paul Courant, economics is the study of the use of scare resources to satisfy unlimited human wants.

    Wealth definition
    The 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 recognised, 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 modern economics," defines economics simply as "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 simply 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 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, the science of getting riches."

    Welfare definition
    Later 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."

    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 definition

    Scarcity 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.
     

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