Economics is a social science that focuses on the production, distribution, and consumption of goods and services while also working to analyze the choices individuals, businesses, governments, and nations make to allocate resources, and how that affects the production, distribution, and consumption of those goods and services. Economics can be defined in a few different ways: the study of scarcity, the study of how people use resources and respond to incentives, and the study of decision-making. It often involves topics of wealth and finance but is about more than just money. As a broad discipline, economics can help societies, governments, and individuals understand historical trends, interpret actions, and make predictions for the wider economy in the coming years based on the decisions of individuals and governments.
Economics can be used to try and determine the most efficient and effective use of resources to meet private and social goals. This can include an analysis of factors such as production and employment, investment and savings, health, money and the banking system, government policies on taxation and spending, international trade, industrial organization and regulation, urbanization, environmental issues, and legal matters, among other factors that depend on the question being asked and answered.
The definitions of economics have changed over time. The word economics comes from the ancient Greek word oikonomikos or oikonomia, which translates to the "task of managing the household." Whereas early French mercantilists would talk about the economie politique, or "political economy," when referring to public administration. Arguably, Adam Smith, the Scottish philosopher, offered the first definition of economics (and developed economics as a science and field of study), defining economics as "an inquiry into the nature and causes of the wealth of nations."
This would later be amended by British economist Alfred Marshall, who would define economics as the study of man in the ordinary business of life. This expanded the study of economics to be both the study of wealth and the study of humankind and believing economics was not a science such as physics or chemistry but a social science. Another British economist, Lionel Robbin, would again redefine economics in 1932 as the subject that studies the allocation of scarce resources with countless possible uses. Further, Robbin stated, "economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses."
The modern definition of economics is often attributed to the twentieth-century economist Paul Samuelson. His definition built upon the past definitions and described the subject as a social science, saying, "economics is the study of how people and society choose, with or without the use of money, to employ scarce productive resources that could have alternative uses, to produce various commodities over time and distribute them for consumption now and in the future among various persons and groups in society. However, the pithiest, and for some disturbing, definition of economics came from Jacob Viner, who suggested "economics is what economists do."
Economists occupy all kinds of jobs, such as professors, government advisors, consultants, and private sector employees. In each of these roles, economists employ theoretical models or empirical data to evaluate programs, study human behavior, and explain social and economic phenomena. Economics, and thereby economists, intersect in many disciplines, with applications in studies such as health, gender, the environment, education, and immigration.
The opinions of economists can help shape economic policies related to interest rates, tax laws, employment programs, international trade agreements, and corporate strategies through the analysis of economic indicators. These indicators can include gross domestic product or the consumer price index in order to identify potential trends or make economic forecasts.
Microeconomics is a study of individual consumers and firms and how they make decisions to allocate resources. Whether a single person, a household, or a business, economists may analyze how these entities respond to changes in price and why they demand what they do at a given price level. Further, microeconomics works to evaluate how and why goods are valued differently, how individuals make financial decisions in the face of these valuations (and in response to wider economic concerns), and how participants in the economy trade, coordinate, and cooperate. It is also a study of the organization of businesses and how individuals approach uncertainty and risk in decision-making, with respect to the dynamics of supply and demand, costs of producing goods and services, and how labor is divided and allocated.
Macroeconomics, as opposed to microeconomics, looks at a wider economic picture, or a study of the behavior and performance of the economy as a whole. The primary focus of macroeconomics is the recurrent economic cycles and broad economic growth and development. This includes a focus on foreign trade, government fiscal and monetary policy, unemployment rates, the level of inflation, interest rates, the growth of total production output, and business cycles that result in expansions, booms, recessions, and depressions.
Economists can use aggregate indicators and macroeconomic models to help formulate economic policies and strategies. These indicators can also be used by economists to study the role of the government to successfully intervene in the economy in a discretionary way to encourage the growth of the overall economy in order to avoid recessions, high unemployment, inflation, and price increases, all of which damage the overall economy as they restrict the number of individuals able to participate in the economy or to the extent to which they can participate.
Public economics, also known as public finance, is the analysis of the impact of public policy on the allocation of resources and the distribution of income in an economy. In the United States, the public sector accounts for about a third of all economic activity, which, compared to other industrialized countries, is a small ratio. Government has an effect on nearly everything an individual does in their daily life, and public economics offers empirical analysis to study the effect of taxation, spending activities, social security, health insurance, income distribution, welfare programs, externalities, public goods, and taxation at federal, state, and local levels on the micro- and macroeconomic health of a nation.
Labor economics studies labor forces as an element in the process of production. Labor forces are defined as those who work for gain in the labor market, either as employees, employers, self-employed individuals, the unemployed, and those seeking work. Further, labor economics studies all that affects workers before, during, and after their working lives. This can include children, education, pay and incentives, fertility, discrimination, non-work time, and pension reforms. Labor markets, as a part of labor economics, function through the interaction of workers and employers and can be bounded geographically within countries or regions. The study can also look at the mobility of workers across markets and across employers.
Development economics focuses on improving fiscal, economic, and social conditions in developing countries. This can include the consideration of factors such as health, education, working conditions, domestic and international policies, and market conditions. The focus of development economics is to help improve conditions in the world's poorest countries. Further, development economics can examine both macro- and microeconomic factors relating to the structure of developing economies and domestic and international economic growth. It includes a study of the forces and policies that can help transform an emerging nation into a prosperous nation. These forces tend to be unique, as a country's cultural and economic framework can differ widely.
Economic indicators are pieces of data used to detail a country's economic performance and therefore are often used for macroeconomic analysis. These indicators are periodically published by governmental agencies or private organizations and will have a considerable effect on stocks, employment, and international markets while being used to predict future economic conditions that can and will move markets and guide decisions regarding investments from a personal to a governmental level.
Consumer Price Index (CPI)
The Consumer Price Index (CPI) is used to measure retail price changes and the costs consumers pay. This is used as a benchmark for measuring inflation. Using a basket representative of the goods and services in the economy. The CPI compares the price changes month over month and year over year. The report is considered an important economic indicator which can increase volatility in equity, fixed income, and forex markets. Increases in price that are greater than expected are considered a sign of inflation, which can cause an underlying currency to depreciate.
Employment data is released by labor bureaus. In the United States, the Bureau of Labor Statistics releases employment data in a report called the nonfarm payrolls on the first Friday of each month. Increases in employment can offer an indication of economic growth, and potential contractions are signaled if a decrease, especially a significant decrease, occurs. These are generalizations but can be important to consider the position of an economy.
Gross domestic product (GDP)
The gross domestic product (GDP) is considered one of the broadest measures of a country's economic performance. It is used to calculate the total market value of all finished goods and services produced in a country in a given year. Reports on the gross domestic product of a given country tend to be issued in the latter part of each month. However, investors, analysts, and traders tend to focus instead on the advance GDP report and the perliminary report which are issued before the final GDP figures are issues. This is because the GDP is considered a lagging indicator, which means it can confirm a trend but cannot predict the trend.
The industrial production report is another monthly issued report, which reports on the production of factories, mines, and utilities in the U.S. One measure included in the report is the capacity utilization ratio, which works to develop an estimate of the productive capacity that is being used rather than standing idle in the economy. Capacity utilization in the range of 82% to 85% is considered "tight" and can increase the likelihood that price will increase or supply shortages can occur in the near term. Whereas levels below 80% are interpreted as showing "slack" in the economy, which can increase the likelihood of a recession.
Retail sales are reported by the Department of Commerce (DOC) during the middle of each month, and the report on retail sales is followed closely. The report measures total receipts, or dollar value, or all merchandise sold in stores. Sampling retailers across the country act as a proxy of consumer spending levels. Consumer spending tends to represent more than two-thirds of GDP, which allows the retail sales report provides a useful gauge of the economy's general direction.
Understanding economics, in part, requires an understanding of the wider economy as the system that is usually being understood as being studied by economics. The economy tends to be defined as a system of interrelated production and consumption activities that determine the allocation of resources within a group. The activities within an economy can determine how resources are allocated among all participants and include the production, consumption, and distribution of goods and services to fulfill the needs of those within the economy.
Types of Economies
These economies are in direct opposition to market-based economies, where the command-based economy depends on a central government that controls the production levels, pricing, and distribution of goods. In this system, the government owns the industries deemed essential on behalf of the consumers who use them, while competition among companies is discourage or banned and prices are controlled. Communist systems require a command-based economy, and these economies attempt to supersed the workings of supply and demand.
Also known as a "free market," a market-based economy allows people and businesses to freely exchange goods and services according to supply and demand. Producers determine what is produced and sold and what price these goods and services are sold at. This requires the producers to produce what consumers want and charge what consumers are willing to pay. Through these decisions, the laws of supply and demand set the market for any product. This type of economy relies on the constant tug of supply and demand to allow the economy to naturally balance itself.
A pure market economy rarely exists in the world, and there is usually some degree of government intervention or central planning. Even the United States is considered a mixed economy, despite it being one of the closest world economies to a pure market-based economy. Most of the world's developed economies have mixed economies. Even China, since 1978, can be considered to have a mixed economy as various reforms have encouraged private enterprise in the country.
Economic systems tend to be considered somewhat distinct, if interrelated, to the types of economies. These typically illustrate the practices used to allocate resources to meet the needs of the individual and the wider society. And they are usually historical looks at how economic systems have worked to solve those challenges.
An agrarian economy is one in which a majority of the income of individuals comes from agriculture. This is sometimes thought of as a primitive society, in which necessities in the economy are produced from building dwellings, growing crops, and hunting game at the household or tribal level.
Often considered to have emerged with or around the time of the industrial revolution, capitalism is a system of production where business owners organize resources including tools, workers, and raw materials to produce goods for market consumption and earn profits. This type of market system relies on supply and demand to set prices and serve the best interests of society.
Communism as an economic system holds that all economic activity is centralized through the coordination of state-sponsored central planners with common ownership of production and distribution. The system seeks to replace private property and profit-based economy with public ownership and communal control of at least the major means of production if not all means of production.
Feudalism is a political and economic system that was prominent in Europe from the ninth to the fifteenth century. Feudalism tended to be defined by the lords who held land and leased it to the peasants for production; in return, peasants received a promise of safety and security from the lord. Peasants under this system were also expected to participate in militaries and pay taxes to the lord, who in turn paid taxes and provided militaries to the ruling lord or king or queen, depending on the specific region.
Socialism is a form of cooperative production economy. Economic socialism is a system where there is limited or hybrid private ownership of the means of production, and where prices, profits, and losses are not the determining factors used to establish who is engaged in the production of goods and services, or what is produced and how to produce the good or service. This model includes more central or government intervention in the economy, as well as collective or public ownership of the means of production.
Various schools of economic thought and theories have evolved. Some of these could be considered retroactive labels, as economics largely emerged with the publication of Scottish philosopher Adam Smith's 1776 treatise An Inquiry into the Nature and Causes of the Wealth of Nations, also known as The Wealth of Nations. Economics existed before this, with various contributions made by scholars, but The Wealth of Nations is considered to be the first full-scale treatment on economics. Since then, economics has been approached as a field of study, and the text largely influenced what is known as classical economic theory.
As noted above, the classical school is regarded as perhaps the first school, or thoroughly cataloged system, of economic thought or theory developed in large part by Adam Smith, along with British economists who would follow, including Robert Malthus and David Ricardo. The main idea of the classical school is that markets work best when left alone, and the government's role in the economy should be a small one. This approach is similar to laissez-faire or free market economics, with a strong belief in the efficiency of free markets to generate economic development.
Further, the school holds that markets should be left to work as the price mechanism can act as an "invisible hand" that guides the economy to allocate resources where they can be best employed. The school explained value as determined by scarcity and costs of production, mainly, such that goods or services that were scarce or cost a lot to produce could be valued highly. And the school of thought assumed the economy would always return to full-employment levels of real output through automatic self-adjustment mechanisms. The school of thought is largely considered to have lasted until 1870.
The neo-classical school of economic thought is a wide-ranging school of ideas often thought to be where modern economic theory largely evolved. The method works to be scientific, with assumptions, hypotheses, and attempts to derive general rules or principles about the behavior of companies and consumers. For example, neo-classical economics assumes that economic agents are rational in their behaviors and that consumers look to maximize utility while companies look to maximize profits.
Those contrasting objectives of maximizing utility on one hand and maximizing profits on the other form the basis of supply and demand theory. Another important contribution of neo-classical economics is a focus on marginal values, such as marginal cost and marginal utilities. The neo-classical school of economics is associated with the work of William Jevons, Carl Menger, and Leon Walras.
Marxian economics is a school of economic thought developed out of the work of Karl Marx, specifically from his seminal work Das Kapital, which was first published in 1867. In this book, Marx described his theory that the capitalist system tended toward self-destruction. This is based on Marx's concept of "surplus value" of labor and the consequences of capitalism. Further, he believed labor in the capitalist system was no more than a commodity capable of being exploited on subsistence wages. Or that workers could create value through their labor but would not be properly compensated in a true capitalist system.
Marxian economics is generally considered separate from the political schools of thought known as Marxism and communism. Generally, Marxian economic principles clash with the virtues of capitalist pursuit, with Marx going as far as predicting that capitalism would eventually destroy itself as more people would be relegated to the worker class.
Marx's economic theory never gained much influence in economics or outside of later communist countries, such as the former USSR. Part of this was due to Marx's exposition of the "law of declining rate of profit," which would be considered largely invalid, practically and logically, and without which the rest of Marx's predictions cannot occur or be justified logically. Further, Marxian economics has little to say on the practical problems that economists in any society deal with daily, such as the effect of taxes on specific commodities or the effects of a rise in the rate of interest.
Developed by British economist John Maynard Keynes during the 1930s and in an attempt to understand the Great Depression, Keynesian economics offers a macroeconomic theory of total spending in the economy and the effect that spending has on output, employment, and inflation. Often considered a demand-side theory, Keynsian economics focuses on changes in the economy over the short run with a central belief that government intervention can be used to stabilize the economy.
Further, his theory was the first to separate the study of economic behavior and markets based on individual incentives. Based on this theory, Keynes would advocate for increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the Great Depression. This interventionist thought is based, in part, on the Keynesian belief that self-interest governs microeconomic behavior, which does not lead to macroeconomic development, let alone short-run macroeconomic stability. It also offers thoughts on how intervention can be used to manipulate an economy and aggregate demand through macroeconomic policy. The Keynesian economic theory would fall out of favor during the 1970s and 1980s, following the rise of new classical economics.
The new classical school originated in the 1970s in the work of economists from the Universities of Chicago and Minnesota, with specific thinkers including Robert Lucas, Thomas Sargent, Neil Wallace, and Edwar Prescott. The new classical school attempts to explain macroeconomic problems and issues using microeconomic concepts, such as rational behavior and rational expectations. The new classical school, despite its apparent similarity in name to neo-classical school, is rather an attempt to provide microfoundations for the labor markets developed in Keynesian economics.
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1.1 What Is Economics, and Why Is It Important? - Principles of Microeconomics
1.1 What Is Economics, and Why Is It Important? - Principles of Microeconomics
American Economic Association
Development Economics Definition
July 8, 2022