Economics

Economics is an attempt to understand the processes that govern the production, distribution and consumption of wealth. Its ability to do so is limited by two important characteristics of those processes:

• their complexity and variety are often too great to permit anything approaching a comprehensive description;
• they are governed by the behaviour of differently-informed individuals with different motives.

Economics uses the methods of the physical sciences, adapted to those characteristics. It is classified as a science on the grounds that it aims to produce testable propositions.

The methodology of economics

Complex economic processes are analysed by mentally replacing them with simplified representations (referred to as a models). The assumptions embodied in those models determine how well their behaviour mirrors the process they are intended to represent. It is sometimes possible to adopt self-evident propositions (or axioms), and proceed successfully by deduction from those axioms. When axioms are not available - as is often the case - an inductive procedure has to be used. One possibility is to use assumptions that have been tested against observed data. Another is to use untested assumptions, and replace them if the model’s behaviour fails to mirror reality.

Among the assumptions embodied in an economic model are assumptions about human behaviour. It is commonly assumed that everyone is equally well-informed and everyone acts rationally. As a generalisation, that is obviously untrue, but its adoption does not necessarily make a model unrealistic. The model may behave “as if” it were true. The difficulty of making an acceptable assumption about human behaviour may nevertheless limit what can be achieved. Economists of the Austrian School are sceptical about the possibility of overcoming that difficulty and tend to reject the model- building procedure, but the mainstream of economic theory operates on the assumption that that difficulty is not decisive.

The categories of economics

The techniques of economics have been applied to many different activities, leading to the development of a wide range of sub-disciplines under the headings of the economics of …. (Links to articles on some of those sub-disciplines are listed in the See Also paragraph below.) However, the principal categories of economics that are of interest to the general reader are microeconomics, macroeconomics, welfare economics and international economics.

• Microeconomics is about the use of the resources of land, capital and labour, their allocation to the production of particular goods and services, their relative prices, and how they are distributed among consumers. It examines those issues by considering transactions between consumers and producers, acting singly or in groups. Many of its theorems were developed by deductive reasoning in the late nineteenth century and have since become consensual.

• Macroeconomics is about such economy-wide quantities as national income, the general level of prices, and the unemployment rate. It treats the economy as a single interactive system. It uses an essentially inductive methodology but is often presented in deductive terms in economics textbooks. It is a twentieth-century development that has had a major influence upon the history of that century. Many of its theorems are considered to be controversial, and the subject is still under development.

• Welfare economics is about the impact of decisions upon the economic well-being of those affected. It provides the theoretical basis for the practice of cost/benefit analysis. Its methodology is the same as that of microeconomics and most of its theorems are uncontroversial.

• International economics is about such matters as import restrictions, exchange rate regimes, internationa capital flows and the impact of trade policies upon developing countries. Its theorems are widely accepted among professional economists but have been hotly contested by others.