Economics

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Economics (/ˌɛkəˈnɒmɪks, ˌiːkə-/)[1][2] is a social science that studies the production, distribution, and consumption of goods and services.[3][4]

Economics focuses on the behaviour and interactions of

public policies that have impact on these elements
.

Other broad distinctions within economics include those between

behavioural economics; and between mainstream economics and heterodox economics.[6]

Economic analysis can be applied throughout society, including

the environment.[21]

Definitions of economics

Main article: Definitions of economics

The earlier term for the discipline was 'political economy', but since the late 19th century, it has commonly been called 'economics'.[22] The term is ultimately derived from Ancient Greek οἰκονομία (oikonomia) which is a term for the "way (nomos) to run a household (oikos)", or in other words the know-how of an οἰκονομικός (oikonomikos), or "household or homestead manager". Derived terms such as "economy" can therefore often mean "frugal" or "thrifty".[23][24][25][26] By extension then, "political economy" was the way to manage a polis or state.

There are a variety of modern definitions of economics; some reflect evolving views of the subject or different views among economists.[27][28] Scottish philosopher Adam Smith (1776) defined what was then called political economy as "an inquiry into the nature and causes of the wealth of nations", in particular as:

a branch of the science of a statesman or legislator [with the twofold objectives of providing] a plentiful revenue or subsistence for the people ... [and] to supply the state or commonwealth with a revenue for the publick services.[29]

Malthus (1798).[31] John Stuart Mill
(1844) delimited the subject matter further:

The science which traces the laws of such of the phenomena of society as arise from the combined operations of mankind for the production of wealth, in so far as those phenomena are not modified by the pursuit of any other object.[32]

microeconomic
level:

Economics is a study of man in the ordinary business of life. It enquires how he gets his income and how he uses it. Thus, it is on the one side, the study of wealth and on the other and more important side, a part of the study of man.[33]

Lionel Robbins (1932) developed implications of what has been termed "[p]erhaps the most commonly accepted current definition of the subject":[28]

Economics is the science which studies

human behaviour as a relationship between ends and scarce means which have alternative uses.[34]

Robbins described the definition as not classificatory in "pick[ing] out certain kinds of behaviour" but rather analytical in "focus[ing] attention on a particular aspect of behaviour, the form imposed by the influence of scarcity."[35] He affirmed that previous economists have usually centred their studies on the analysis of wealth: how wealth is created (production), distributed, and consumed; and how wealth can grow.[36] But he said that economics can be used to study other things, such as war, that are outside its usual focus. This is because war has as the goal winning it (as a sought after end), generates both cost and benefits; and, resources (human life and other costs) are used to attain the goal. If the war is not winnable or if the expected costs outweigh the benefits, the deciding actors (assuming they are rational) may never go to war (a decision) but rather explore other alternatives. Economics cannot be defined as the science that studies wealth, war, crime, education, and any other field economic analysis can be applied to; but, as the science that studies a particular common aspect of each of those subjects (they all use scarce resources to attain a sought after end).

Some subsequent comments criticized the definition as overly broad in failing to limit its subject matter to analysis of markets. From the 1960s, however, such comments abated as the economic theory of maximizing behaviour and

expanded the domain of the subject to areas previously treated in other fields.[37] There are other criticisms as well, such as in scarcity not accounting for the macroeconomics of high unemployment.[38]

social interaction that [such] analysis involves." The same source reviews a range of definitions included in principles of economics textbooks and concludes that the lack of agreement need not affect the subject-matter that the texts treat. Among economists more generally, it argues that a particular definition presented may reflect the direction toward which the author believes economics is evolving, or should evolve.[28]

Many economists including nobel prize winners James M. Buchanan and Ronald Coase reject the method-based definition of Robbins and continue to prefer definitions like those of Say, in terms of its subject matter.[37] Ha-Joon Chang has for example argued that the definition of Robbins would make economics very peculiar because all other sciences define themselves in terms of the area of inquiry or object of inquiry rather than the methodology. In the biology department, they do not say that all biology should be studied with DNA analysis. People study living organisms in many different ways, so some people will do DNA analysis, others might do anatomy, and still others might build game theoretic models of animal behavior. But they are all called biology because they all study living organisms. According to Ha Joon Chang, this view that the economy can and should be studied in only one way (for example by studying only rational choices), and going even one step further and basically redefining economics as a theory of everything, is very peculiar.[40]

History of economic thought

Main articles: History of economic thought and History of macroeconomic thought

From antiquity through the physiocrats

Questions regarding distribution of resources are found throughout the writings of the

Juan de Lugo, 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.[47]

A seaport with a ship arriving
A 1638 painting of a French seaport during the heyday of mercantilism

Two groups, who later were 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.[48]

circular flow of income and output. Physiocrats believed that only agricultural production generated a clear surplus over cost, so that agriculture was the basis of all wealth.[49] 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. In reaction against copious mercantilist trade regulations, the physiocrats advocated a policy of laissez-faire, which called for minimal government intervention in the economy.[50]

Adam Smith (1723–1790) was an early economic theorist.[51] Smith was harshly critical of the mercantilists but described the physiocratic system "with all its imperfections" as "perhaps the purest approximation to the truth that has yet been published" on the subject.[52]

Classical political economy

Main article: Classical economics
Picture of Adam Smith facing to the right
The publication of Adam Smith's The Wealth of Nations in 1776 is considered to be the first formalisation of economic thought.

The publication of Adam Smith's The Wealth of Nations in 1776, has been described as "the effective birth of economics as a separate discipline."[53] The book identified land, labour, and capital as the three factors of production and the major contributors to a nation's wealth, as distinct from the physiocratic idea that only agriculture was productive.

Smith discusses potential benefits of specialization by

resource-allocation theory—that, under competition, resource owners (of labour, land, and capital) seek their most profitable uses, resulting in an equal rate of return for all uses in equilibrium (adjusted for apparent differences arising from such factors as training and unemployment).[56]

In an argument that includes "one of the most famous passages in all economics,"[57] Smith represents every individual as trying to employ any capital they might command for their own advantage, not that of the society,[a] and for the sake of profit, which is necessary at some level for employing capital in domestic industry, and positively related to the value of produce.[59] In this:

He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.[60]

The

Julian Lincoln Simon has criticized Malthus's conclusions.[62]

While Adam Smith emphasized production and income, David Ricardo (1817) focused on the distribution of income among landowners, workers, and capitalists. Ricardo saw an inherent conflict between landowners on the one hand and labour 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. Ricardo was also the first to state and prove the principle of comparative advantage, according to which each country should specialize in producing and exporting goods in that it has a lower relative cost of production, rather relying only on its own production.[63] It has been termed a "fundamental analytical explanation" for gains from trade.[64]

Coming at the end of the classical tradition, John Stuart Mill (1848) 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.[65]

Value theory was important in classical theory. Smith wrote that the "real price of every thing ... is the toil and trouble of acquiring it". Smith maintained that, with rent and profit, other costs besides wages also enter the price of a commodity.

labour theory of value'. Classical economics focused on the tendency of any market economy to settle in a final stationary state made up of a constant stock of physical wealth (capital) and a constant population size
.

Photograph of Karl Marx facing the viewer
The Marxist critique of political economy comes from the work of German philosopher Karl Marx.

Marxian economics

Main article: Marxian economics

Marxist (later, Marxian) economics descends from classical economics and it derives from the work of

theory of surplus value which, he believed, explained the exploitation of labour by capital.[67] The labour theory of value held that the value of an exchanged commodity was determined by the labour that went into its production, and the theory of surplus value demonstrated how workers were only paid a proportion of the value their work had created.[68]

Marxian economics was further developed by

Finance Capital, Vladimir Lenin (1870–1924)'s The Development of Capitalism in Russia and Imperialism, the Highest Stage of Capitalism, and Rosa Luxemburg (1871–1919)'s The Accumulation of Capital
.

Neoclassical economics

Main article: Neoclassical economics

At its inception as a social science, economics was defined and discussed at length as the study of production, distribution, and consumption of wealth by Jean-Baptiste Say in his Treatise on Political Economy or, The Production, Distribution, and Consumption of Wealth (1803). These three items were considered only in relation to the increase or diminution of wealth, and not in reference to their processes of execution.

Lionel Robbins noticed that this definition no longer sufficed,[c] because many economists were making theoretical and philosophical inroads in other areas of human activity. In his Essay on the Nature and Significance of Economic Science, he proposed a definition of economics as a study of human behaviour, subject to and constrained by scarcity,[d] which forces people to choose, allocate scarce resources to competing ends, and economize (seeking the greatest welfare while avoiding the wasting of scarce resources). According to Robbins: "Economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses".[35] Robbins' definition eventually became widely accepted by mainstream economists, and found its way into current textbooks.[69] Although far from unanimous, most mainstream economists would accept some version of Robbins' definition, even though many have raised serious objections to the scope and method of economics, emanating from that definition.[70]

A body of theory later termed "neoclassical economics" formed from about 1870 to 1910. The term "economics" was popularized by such neoclassical economists as Alfred Marshall and Mary Paley Marshall as a concise synonym for "economic science" and a substitute for the earlier "political economy".[25][26] This corresponded to the influence on the subject of mathematical methods used in the natural sciences.[71]

Neoclassical economics systematically integrated

labour theory of value in favor of a marginal utility theory of value on the demand side and a more comprehensive theory of costs on the supply side.[72] In the 20th century, neoclassical theorists departed from an earlier idea that suggested measuring total utility for a society, opting instead for ordinal utility, which posits behavior-based relations across individuals.[73][74]

In

consumer theory of individual demand, which isolates how prices (as costs) and income affect quantity demanded.[73] In macroeconomics it is reflected in an early and lasting neoclassical synthesis with Keynesian macroeconomics.[75][73]

Neoclassical economics is occasionally referred as orthodox economics whether by its critics or sympathizers. Modern

national income
.

Neoclassical economics studies the behaviour of individuals, households, and organizations (called economic actors, players, or agents), when they manage or use scarce resources, which have alternative uses, to achieve desired ends. Agents are assumed to act rationally, have multiple desirable ends in sight, limited resources to obtain these ends, a set of stable preferences, a definite overall guiding objective, and the capability of making a choice. There exists an economic problem, subject to study by economic science, when a decision (choice) is made by one or more players to attain the best possible outcome.[76]

Keynesian economics

Main article: Keynesian economics
John Maynard Keynes
John Maynard Keynes was a key theorist 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.[77] 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. The term "revolutionary" has been applied to the book in its impact on economic analysis.[78]

During the following decades, many economists followed Keynes' ideas and expanded on his works. John Hicks and Alvin Hansen developed the IS–LM model which was a simple formalisation of some of Keynes' insights on the economy's short-run equilibrium. Franco Modigliani and James Tobin developed important theories of private consumption and investment, respectively, two major components of aggregate demand. Lawrence Klein built the first large-scale macroeconometric model, applying the Keynesian thinking systematically to the US economy.[79]

Post-WWII economics

Immediately after World War II, Keynesian was the dominant economic view of the United States establishment and its allies, Marxian economics was the dominant economic view of the Soviet Union nomenklatura and its allies.

Monetarism

Main article: Monetarism

Monetarism appeared in the 1950s and 1960s, its intellectual leader being Milton Friedman. Monetarists contended that monetary policy and other monetary shocks, as represented by the growth in the money stock, was an important cause of economic fluctuations, and consequently that monetary policy was more important than fiscal policy for purposes of stabilization.[80][81] Friedman was also skeptical about the ability of central banks to conduct a sensible active monetary policy in practice, advocating instead using simple rules such as a steady rate of money growth.[82]

Monetarism rose to prominence in the 1970s and 1980s, when several major central banks followed a monetarist-inspired policy, but was later abandoned again because the results turned out to be unsatisfactory.[83][84]

New classical economics

Main article: New classical macroeconomics

A more fundamental challenge to the prevailing Keynesian paradigm came in the 1970s from

Edward Prescott. They introduced the notion of rational expectations in economics, which had profound implications for many economic discussions, among which were the so-called Lucas critique and the presentation of real business cycle models.[85]

New Keynesians

Main article: New Keynesian economics

During the 1980s a group of researchers appeared being called

Gregory Mankiw and Olivier Blanchard. They adopted the principle of rational expectations and other monetarist or new classical ideas such as building upon models employing micro foundations and optimizing behaviour, but simultaneously emphasized the importance of various market failures for the functioning of the economy, as had Keynes.[86] Not least, they proposed various reasons that potentially explained the empirically observed features of price and wage rigidity
, usually made to be endogenous features of the models, rather than simply assumed as in older Keynesian-style ones.

New neoclassical synthesis

Main article: New neoclassical synthesis

After decades of often heated discussions between Keynesians, monetarists, new classical and new Keynesian economists, a synthesis emerged by the 2000s, often given the name the

imperfect information in goods, labour and credit markets. The monetarist importance of monetary policy in stabilizing[87] the economy and in particular controlling inflation was recognized as well as the traditional Keynesian insistence that fiscal policy could also play an influential role in affecting aggregate demand. Methodologically, the synthesis led to a new class of applied models, known as dynamic stochastic general equilibrium or DSGE models, descending from real business cycles models, but extended with several new Keynesian and other features. These models proved very useful and influential in the design of modern monetary policy and are now standard workhorses in most central banks.[88]

After the financial crisis

After the 2007–2008 financial crisis, macroeconomic research has put greater emphasis on understanding and integrating the financial system into models of the general economy and shedding light on the ways in which problems in the financial sector can turn into major macroeconomic recessions. In this and other research branches, inspiration from behavioral economics has started playing a more important role in mainstream economic theory.[89] Also, heterogeneity among the economic agents, e.g. differences in income, plays an increasing role in recent economic research.[90]

Other schools and approaches

Main article: Schools of economic thought

Other schools or trends of thought referring to a particular style of economics practised at and disseminated from well-defined groups of academicians that have become known worldwide, include the

Chicago school approach.[91]

Within macroeconomics there is, in general order of their historical appearance in the literature;

new classical economics, New Keynesian economics[92] and the new neoclassical synthesis.[93]

Beside the mainstream development of economic thought, various alternative or heterodox economic theories have evolved over time, positioning themselves in contrast to mainstream theory.[94] These include:[94]

Additionally, alternative developments include

biophysical economics.[100]

Feminist economics emphasizes the role that gender plays in economies, challenging analyses that render gender invisible or support gender-oppressive economic systems.[101] The goal is to create economic research and policy analysis that is inclusive and gender-aware to encourage gender equality and improve the well-being of marginalized groups.

Methodology

Theoretical research

Main articles: Microeconomics, Macroeconomics, and Mathematical economics
"Economic theory" redirects here. For the publication, see
Economic Theory (journal)
.

Mainstream economic theory relies upon analytical

economic models. When creating theories, the objective is to find assumptions which are at least as simple in information requirements, more precise in predictions, and more fruitful in generating additional research than prior theories.[102] While neoclassical economic theory constitutes both the dominant or orthodox theoretical as well as methodological framework, economic theory can also take the form of other schools of thought such as in heterodox economic theories
.

In

new Keynesians, reformulated their models with microfoundations,[104]
in which microeconomic concepts play a major part.

Sometimes an economic hypothesis is only qualitative, not quantitative.[105]

Expositions of economic reasoning often use two-dimensional graphs to illustrate theoretical relationships. At a higher level of generality, mathematical economics is the application of mathematical methods to represent theories and analyze problems in economics. Paul Samuelson's treatise Foundations of Economic Analysis (1947) exemplifies the method, particularly as to maximizing behavioral relations of agents reaching equilibrium. The book focused on examining the class of statements called operationally meaningful theorems in economics, which are theorems that can conceivably be refuted by empirical data.[106]

Empirical research

Main articles: Econometrics and Experimental economics

Economic theories are frequently tested

natural experiments
.

Statistical methods such as regression analysis are common. Practitioners use such methods to estimate the size, economic significance, and statistical significance ("signal strength") of the hypothesized relation(s) and to adjust for noise from other variables. By such means, a hypothesis may gain acceptance, although in a probabilistic, rather than certain, sense. Acceptance is dependent upon the falsifiable hypothesis surviving tests. Use of commonly accepted methods need not produce a final conclusion or even a consensus on a particular question, given different tests, data sets, and prior beliefs.

Experimental economics has promoted the use of scientifically controlled experiments. This has reduced the long-noted distinction of economics from natural sciences because it allows direct tests of what were previously taken as axioms.[109] In some cases these have found that the axioms are not entirely correct.

In

heuristics. Similar empirical testing occurs in neuroeconomics. Another example is the assumption of narrowly selfish preferences versus a model that tests for selfish, altruistic, and cooperative preferences.[110] These techniques have led some to argue that economics is a "genuine science".[111]

Microeconomics

Main articles: Microeconomics and Market (economics)
A vegetable vendor in a marketplace.
Economists study trade, production and consumption decisions, such as those that occur in a traditional marketplace.
São Paulo Stock Exchange
, Brazil.

Microeconomics examines how entities, forming a market structure, interact within a market to create a market system. These entities include private and public players with various classifications, typically operating under scarcity of tradable units and regulation. The item traded may be a tangible product such as apples or a service such as repair services, legal counsel, or entertainment.

Various market structures exist. In perfectly competitive markets, no participants are large enough to have the market power to set the price of a homogeneous product. In other words, every participant is a "price taker" as no participant influences the price of a product. In the real world, markets often experience imperfect competition.

Forms of imperfect competition include monopoly (in which there is only one seller of a good), duopoly (in which there are only two sellers of a good), oligopoly (in which there are few sellers of a good), monopolistic competition (in which there are many sellers producing highly differentiated goods), monopsony (in which there is only one buyer of a good), and oligopsony (in which there are few buyers of a good). Firms under imperfect competition have the potential to be "price makers", which means that they can influence the prices of their products.

In

General-equilibrium theory studies various markets and their behaviour. It aggregates (the sum of all activity) across all markets. This method studies both changes in markets and their interactions leading towards equilibrium.[112]

Production, cost, and efficiency

Main articles: Production (economics), Opportunity cost, Economic efficiency, and Production–possibility frontier

In microeconomics,

commodity or a service for exchange or direct use. Production is a flow and thus a rate of output per period of time. Distinctions include such production alternatives as for consumption (food, haircuts, etc.) vs. investment goods (new tractors, buildings, roads, etc.), public goods (national defence, smallpox vaccinations, etc.) or private goods (new computers, bananas, etc.), and "guns" vs "butter"
.

Inputs used in the production process include such primary

labour services, capital (durable produced goods used in production, such as an existing factory), and land (including natural resources). Other inputs may include intermediate goods
used in production of final goods, such as the steel in a new car.

Economic efficiency measures how well a system generates desired output with a given set of inputs and available technology. Efficiency is improved if more output is generated without changing inputs. A widely accepted general standard is Pareto efficiency, which is reached when no further change can make someone better off without making someone else worse off.

An example production–possibility frontier with illustrative points marked

The production–possibility frontier (PPF) is an expository figure for representing scarcity, cost, and efficiency. In the simplest case an economy can produce just two goods (say "guns" and "butter"). The PPF is a table or graph (as at the right) showing the different quantity combinations of the two goods producible with a given technology and total factor inputs, which limit feasible total output. Each point on the curve shows potential total output for the economy, which is the maximum feasible output of one good, given a feasible output quantity of the other good.

inverse relationship
. This is because increasing output of one good requires transferring inputs to it from production of the other good, decreasing the latter.

The slope of the curve at a point on it gives the trade-off between the two goods. It measures what an additional unit of one good costs in units forgone of the other good, an example of a real opportunity cost. Thus, if one more Gun costs 100 units of butter, the opportunity cost of one Gun is 100 Butter. Along the PPF, scarcity implies that choosing more of one good in the aggregate entails doing with less of the other good. Still, in a market economy, movement along the curve may indicate that the choice of the increased output is anticipated to be worth the cost to the agents.

By construction, each point on the curve shows productive efficiency in maximizing output for given total inputs. A point inside the curve (as at A), is feasible but represents production inefficiency (wasteful use of inputs), in that output of one or both goods could increase by moving in a northeast direction to a point on the curve. Examples cited of such inefficiency include high unemployment during a business-cycle recession or economic organization of a country that discourages full use of resources. Being on the curve might still not fully satisfy allocative efficiency (also called Pareto efficiency) if it does not produce a mix of goods that consumers prefer over other points.

Much applied economics in public policy is concerned with determining how the efficiency of an economy can be improved. Recognizing the reality of scarcity and then figuring out how to organize society for the most efficient use of resources has been described as the "essence of economics", where the subject "makes its unique contribution."[114]

Specialization

Main articles: Division of labour, Comparative advantage, and Gains from trade
A map showing the main trade routes for goods within late medieval Europe

Specialization is considered key to economic efficiency based on theoretical and

labour ratios. According to theory, this may give a comparative advantage
in production of goods that make more intensive use of the relatively more abundant, thus relatively cheaper, input.

Even if one region has an absolute advantage as to the ratio of its outputs to inputs in every type of output, it may still specialize in the output in which it has a comparative advantage and thereby gain from trading with a region that lacks any absolute advantage but has a comparative advantage in producing something else.

It has been observed that a high volume of trade occurs among regions even with access to a similar technology and mix of factor inputs, including high-income countries. This has led to investigation of economies of scale and agglomeration to explain specialization in similar but differentiated product lines, to the overall benefit of respective trading parties or regions.[115][116]

The general theory of specialization applies to trade among individuals, farms, manufacturers, service providers, and economies. Among each of these production systems, there may be a corresponding division of labour with different work groups specializing, or correspondingly different types of capital equipment and differentiated land uses.[117]

An example that combines features above is a country that specializes in the production of high-tech knowledge products, as developed countries do, and trades with developing nations for goods produced in factories where labour is relatively cheap and plentiful, resulting in different in opportunity costs of production. More total output and utility thereby results from specializing in production and trading than if each country produced its own high-tech and low-tech products.

Theory and observation set out the conditions such that market

low-cost inputs go to producing low-cost outputs. In the process, aggregate output may increase as a by-product or by design.[118] Such specialization of production creates opportunities for gains from trade whereby resource owners benefit from trade in the sale of one type of output for other, more highly valued goods. A measure of gains from trade is the increased income levels that trade may facilitate.[119]

Supply and demand

Main article: Supply and demand
A graph depicting Quantity on the X-axis and Price on the Y-axis
The supply and demand model describes how prices vary as a result of a balance between product availability and demand. The graph depicts an increase (that is, 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).

Prices and quantities have been described as the most directly observable attributes of goods produced and exchanged in a market economy.[120] The theory of supply and demand is an organizing principle for explaining how prices coordinate the amounts produced and consumed. In microeconomics, it applies to price and output determination for a market with perfect competition, which includes the condition of no buyers or sellers large enough to have price-setting power
.

For a given market of a

wealth as the constraints on demand). Here, utility
refers to the hypothesized relation of each individual consumer for ranking different commodity bundles as more or less preferred.

The

income effect). Other factors can change demand; for example an increase in income will shift the demand curve for a normal good
outward relative to the origin, as in the figure. All determinants are predominantly taken as constant factors of demand and supply.

Supply is the relation between the price of a good and the quantity available for sale at that price. It may be represented as a table or graph relating price and quantity supplied. Producers, for example business firms, are hypothesized to be profit maximizers, meaning that they attempt to produce and supply the amount of goods that will bring them the highest profit. Supply is typically represented as a function relating price and quantity, if other factors are unchanged.

That is, the higher the price at which the good can be sold, the more of it producers will supply, as in the figure. The higher price makes it profitable to increase production. Just as on the demand side, the position of the supply can shift, say from a change in the price of a productive input or a technical improvement. The "Law of Supply" states that, in general, a rise in price leads to an expansion in supply and a fall in price leads to a contraction in supply. Here as well, the determinants of supply, such as price of substitutes, cost of production, technology applied and various factors inputs of production are all taken to be constant for a specific time period of evaluation of supply.

model
of supply and demand predicts that for given supply and demand curves, price and quantity will stabilize at the price that makes quantity supplied equal to quantity demanded. Similarly, demand-and-supply theory predicts a new price-quantity combination from a shift in demand (as to the figure), or in supply.

Firms

Main articles: Theory of the firm, Industrial organization, Business economics, and Managerial economics

People frequently do not trade directly on markets. Instead, on the supply side, they may work in and produce through firms. The most obvious kinds of firms are

trusts. According to Ronald Coase, people begin to organize their production in firms when the costs of doing business becomes lower than doing it on the market.[121] Firms combine labour and capital, and can achieve far greater economies of scale
(when the average cost per unit declines as more units are produced) than individual market trading.

In perfectly competitive markets studied in the theory of supply and demand, there are many producers, none of which significantly influence price. Industrial organization generalizes from that special case to study the strategic behaviour of firms that do have significant control of price. It considers the structure of such markets and their interactions. Common market structures studied besides perfect competition include monopolistic competition, various forms of oligopoly, and monopoly.[122]

optimize business decisions, including unit-cost minimization and profit maximization, given the firm's objectives and constraints imposed by technology and market conditions.[123]

Uncertainty and game theory

Main articles: Information economics, Game theory, and Financial economics

Uncertainty in economics is an unknown prospect of gain or loss, whether quantifiable as risk or not. Without it, household behaviour would be unaffected by uncertain employment and income prospects, financial and capital markets would reduce to exchange of a single instrument in each market period, and there would be no communications industry.[124] Given its different forms, there are various ways of representing uncertainty and modelling economic agents' responses to it.[125]

behavioural economics, it has been used to model the strategies agents choose when interacting with others whose interests are at least partially adverse to their own.[126]

In this, it generalizes maximization approaches developed to analyse market actors such as in the

nuclear strategies, ethics, political science, and evolutionary biology.[127]

financial instruments. Financial economics or simply finance describes the allocation of financial resources. It also analyses the pricing of financial instruments, the financial structure of companies, the efficiency and fragility of financial markets,[128] financial crises, and related government policy or regulation.[129][130][131][132][133]

Some market organizations may give rise to inefficiencies associated with uncertainty. Based on

Market for Lemons" article, the paradigm example is of a dodgy second-hand car market. Customers without knowledge of whether a car is a "lemon" depress its price below what a quality second-hand car would be.[134] Information asymmetry arises here, if the seller has more relevant information than the buyer but no incentive to disclose it. Related problems in insurance are adverse selection, such that those at most risk are most likely to insure (say reckless drivers), and moral hazard, such that insurance results in riskier behaviour (say more reckless driving).[135]

Both problems may raise insurance costs and reduce efficiency by driving otherwise willing transactors from the market ("

bankruptcy law, inspection, and regulation for quality and information disclosure.[136][137][138][139][140]

Market failure

Main article: Market failure
See also: Government failure, Information economics, Environmental economics, Ecological economics, and Agricultural economics
costs of production
are not borne by producers but are by the environment, accident victims or others, then prices are distorted.
Environmental scientist
sampling water

The term "market failure" encompasses several problems which may undermine standard economic assumptions. Although economists categorize market failures differently, the following categories emerge in the main texts.[e]

Information asymmetries and incomplete markets
may result in economic inefficiency but also a possibility of improving efficiency through market, legal, and regulatory remedies, as discussed above.

Natural monopoly, or the overlapping concepts of "practical" and "technical" monopoly, is an extreme case of failure of competition as a restraint on producers. Extreme economies of scale are one possible cause.

Public goods
are goods which are under-supplied in a typical market. The defining features are that people can consume public goods without having to pay for them and that more than one person can consume the good at the same time.

distortions caused by these externalities.[141] 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.[142]

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
.

Some specialized fields of economics deal in market failure more than others. The

economics of the public sector is one example. Much environmental economics concerns externalities or "public bads
".

Policy options include regulations that reflect cost–benefit analysis or market solutions that change incentives, such as emission fees or redefinition of property rights.[143]

Welfare

Main article: Welfare economics

Welfare economics uses microeconomics techniques to evaluate

general equilibrium.[144] It analyzes social welfare, however measured, in terms of economic activities of the individuals that compose the theoretical society considered. Accordingly, individuals, with associated economic activities, are the basic units
for aggregating to social welfare, whether of a group, a community, or a society, and there is no "social welfare" apart from the "welfare" associated with its individual units.

Macroeconomics

Main article: Macroeconomics
natural resources and the generation of waste (like greenhouse gases
) is not included.

Macroeconomics, another branch of economics, examines the economy as a whole to explain broad aggregates and their interactions "top down", that is, using a simplified form of

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

efficient use of market information, and imperfect competition.[146] This has addressed a long-standing concern about inconsistent developments of the same subject.[147]

Macroeconomic analysis also considers factors affecting the long-term level and

labour force growth.[148]

Growth

Main article: Economic growth

Growth economics studies factors that explain

converge
at the same rates of growth.

Much-studied factors include the rate of

endogenous growth models) and in growth accounting.[149]

Business cycle

Main article: Business cycle
See also: Circular flow of income, Aggregate supply, Aggregate demand, and Unemployment
A basic illustration of economic/business cycles

The economics of a depression were the spur for the creation of "macroeconomics" as a separate discipline. During the Great Depression of the 1930s, John Maynard Keynes authored a book entitled The General Theory of Employment, Interest and Money outlining the key theories of Keynesian economics. Keynes contended that aggregate demand for goods might be insufficient during economic downturns, leading to unnecessarily high unemployment and losses of potential output.

He therefore advocated active policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle.[150] Thus, a central conclusion of Keynesian economics is that, in some situations, no strong automatic mechanism moves output and employment towards

IS/LM
model has been the most influential interpretation of The General Theory.

Over the years, understanding of the

long run.[75]

real business cycle theory.[152]

In contrast, the

sticky", which means they do not adjust instantaneously to changes in economic conditions.[104]

Thus, the new classicals assume that prices and wages adjust automatically to attain full employment, whereas the new Keynesians see full employment as being automatically achieved only in the long run, and hence government and central-bank policies are needed because the "long run" may be very long.

Unemployment

Main article: Unemployment
U.S. unemployment rate from 1990 to 2022

The amount of unemployment in an economy is measured by the unemployment rate, the percentage of workers without jobs in the labour force. The labour force only includes workers actively looking for jobs. People who are retired, pursuing education, or discouraged from seeking work by a lack of job prospects are excluded from the labour force. Unemployment can be generally broken down into several types that are related to different causes.[153]

Classical models of unemployment occurs when wages are too high for employers to be willing to hire more workers. Consistent with classical unemployment, frictional unemployment occurs when appropriate job vacancies exist for a worker, but the length of time needed to search for and find the job leads to a period of unemployment.[153]

Structural unemployment covers a variety of possible causes of unemployment including a mismatch between workers' skills and the skills required for open jobs.[154] Large amounts of structural unemployment can occur when an economy is transitioning industries and workers find their previous set of skills are no longer in demand. Structural unemployment is similar to frictional unemployment since both reflect the problem of matching workers with job vacancies, but structural unemployment covers the time needed to acquire new skills not just the short term search process.[155]

While some types of unemployment may occur regardless of the condition of the economy, cyclical unemployment occurs when growth stagnates. Okun's law represents the empirical relationship between unemployment and economic growth.[156] The original version of Okun's law states that a 3% increase in output would lead to a 1% decrease in unemployment.[157]

Money and monetary policy

Main article: Monetary policy
See also: Monetary economics and History of money

social convention, like language, useful to one largely because it is useful to others. In the words of Francis Amasa Walker, a well-known 19th-century economist, "Money is what money does" ("Money is that money does" in the original).[158]

As a medium of exchange, money facilitates trade. It is essentially a measure of value and more importantly, a store of value being a basis for credit creation. Its economic function can be contrasted with barter (non-monetary exchange). Given a diverse array of produced goods and specialized producers, barter may entail a hard-to-locate double coincidence of wants as to what is exchanged, say apples and a book. Money can reduce the transaction cost of exchange because of its ready acceptability. Then it is less costly for the seller to accept money in exchange, rather than what the buyer produces.[159]

Monetary policy is the policy that central banks conduct to accomplish their broader objectives. Most central banks in developed countries follow

net export, and hence aggregate demand, output
and employment, and ultimately the development of wages and inflation.

Fiscal policy

Main articles: Fiscal policy, Government spending, and Tax

Governments implement fiscal policy to influence macroeconomic conditions by adjusting spending and taxation policies to alter aggregate demand. When aggregate demand falls below the potential output of the economy, there is an output gap where some productive capacity is left unemployed. Governments increase spending and cut taxes to boost aggregate demand. Resources that have been idled can be used by the government.

For example, unemployed home builders can be hired to expand highways. Tax cuts allow consumers to increase their spending, which boosts aggregate demand. Both tax cuts and spending have multiplier effects where the initial increase in demand from the policy percolates through the economy and generates additional economic activity.

The effects of fiscal policy can be limited by crowding out. When there is no output gap, the economy is producing at full capacity and there are no excess productive resources. If the government increases spending in this situation, the government uses resources that otherwise would have been used by the private sector, so there is no increase in overall output. Some economists think that crowding out is always an issue while others do not think it is a major issue when output is depressed.

Sceptics of fiscal policy also make the argument of Ricardian equivalence. They argue that an increase in debt will have to be paid for with future tax increases, which will cause people to reduce their consumption and save money to pay for the future tax increase. Under Ricardian equivalence, any boost in demand from tax cuts will be offset by the increased saving intended to pay for future higher taxes.

Inequality

Main article: Economic inequality

Economic inequality includes

equality of opportunity
.

Research has linked economic inequality to political and social instability, including revolution, democratic breakdown and civil conflict.[167][168][169][170] Research suggests that greater inequality hinders economic growth and macroeconomic stability, and that land and human capital inequality reduce growth more than inequality of income.[167][171] Inequality is at the center stage of economic policy debate across the globe, as government tax and spending policies have significant effects on income distribution.[167] In advanced economies, taxes and transfers decrease income inequality by one-third, with most of this being achieved via public social spending (such as pensions and family benefits.)[167]

Other branches of economics

Public economics

Main article: Public economics

Public economics is the field of economics that deals with economic activities of a

public choice theory, models public-sector behaviour analogously to microeconomics, involving interactions of self-interested voters, politicians, and bureaucrats.[172]

Much of economics is positive, seeking to describe and predict economic phenomena. Normative economics seeks to identify what economies ought to be like.

Welfare economics is a normative branch of economics that uses

social welfare by examining the economic activities of the individuals that comprise society.[173]

International economics

Main article: International economics
List of countries by GDP (PPP) per capita in April 2022

International trade studies determinants of goods-and-services flows across international boundaries. It also concerns the size and distribution of gains from trade. Policy applications include estimating the effects of changing tariff rates and trade quotas. 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.[174]

Labor economics

Main article:
Labor economics

Labor economics seeks to understand the functioning and dynamics of the

wage labor. Labor markets function through the interaction of workers and employers. Labor economics looks at the suppliers of labor services (workers), the demands of labor services (employers), and attempts to understand the resulting pattern of wages, employment, and income. In economics, labor is a measure of the work done by human beings. It is conventionally contrasted with such other factors of production as land and capital. There are theories which have developed a concept called human capital (referring to the skills that workers possess, not necessarily their actual work), although there are also counter posing macro-economic system theories that think human capital is a contradiction in terms.[citation needed
]

Development economics

Main article: Development economics

Development economics examines economic aspects of the

low-income countries focusing on structural change, poverty, and economic growth. Approaches in development economics frequently incorporate social and political factors.[175]

Criticism

Economics has been subject to criticism that it relies on unrealistic, unverifiable, or highly simplified assumptions, in some cases because these assumptions simplify the proofs of desired conclusions.

behavioural psychology, and confounding factors to the neoclassical assumptions are the subject of substantial study in many areas of economics.[181][182][183]

Prominent historical mainstream economists such as Keynes

ex post". He argued that formal models were largely not important in the empirical work, either, and that the fundamental factor behind the theory of the firm, behaviour, was neglected.[185] Deirdre McCloskey has argued that many empirical economic studies are poorly reported, and she and Stephen Ziliak argue that although her critique has been well-received, practice has not improved.[186] The extent to which practice has improved since the early 2000s is contested: although economists have noted the discipline's adoption of increasingly rigorous modeling,[187][188] other have criticized the field's focus on creating computer simulations detached from reality, as well as noting the loss of prestige suffered by the field for failing to anticipate the Great Recession.[189]

Economics has been derogatorily dubbed "the dismal science", first coined by the Victorian historian Thomas Carlyle in the 19th century. It is often stated that Carlyle gave it this nickname as a response to the work of Thomas Robert Malthus, who predicted widespread starvation resulting from projections that population growth would exceed the rate of increase in the food supply. However, the actual phrase was coined by Carlyle in the context of a debate with John Stuart Mill on slavery, in which Carlyle argued for slavery; the "dismal" nature of economics in Carlyle's view was that it "[found] the secret of this Universe in 'supply and demand', and reduc[ed] the duty of human governors to that of letting men alone"."[31]

Related subjects

Main articles: Law and economics, Natural resource economics, Philosophy and economics, and Political economy

Economics is one social science among several and has fields bordering on other areas, including economic geography, economic history, public choice, energy economics, cultural economics, family economics and institutional economics.

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

externalities.[191]

externalities should impact government policy.[192][193] Historians have employed political economy to explore the ways in the past that persons and groups with common economic interests have used politics to effect changes beneficial to their interests.[194]

Georgescu-Roegen reintroduced the concept of entropy in relation to economics and energy from thermodynamics, as distinguished from what he viewed as the mechanistic foundation of neoclassical economics drawn from Newtonian physics. His work contributed significantly to thermoeconomics and to ecological economics. He also did foundational work which later developed into evolutionary economics.[195]

The

Peter Hedstrom and Richard Swedberg
have been influential in this field.

Gary Becker in 1974 presented an economic theory of social interactions, whose applications included the family, charity, merit goods and multiperson interactions, and envy and hatred. [198] He and Kevin Murphy authored a book in 2001 that analyzed market behavior in a social environment.[199]

Profession

Main article: Economist

The professionalization of economics, reflected in the growth of graduate programmes on the subject, has been described as "the main change in economics since around 1900".

liberal arts
, business, or for professional study. See Bachelor of Economics and Master of Economics.

In the private sector, professional economists are employed as consultants and in industry, including

Economic analyst
.

There are dozens of prizes awarded to economists each year for outstanding intellectual contributions to the field, the most prominent of which is the Nobel Memorial Prize in Economic Sciences, though it is not a Nobel Prize.

Contemporary economics uses mathematics. Economists draw on the tools of calculus, linear algebra, statistics, game theory, and computer science.[201] Professional economists are expected to be familiar with these tools, while a minority specialize in econometrics and mathematical methods.

Women in economics

Nobel Prize in Economics: Elinor Ostrom (2009), Esther Duflo (2019) and Claudia Goldin (2023). Five have received the John Bates Clark Medal: Susan Athey (2007), Esther Duflo (2010), Amy Finkelstein (2012), Emi Nakamura (2019) and Melissa Dell
(2020).

Women's authorship share in prominent economic journals reduced from 1940 to the 1970s, but has subsequently risen, with different patterns of gendered coauthorship.

RePEc database in 2018), with national variation.[204]

See also

Notes

  1. ^ "Capital" in Smith's usage includes fixed capital and circulating capital. The latter includes wages and labour maintenance, money, and inputs from land, mines, and fisheries associated with production.[58]
  2. ^ "This science indicates the cases in which commerce is truly productive, where whatever is gained by one is lost by another, and where it is profitable to all; it also teaches us to appreciate its several processes, but simply in their results, at which it stops. Besides this knowledge, the merchant must also understand the processes of his art. He must be acquainted with the commodities in which he deals, their qualities and defects, the countries from which they are derived, their markets, the means of their transportation, the values to be given for them in exchange, and the method of keeping accounts. The same remark is applicable to the agriculturist, to the manufacturer, and to the practical man of business; to acquire a thorough knowledge of the causes and consequences of each phenomenon, the study of political economy is essentially necessary to them all; and to become expert in his particular pursuit, each one must add thereto a knowledge of its processes." (Say 1803, p. XVI)
  3. ^ "And when we submit the definition in question to this test, it is seen to possess deficiencies which, so far from being marginal and subsidiary, amount to nothing less than a complete failure to exhibit either the scope or the significance of the most central generalisations of all." (Robbins 2007, p. 5)
  4. ^ "The conception we have adopted may be described as analytical. It does not attempt to pick out certain kinds of behaviour, but focuses attention on a particular aspect of behaviour, the form imposed by the influence of scarcity. (Robbins 2007, p. 17)
  5. ISBN 978-0-393-93709-1
    .).

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