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Face-to-face trading interactions on the New York Stock Exchange trading floor. Financial decisions can be one of those many economic choices people make.
Economics is the social science that studies the production, distribution, and consumption of goods and services. The term economics comes from the Greek for oikos (house) and nomos (custom or law), hence "rules of the house(hold)."Harper, Douglas (November 2001). Online Etymology Dictionary - Economy (HTML). Retrieved on October 27, 2007.
A definition that captures much of modern economics is that of Lionel Robbins in a 1932 essay: "the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses."Robbins, Lionel (1945). An Essay on the Nature and Significance of Economic Science. London: Macmillan and Co., Limited. Scarcity means that available resources are insufficient to satisfy all wants and needs. Absent scarcity and alternative uses of available resources, there is no economic problem. The subject thus defined involves the study of choices as they are affected by incentives and resources.
Areas of economics may be divided or classified into various types, including:
One of the uses of economics is to explain how economies, as economic systems, work and what the relations are between economic players (agents) 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,Friedman, David D. (2002). "Crime," The Concise Encyclopedia of Economics. Accessed October 21, 2007. education,The World Bank (2007). "Economics of Education." Accessed October 21, 2007. the family, health, law, politics, religion,Iannaccone, Laurence R. (1998). "Introduction to the Economics of Religion," Journal of Economic Literature, 36(3), pp. 1465-1495. Accessed October 21, 2007. social institutions, and war.Nordhaus, William D. (2002). “The Economic Consequences of a War with Iraq,” in War with Iraq: Costs, Consequences, and Alternatives, pp. 51-85. American Academy of Arts and Sciences. Cambridge, MA. Accessed October 21, 2007.
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 as a separate discipline is conventionally dated from the publication of Adam Smith\'s The Wealth of Nations in 1776.Steven Pressman. Fifty Major Economists. (1999). Routledge. ISBN 0415134811 p. 20 In this work, describes the subject in these practical and exacting terms:
Smith referred to the subject as \'political economy\', but that term was gradually replaced in general usage by \'economics\' after 1870.[citation needed]
Smith notably discusses the benefits of the division of labor as well as the subject of resource allocation. Just how individuals can best apply their own labor or any other resource is a central subject in the first book of the series. Smith claimed that an individual would invest a resource, for example, land or labor, so as to earn the highest possible return on it. Consequently, all uses of the resource must yield an equal rate of return (adjusted for the relative riskiness of each enterprise). Otherwise reallocation would result. This idea, wrote George Stigler, is the central proposition of economic theory. French economist Turgot had made the same point in 1766. [1]
Areas of economics may be classified in various ways, but an economy is usually analyzed by use of microeconomics or macroeconomics.
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.Blaug, Mark (2007). "The Social Sciences: Economics," Microeconomics, The New Encyclopædia Britannica, v. 27, pp. 347-49. Chicago. ISBN 0852294239Varian, Hal R. (1987). "microeconomics," The New Palgrave: A Dictionary of Economics, v. 3, pp. 461-63. London and New York: Macmillan and Stockton. ISBN 0-333-37235-2
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.Ng, Yew-Kwang (1992). "Business Confidence and Depression Prevention: A Mesoeconomic Perspective," American Economic Review 82(2), pp. 365-371. [2] This has addressed a long-standing concern about inconsistent developments of the same subject. Howitt, Peter M. (1987). "macroeconomics: relations with microeconomics". The New Palgrave: A Dictionary of Economics, pp. 273-76. London and New York: Macmillan and Stockton. ISBN 0-333-37235-2. Macroeconomic analysis also considers factors affecting the long-term level and growth of national income. Such factors include capital accumulation, technological change and labor force growth. Blaug, Mark (2007). "The Social Sciences: Economics," Macroeconomics, The New Encyclopædia Britannica, v. 27, p. 349.Blanchard, Olivier Jean (1987). "neoclassical synthesis," The New Palgrave: A Dictionary of Economics, v. 3, pp. 634-36.
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."Davis, John B. (2006). "Heterodox Economics, the Fragmentation of the Mainstream, and Embedded Individual Analysis,” in Future Directions in Heterodox Economics. Ann Arbor: University of Michigan Press.
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.Eatwell|, John, Murray Milgate, and Peter Newman, ed. (1987). Appendix IV, Subject Index, The New Palgrave: A Dictionary of Economics, v. 4, pp. 980-88.
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 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.Debreu, Gerard (1987). "mathematical economics," The New Palgrave: A Dictionary of Economics, v. 3, pp. 401-03. For example, Paul Samuelson\'s book Foundations of Economic Analysis (1947) identifies a common mathematical structure across multiple fields in the subject.
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. Hashem, M. Pesaren (1987). "econometrics", The New Palgrave: A Dictionary of Economics, v. 2, p. 8.
National accounting is a method for summarizing economic activity of a nation. The national accounts are double-entry accounting systems that provide detailed underlying measures of such information. These include the national income and product accounts (NIPA), which provide estimates for the money value of output and income per year or quarter. NIPA allows for tracking the performance of an economy and its components through business cycles or over longer periods. Price data may permit distinguishing nominal from real amounts, that is, correcting money totals for price changes over time.Usher, D. (1987), "real income," The New Palgrave: A Dictionary of Economics, v. 4, p. 104.Sen, Amartya (1979), "The Welfare Basis of Real Income Comparisons: A Survey," Journal of Economic Literature, 17(1), pp. 1-45. The national accounts also include measurement of the capital stock, wealth of a nation, and international capital flows. Ruggles, Nancy D. (1987), "social accounting". The New Palgrave: A Dictionary of Economicsdate=. London and New York: Macmillan and Stockton, v. 3, 377. ISBN 0-333-37235-2.
Agricultural economics is one the oldest and most established fields of economics. It is the study of the economic forces that affect the agricultural sector and the agricultural sector\'s impact on the rest of the economy. It is an area of economics that, thanks to the necessity of applying microeconomic theories to complex real world situations, has given rise to many important advances of more general applicability; the role of risk and uncertainty, the behaviour of households and links between property rights and incentives. More recently policy areas such as international commodity trade and the environment have been stressed. Colman, D and Young, T (1989) Principles of Agricultural Economics: Markets and Prices in Less Developed Markets and Prices
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 long 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.Samuelson, Paul A., and William D. Nordhaus (2004). Economics, ch. 27, "The Process of Economic Growth" McGraw-Hill. ISBN 0-07-287205-5.Uzawa, H. (1987). "models of growth," The New Palgrave: A Dictionary of Economics, v. 3, pp. 483-89. The distinct field of development economics examines economic aspects of the development process in relatively low-income countries focussing on structural change, poverty, and economic growth. Approaches in development economics frequently incorporate social and political factors.Bell, Clive (1987). "development economics," The New Palgrave: A Dictionary of Economics, v. 1, pp. 818-26.Blaug, Mark (2007). "The Social Sciences: Economics," Growth and development, The New Encyclopædia Britannica, v. 27, p. 351. Chicago.
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.Heilbroner, Robert L. and Peter J. Boettke (2007). "Economic Systems", The New Encyclopædia Britannica, v. 17, pp. 908-15.NA (2007). "economic system," Encyclopædia Britannica online Concise Encyclopedia entry.
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.Kneese, Allen K., and Clifford S. Russell (1987). "environmental economics," The New Palgrave: A Dictionary of Economics, v. 2, pp. 159-64.Samuelson, Paul A., and William D. Nordhaus (2004). Economics, ch. 18, "Protecting the Environment." McGraw-Hill. Environmental Economics should not be conflated with new schools of economic thought sometimes referred to as ecological 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.Ross, Stephen A. (1987). "finance," The New Palgrave: A Dictionary of Economics, v. 2, pp. 322-26.
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.Aumann, R.J. (1987). "game theory," The New Palgrave: A Dictionary of Economics, v. 2, pp. 460-82.
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.Schmalensee, Richard (1987). "industrial organization," The New Palgrave: A Dictionary of Economics, v. 2, pp. 803-808.
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 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 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.Freeman, R.B. (1987). "labour economics," The New Palgrave: A Dictionary of Economics, v. 3, pp. 72-76.
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.Friedman, David (1987). "law and economics," The New Palgrave: A Dictionary of Economics, v. 3, p. 144.Posner, Richard A. (1972). Economic Analysis of Law. Aspen, 7th ed., 2007) ISBN 978-0-735-56354-4. A seminal article by Ronald Coase published in 1961 suggested that well-defined property rights could overcome the problems of externalities.Coase, Ronald, "The Problem of Social Cost", The Journal of Law and Economics Vol.3, No.1 (1960). This issue was actually published in 1961.
Managerial economics applies microeconomic analysis to specific decisions in business firms or other management units. It draws heavily from quantitative methods such as operations research and programming and from statistical methods such as regression analysis in the absence of certainty and perfect knowledge. A unifying theme is the attempt to optimize business decisions, including unit-cost minimization and profit maximization, given the firm\'s objectives and constraints imposed by technology and market conditons.NA (2007). "managerial economics". The New Encyclopaedia Britannica. Chicago: The New Encyclopaedia Britannica, v. 7, p. 757. ISBN 0852294239. Hughes, Alan (1987). "managerial capitalism". The New Palgrave: A Dictionary of Economics, v. 3, pp. 293-96.
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.Musgrave, R.A. (1987). "public finance," The New Palgrave: A Dictionary of Economics, v. 3, pp. 1055-60.
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.Feldman, Allan M. ((1987). "welfare economics," The New Palgrave: A Dictionary of Economics, v. 4, pp. 889-95.
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 utilityBaumol, William J. (2007). "Economic Theory" (Measurement and ordinal utility). The New Encyclopædia Britannica, v. 17, p. 719. 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.Hicks, John Richard (1939). Value and Capital. London: Oxford University Press. 2nd ed., paper, 2001. ISBN 978-0198282693.
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.
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.Brody, A. (1987). ""prices and quantities," The New Palgrave: A Dictionary of Economics, v. 3, p. 957. 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.Jordan, J.S. (1982). "The Competitive Allocation Process Is Informationally Efficient Uniquely." Journal of Economic Theory, 28(1), p. 1-18. 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.Blaug, Mark (2007). "The Social Sciences: Economics". The New Encyclopædia Britannicav. 27, p. 347. Chicago. ISBN 0852294239 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.Laffont, J.J. (1987). "externalities,"," The New Palgrave: A Dictionary of Economics, v. 2, p. 263-65.
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.Samuelson, Paul A., and William D. Nordhaus (2004), Economics, pp.4-5, 7-15. Scarcity is defined by the amount of producible or exchangeable goods, whether needed or desired, exceeding feasible production.Montani, Guido (1987), "scarcity," The New Palgrave: A Dictionary of Economics, v. 4, p. 254. 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.This was first described by the Italian economist Enrico Barone in 1908. In 1939 the Soviet mathematician Leonid Kantorovich generalized and extended the analysis. 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.
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.Milton Friedman (1953), "The Methodology of Positive Economics," Essays in Positive Economics, University of Chicago Press, pp. 10, 14-15. 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.Smith, Vernon L. (1987), "experimental methods in economics," The New Palgrave: A Dictionary of Economics, v. 2, pp. 241-42.
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.Samuelson, Paul (1947, 1983). Foundations of Economic Analysis, Enlarged Edition. Boston: Harvard University Press, p. 4. ISBN 978-0674313019. Such assertions permit testing of a theory.
Some reject mathematical economics; 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.Lazear, Edward P. (2000). "Economic Imperialism," The Quarterly Journal of Economics, 115(1), pp. 99-146.
Ancient economic thought dates from earlier Mesopotamian, Greek, Roman, Indian, Chinese, Persian and Arab civilizations. Notable writers include Aristotle, Chanakya, Qin Shi Huang, Thomas Aquinas and Ibn Khaldun through to the 14th century. Joseph Schumpeter initially considered the late scholastics of the 14th to 17th centuries as "coming nearer than any other group to being the \'founders\' of scientific economics" as to monetary, interest, and value theory within a natural-law perspective.Schumpeter, Joseph A. (1954). History of Economic Analysis, pp. 97-115. Oxford. After discovering Ibn Khaldun\'s Muqaddimah, however, Schumpeter later viewed Ibn Khaldun as being the closest forerunner of modern economics,I. M. Oweiss (1988), "Ibn Khaldun, the Father of Economics", Arab Civilization: Challenges and Responses, New York University Press, ISBN 0887066984. as many of his economic theories were not known in Europe until relatively modern times.Jean David C. Boulakia (1971), "Ibn Khaldun: A Fourteenth-Century Economist", The Journal of Political Economy 79 (5): 1105-1118.
Two other groups, later called \'mercantilists\' and \'physiocrats\', more directly influenced the subsequent development of the subject. Both groups were associated with the rise of economic nationalism and modern capitalism in Europe. Mercantilism was an economic doctrine that flourished from the 16th to 18th century in a prolific pamphlet literature, whether of merchants or statesmen. It held that a nation\'s wealth depended on its accumulation of gold and silver. Nations without access to mines could obtain gold and silver from trade only by selling goods abroad and restricting imports other than of gold and silver. The doctrine called for importing cheap raw materials to be used in manufacturing goods, which could be exported, and for state regulation to impose protective tariffs on foreign manufactured goods and prohibit manufacturing in the colonies.NA (2007). "mercantilism," The New Encyclopædia Britannica, v. 8, p. 26. Blaug, Mark (2007). "The Social Sciences: Economics". The New Encyclopædia Britannica, v. 27, p. 343.
Physiocrats, a group of 18th century French thinkers and writers, developed the idea of the economy as a circular flow of income and output. Adam Smith described their system "with all its imperfections" as "perhaps the purest approximation to the truth that has yet been published" on the subject. Physiocrats believed that only agricultural production generated a clear surplus over cost, so that agriculture was the basis of all wealth. Thus, they opposed the mercantilist policy of promoting manufacturing and trade at the expense of agriculture, including import tariffs. Physiocrats advocated replacing administratively costly tax collections with a single tax on income of land owners. Variations on such a land tax were taken up by subsequent economists (including Henry George a century later) as a relatively non-distortionary source of tax revenue. In reaction against copious mercantilist trade regulations, the physiocrats advocated a policy of laissez-faire, which called for minimal government intervention in the economy.NA (2007). "physiocrat," The New Encyclopædia Britannica, v. 9, p. 414.. Blaug, Mark (1997, 5th ed.) Economic Theory in Retrospect, pp, 24-29, 82-84. Cambridge.
Publication of Adam Smith\'s The Wealth of Nations in 1776, has been described as "the effective birth of economics as a separate discipline."Blaug, Mark (2007). "The Social Sciences: Economics". The New Encyclopædia Britannica, v. 27, p. 343. 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.Blaug, Mark (1987). "classical economics". The New Palgrave: A Dictionary of Economics, v. 1, pp. 434-35 Blaug notes less widely used datings and uses of \'classical economics\', including those of Marx and Keynes.
While Adam Smith emphasized the production of income, David Ricardo focused on the distribution of income among landowners, workers, and capitalists. Ricardo saw an inherent 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.Smith, Adam (1776). The Wealth of Nations, Bk. 1, Ch. 5, 6. 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.
The Marxist school of economic thought comes from the work of German economist Karl Marx.
Marxist (later, Marxian) economics descends from classical economics. It derives from the work of Karl Marx. The first volume of Marx\'s major work, Capital, was published in German in 1867. In it, Marx focused on the labour theory of value and what he considered to be the exploitation of labour by capital. Thus, the labour theory of value, rather than simply a theory of price, was a method for measuring the exploitation of labour in a capitalist society, Roemer, J.E. (1987). "Marxian Value Analysis". The New Palgrave: A Dictionary of Economics, v. 3, 383.Mandel, Ernest (1987). "Marx, Karl Heinrich", The New Palgrave: A Dictionary of Economicsv. 3, pp. 372, 376. although concealed by appearances of "vulgar" political economy.Vianello, Fernando (1987). "labour theory of value," The New Palgrave: A Dictionary of Economics, v. 3, pp. 111-12.Baradwaj Krishna (1987). "vulgar economy," The New Palgrave: A Dictionary of Economics, v. 3, p. 831.
A body of theory later termed \'neoclassical economics\' or \'marginalist economics\' formed from about 1870 to 1910. The term \'economics\' was popularized by neoclassical economists such as Alfred Marshall as a substitute for the earlier term \'political economy\'. Neoclassical economics systematized supply and demand as joint determinants of price and quantity in market equilibrium, affecting both the allocation of output and the distribution of income. It dispensed with the labour theory of value inherited from classical economics in favor of a marginal utility theory of value on the demand side and a more general theory of costs on the supply side.Campos, Antonietta (1987). "marginalist economics", The New Palgrave: A Dictionary of Economics, v. 3, p. 320
In microeconomics, neoclassical economics represents incentives and costs as playing a pervasive role in shaping decision making. An immediate example of this is the consumer theory of individual demand, which isolates how prices (as costs) and income affect quantity demanded. In macroeconomics it is reflected in an early and lasting neoclassical synthesis with Keynesian macroeconomics.Hicks, J.R. (1937). "Mr. Keynes and the \'Classics\': A Suggested Interpretation," Econometrica, 5(2), pp. 147-159.Blanchard, Olivier Jean (1987). "neoclassical synthesis," The New Palgrave: A Dictionary of Economics, v. 3, pp. 634-36.
Neoclassical economics is occasionally referred as orthodox economics whether by its critics or sympathizers. Modern mainstream economics builds on neoclassical economics but with many refinements that either supplement or generalize earlier analysis, such as econometrics, game theory, analysis of market failure and imperfect competition, and the neoclassical model of economic growth for analyzing long-run variables affecting national income.
John Maynard Keynes (above, right), widely considered a towering figure in economics.
Keynesian economics derives from John Maynard Keynes, in particular his book The General Theory of Employment, Interest and Money (1936), which ushered in contemporary macroeconomics as a distinct field.Keynes, John Maynard (1936). The General Theory of Employment, Interest and Money. London: Macmillan. ISBN 1-57392-139-4. Blaug, Mark (2007). "The Social Sciences: Economics," The New Encyclopædia Britannica, v. 27, p. 347. Chicago. The book focused on determinants of national income in the short run when prices are relatively inflexible. Keynes attempted to explain in broad theoretical detail why high labour-market unemployment might not be self-correcting due to low "effective demand" and why even price flexibility and monetary policy might be unavailing. Such terms as "revolutionary" have been applied to the book in its impact on economic analysis.Tarshis, L. (1987). "Keynesian Revolution", The New Palgrave: A Dictionary of Economics, v. 3, pp. 47-50.Samuelson, Paul A., and William D. Nordhaus (2004). Economics, p. 5.Blaug, Mark (2007). "The Social Sciences: Economics," The New Encyclopædia Britannica, v. 27, p. 346. Chicago.
Keynesian economics has two successors. Post-Keynesian economics also concentrates on macroeconomic rigidities and adjustment processes. Research on micro foundations for their models is represented as based on real-life practices rather than simple optimizing models. It is generally associated with the University of Cambridge and the work of Joan Robinson.Harcourt, G.C.(1987). "post-Keynesian economics," The New Palgrave: A Dictionary of Economics, v. 3, pp. 47-50. New-Keynesian economics is also associated with developments in the Keynesian fashion. Within this group researchers tend to share with other economists the emphasis on models employing micro foundations and optimizing behavior but with a narrower focus on standard Keynesian themes such as price and wage rigidity. These are usually made to be endogenous features of the models, rather than simply assumed as in older Keynesian-style ones.
Other well-known 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, include the Austrian School, Chicago School, the Freiburg School, the School of Lausanne and the Stockholm school.
Within macroeconomics there is, in general order of their appearance in the literature; classical economics, Keynesian economics, the neoclassical synthesis, post-Keynesian economics, monetarism, new classical economics, and supply-side economics. New alternative developments include ecological economics, evolutionary economics, dependency theory, structuralist economics and world systems theory.
This section extends the discussion of the definitions of Economics at the beginning of the article.
Influential early discussions of political economy were related to wealth broadly defined, as in the work of David Hume and Adam Smith. Hume argued that additional gold without increased production only served to raise prices. Hume, David; Copley, Stephen and Edgar, Andrew, editors (1998). "Of the Balance of Trade" Selected Essays. New York: Oxford University Press, USA, 188. ISBN 978-0192836212. Smith also described real wealth, not in earlier terms of gold and silver, but the "annual produce of the labour and land of the society."Smith (1776) The Wealth of Nations, v. I, Introduction and Plan of the Work, para. I.I.9 and Ch.5, para. I.5.2.
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.Mill, John Stuart (1848). Principles of Political Economy with Some of Their Applications to Social Philosophy. Boston: C.C. Little & J. Brown, 1, 8. ISBN 978-0192836212.
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"Ruskin, John (1860) The Veins of Wealth. Cornhill Magazine. Retrieved on 2007-03-17. Reprinted as Unto This Last, 1862 and a "bastard science."Ruskin, John (1860). Ad Valorem. Cornhill Magazine. Retrieved on 2007-03-17. Reprinted as Unto This Last, 1862
Broader later definitions evolved to include the study of man, human activity, and human welfare, not wealth as such. Alfred Marshall in his 1890 book Principles of Economics wrote, "Political Economy or Economics is a study of m
