The subject of economics

The subject of economics

There are many definitions of economics. One of them was formulated by Paul Samuelson, a prominent American economist and the author of textbooks on economics which have been used by economics students all over the world for decades: Economics is the study of how societies use scarce resources to produce valuable commodities and distribute them among different people.  Economics is a science. However it is of practical value in business. An understanding of the overall operation of the economic system puts the business executive in a better position to formulate policies. The executive who understands the causes and consequences of inflation is better equipped during inflationary periods to make more intelligent decisions than otherwise. Indeed, more and more economists are employed by corporations. Their job? To gather and interpret economic information upon which rational business decisions can be made.

In spite of its practical benefits, however, the students must be warned that economics is an academic subject. Unlike accounting, advertising, corporation finance, and marketing, economics is not primarily a how-to-make-money area of study. A knowledge of economists may be helpful in running a business or in managing one’s personal finances, but this is not its primary objective. In economics, problems are usually examined from the social, not from the individual point of view. Production and consumption of goods and services are discussed from the viewpoint of society as a whole, not from the standpoint of one’s own personal financial benefits.

Economics is concerned with the following:

1. The production of goods and services: how much the economy produces; what particular combination of goods and services; how much each firm produces; what techniques of production it uses; how many people it employs.

2. The consumption of goods and services: how much the population as a whole spends (and how much it saves); what pattern of consumption is in the economy; how much people buy of particular items; how people’s consumption is affected by prices, advertising, fashion and other factors.

As individuals want more than they can have, this makes them behave in certain ways. Economics studies that behaviour of people as consumers of various goods and services. The society as a whole faces the similar problem, so economics also studies the behaviour of producers (firms), and of governments which can influence the level of production and consumption as a whole.

Methodology

What do economists do? What procedures do they employ?

The economist must first gather the facts which are relevant to consideration of a specific economic problem. Then the economics puts this collection of facts in order and summarizes them, and finds out a principle concerning the way individuals and institutions actually behave. Deriving principles from facts is called “economic theory” or “economic analysis”. Finally, the general knowledge of economic behavior which economic principles provide can then be used in developing policies for correcting or avoiding the problem.

This final aspect of the field is called “applied economics” or “policy economics”. In this way economic theory serves as the basis for economic policy. Economic principles are extremely valuable as predictive devices. If some undesirable event (such as unemployment or inflation) can be predicted or understood through economic theory, we may be able to influence or control the event, or prepare for it. Ability to predict a rainstorm does not give us control over the weather, but it does permit us to prepare for it by carrying a raincoat and an umbrella.

 

Facts

Economics is concerned with gathering the facts relevant to a specific problem of the economy

Principles or theories

Theoretical economics involves generalizing about  economic behaviour

Policies

Policy economics is concerned with influencing economic behaviour or its consequences  Economic principles are generalizations and characterized by imprecise quantitative statement. Economic facts are usually diverse; some individuals and institutions act one way and some another way. Hence, economic principles are stated in terms of averages. For example, when economists say that the average household earned an income of $22,390 in 1981, they are making a generalization. It is recognized that some households earned much more and many others much less. Yet this generalization, properly handled and interpreted, can be very meaningful and useful.

Economists try to find economic principles by building models. The predictions of the models form the basis of economic theories. The theories can be tested by comparing the predictions of the models with the facts of the real world.

What methods are used by economists to develop their theories?

Induction and deduction

Induction takes place when accumulated facts are arranged systematically and analyzed so as to permit the derivation of principle. Deriving principles of facts we are describing the inductive or empirical method.

The other method is called deductive or hypothetical. For example, economists may say that it is rational for consumers to buy more of a product when its price is low than when its price is high.

Such untested principle is called a hypothesis. The validity of this hypothesis can be tested by the systematic and repeated examination of relevant facts. Thus, the deductive method goes from the general to the particular, from theory to facts. Most economists view deduction and induction as complementary, rather than opposing, techniques of investigation.

All sciences are careful to distinguish between two types of statements: statements about what is or was or will be –  positive statements; and statements about what ought to be –  normative statements. Thus, positive economics investigates the ways in which economic agents seek to achieve their goals. It deals with facts and is free from subjective opinions. For example, ‘The unemployment rate is 7%’. 

Normative economics makes suggestions about the ways in which society’s goals might be more efficiently realized. For example, ‘The unemployment should be lowered’.

Economic models

When economic science discovers a relationship between two or more things, then a model can be designed. Economics uses economic models to explain economic processes which are so complex in the real economy that models become useful.

A model is a simplified picture of reality that tells how some things influence other things. And various simplifying assumptions are used. For example, “other things being equal” assumption:

In constructing their generalizations, economists as well as other scientists make use of the ceteris paribus (Latin) or 'other things being equal’ assumption. That is, they assume all other variables are held constant except the one under consideration. To illustrate: If economists want to focus on “the price of product X – purchases of product X” relationship, they assume that only the price of product X varies, and all other factors which may influence the amount of product X purchased are constant, such as the prices of other products, consumer incomes, tastes, fashion, etc.

Exactly what is an economic model?

An economic model is the same thing as an economic theory or principle or law. Economists talk about the “principle of diminishing marginal utility” and the “law of demand”  and the “theory of the firm”. All these are models: statements of “what causes what” and “what would happen if…”. A model can be represented in three ways:

• verbally (in words)

• graphically (in graphs and diagrams)

• mathematically (equations)

There are two levels of the economic analysis: microeconomics and macroeconomics.

Microeconomics deals with the problems that consumers and firms face in their economic activity. Microeconomics also studies the way that individual markets work and the detailed way that government activities such as regulations and taxes affect individual markets. Much of microeconomics focuses on trying to understand what factors affect the prices and quantities traded in individual markets.

Macroeconomics deals with the economy as a whole. It is concerned with the economy of a country and regulation of the economy by the governments. In particular, it studies the overall values of output as a whole, of unemployment and of inflation.  The division is useful because what is rational for the individual firm or household is not necessary rational when considering the whole economy.

Applied economics includes the following: management, marketing, finance, accounting, logistics, to name just a few.