Economics

 

For a given quantity of a good, the price point on the demand curve indicates the value, or marginal utility[53] to consumers for that unit of output. It measures what the consumer would be prepared to pay for the corresponding unit of the good. The price point on the supply curve measures marginal cost, the increase in total cost to the supplier for the corresponding unit of the good. The price in equilibrium is determined by supply and demand. In a perfectly competitive market, supply and demand equate cost and value at equilibrium.

 

Demand and supply can also be used to model the distribution of income to the factors of production, including labour and capital, through factor markets. In a labour market for example, the quantity of labour employed and the price of labour (the wage rate) are modeled as set by the demand for labour (from business firms etc. for production) and supply of labour (from workers).

 

Demand and supply are used to explain the behavior of perfectly competitive markets, but their usefulness as a standard of performance extends to any type of market. Demand and supply can also be generalized to explain variables applying to the whole economy, for example, quantity of total output and the general price level, studied in macroeconomics.

 

 

Diminishing marginal utility, given quantification

 

In supply-and-demand analysis, the price of a good coordinates production and consumption quantities. Price and quantity have been described as the most directly observable characteristics of a good produced for the market.[55] Supply, demand, and market equilibrium are theoretical constructs linking price and quantity. But tracing the effects of factors predicted to change supply and demand—and through them, price and quantity—is a standard exercise in applied microeconomics and macroeconomics. Economic theory can specify under what circumstances price serves as an efficient communication device to regulate quantity. A real-world application might attempt to measure how much variables that increase supply or demand change price and quantity.

 

Marginalism is the use of marginal concepts within economics. Marginal concepts are associated with a specific change in the quantity used of a good or of a service, as opposed to some notion of the over-all significance of that class of good or service, or of some total quantity thereof. The central concept of marginalism proper is that of marginal utility, but marginalists following the lead of Alfred Marshall were further heavily dependent upon the concept of marginal physical productivity in their explanation of cost; and the neoclassical tradition that emerged from British marginalism generally abandoned the concept of utility and gave marginal rates of substitution a more fundamental rôle in analysis.

 

Market failure

 

Pollution can be a simple example of market failure. If costs of production are not borne by producers but are by the environment, accident victims or others, then prices are distorted.

 

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

 

Natural monopoly, or the overlapping concepts of "practical" and "technical" monopoly, involves a failure of competition as a restraint on producers. The problem is described as one where the more of a product is made, the greater the returns are. This means it only makes economic sense to have one producer.

 

Information asymmetries arise where one party has more or better information than the other. The existence of information asymmetry gives rise to problems such as moral hazard, and adverse selection, studied in contract theory. The economics of information has relevance in many fields, including finance, insurance, contract law, and decision-making under risk and uncertainty.

 

Incomplete markets is a term used for a situation where buyers and sellers do not know enough about each other's positions to price goods and services properly. Based on George Akerlof's Market for Lemons article, the paradigm example is of a dodgy second hand car market. Customers without the possibility to know for certain whether they are buying a "lemon" will push the average price down below what a good quality second hand car would be. In this way, prices may not reflect true values.

 

Public goods are goods which are undersupplied 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.

 

Externalities occur where there are significant social costs or benefits from production or consumption that are not reflected in market prices. For example, air pollution may generate a negative externality, and education may generate a positive externality (less crime, etc.). Governments often tax and otherwise restrict the sale of goods that have negative externalities and subsidize or otherwise promote the purchase of goods that have positive externalities in an effort to correct the price distortions caused by these externalities. 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. 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.

 

Macroeconomic instability, addressed below, is a prime source of market failure, whereby a general loss of business confidence or external shock can grind production and distribution to a halt, undermining ordinary markets that are otherwise sound.

 

 

Environmental Scientist sampling water.

 

Some specialised fields of economics deal in market failure more than others. The economics of the public sector is one example, since where markets fail, some kind of regulatory or government programme is the remedy. 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. Environmental economics is related to ecological economics but there are differences.

 

Firms

 

In Virtual Markets, buyer and seller are not present and trade via intermediates and electronic information. Pictured: São Paulo Stock Exchange.

 

One of the assumptions of perfectly competitive markets is that there are many producers, none of whom can influence prices or act independently of market forces. In reality, however, people do not simply trade on markets, they work and produce through firms. The most obvious kinds of firms are corporations, partnerships and trusts. According to Ronald Coase people begin to organise their production in firms when the costs of doing business becomes lower than doing it on the market. Firms combine labour and capital, and can achieve far greater economies of scale (when producing two or more things is cheaper than one thing) than individual market trading.

 

Labour economics seeks to understand the functioning of the market and dynamics for labour. Labour markets function through the interaction of workers and employers. Labour economics looks at the suppliers of labour services (workers), the demanders of labour services (employers), and attempts to understand the resulting patterns of wages and other labour income and of employment and unemployment, Practical uses include assisting the formulation of full employment of policies.

 

Industrial organization studies the strategic behavior of firms, the structure of markets and their interactions. The common market structures studied include perfect competition, monopolistic competition, various forms of oligopoly, and monopoly.

 

Financial economics, often simply referred to as finance, is concerned with the allocation of financial resources in an uncertain (or risky) environment. Thus, its focus is on the operation of financial markets, the pricing of financial instruments, and the financial structure of companies.

 

Managerial economics applies microeconomic analysis to specific decisions in business firms or other management units. It draws heavily from quantitative methods such as operations research and programming and from statistical methods such as regression analysis in the absence of certainty and perfect knowledge. A unifying theme is the attempt to optimize business decisions, including unit-cost minimization and profit maximization, given the firm's objectives and constraints imposed by technology and market conditions.

 

Public sector

 

Public finance is the field of economics that deals with budgeting the revenues and expenditures of a public sector entity, usually government. The subject addresses such matters as tax incidence (who really pays a particular tax), cost-benefit analysis of government programs, effects on economic efficiency and income distribution of different kinds of spending and taxes, and fiscal politics. The latter, an aspect of public choice theory, models public-sector behavior analogously to microeconomics, involving interactions of self-interested voters, politicians, and bureaucrats.

 

Much of economics is positive, seeking to describe and predict economic phenomena. Normative economics seeks to identify what is economically good and bad.

 

Welfare economics is a normative branch of economics that uses microeconomic techniques to simultaneously determine the allocative efficiency within an economy and the income distribution associated with it. It attempts to measure social welfare by examining the economic activities of the individuals that comprise society.

 

 

 

 

 

Macroeconomics

 

A depiction of the circular flow of income

 

Macroeconomics examines the economy as a whole to explain broad aggregates and their interactions "top down," that is, using a simplified form of general-equilibrium theory. Such aggregates include national income and output, the unemployment rate, and price inflation and subaggregates like total consumption and investment spending and their components. It also studies effects of monetary policy and fiscal policy. Since at least the 1960s, macroeconomics has been characterized by further integration as to micro-based modeling of sectors, including rationality of players, efficient use of market information, and imperfect competition. This has addressed a long-standing concern about inconsistent developments of the same subject. Macroeconomic analysis also considers factors affecting the long-term level and growth of national income. Such factors include capital accumulation, technological change and labor force growth.

 

World map showing GDP real growth rates for 2008.

 

Growth

 

Growth economics studies factors that explain economic growth –  the increase in output per capita of a country over a long period of time. The same factors are used to explain differences in the level of output per capita between countries. Much-studied factors include the rate of investment, population growth, and technological change. These are represented in theoretical and empirical forms (as in the neoclassical growth model) and in growth accounting.

 

Depression and unemployment

See also: Circular flow of income, Aggregate supply, Aggregate demand, Great Depression, and Unemployment

 

The economics of a depression were the spur for the creation of "macroeconomics" as a separate discipline field of study. During the Great Depression of the 1930s, John Maynard Keynes produced a book entitled The General Theory of Employment, Interest and Money. In it he argued that markets were not self correcting and that if the economy was in a crisis of confidence and downward spiral, it was necessary for government to use spending to stimulate the economy (and the animal spirits of the people to regain confidence) back to good health. It would pay the money back later. Otherwise a general deficit of effective demand would lead to a very long slump. A crisis in confidence could send stock markets plummeting, meaning companies go out of business, meaning more redundancies and fewer people with jobs, meaning people have less money to spend, meaning businesses have fewer customers, meaning more companies go out of business, and so on. The circular flow of income needed an external boost by the state.

 

Inflation and monetary policy

See also: Money, Quantity theory of money, Monetary policy, History of money, and Milton Friedman

Money is a means of final payment for goods in most price system economies and the unit of account in which prices are typically stated. It includes currency held by the nonbank public and checkable deposits. It has been described as a social convention, like language, useful to one largely because it is useful to others. As a medium of exchange, money facilitates trade. 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.

 

At the level of an economy, theory and evidence are consistent with a positive relationship running from the total money supply to the nominal value of total output and to the general price level. For this reason, management of the money supply is a key aspect of monetary policy.

 

Fiscal policy and regulation

 

National accounting is a method for summarizing aggregate economic activity of a nation. The national accounts are double-entry accounting systems that provide detailed underlying measures of such information. These include the national income and product accounts (NIPA), which provide estimates for the money value of output and income per year or quarter. NIPA allows for tracking the performance of an economy and its components through business cycles or over longer periods. Price data may permit distinguishing nominal from real amounts, that is, correcting money totals for price changes over time. The national accounts also include measurement of the capital stock, wealth of a nation, and international capital flows.

International economics

 

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.

 

World map showing GDP (PPP) per capita.

 

The distinct field of development economics examines economic aspects of the development process in relatively low-income countries focussing on structural change, poverty, and economic growth. Approaches in development economics frequently incorporate social and political factors.

 

Economic systems is the branch of economics that studies the methods and institutions by which societies determine the ownership, direction, and allocaton of economic resources. An economic system of a society is the unit of analysis. Among contemporary systems at different ends of the organizational spectrum are socialist systems and capitalist systems, in which most production occurs in respectively state-run and private enterprises. In between are mixed economies. A common element is the interaction of economic and political influences, broadly described as political economy. Comparative economic systems studies the relative performance and behavior of different economies or systems.

 

Economics in practice

 

Contemporary mainstream economics, as a formal mathematical modeling field, could also be called mathematical economics. It draws on the tools of calculus, linear algebra, statistics, game theory, and computer science. Professional economists are expected to be familiar with these tools, although all economists specialize, and some specialize in econometrics and mathematical methods while others specialize in less quantitative areas. Heterodox economists place less emphasis upon mathematics, and several important historical economists, including Adam Smith and Joseph Schumpeter, have not been mathematicians. Economic reasoning involves intuition regarding economic concepts, and economists attempt to analyze to the point of discovering unintended consequences.

 

Theory

 

Mainstream economic theory relies upon a priori quantitative economic models, which employ a variety of concepts. Theory typically proceeds with an assumption of ceteris paribus, which means holding constant explanatory variables other than the one under consideration. When creating theories, the objective is to find ones which are at least as simple in information requirements, more precise in predictions, and more fruitful in generating additional research than prior theories.

 

In microeconomics, principal concepts include supply and demand, marginalism, rational choice theory, opportunity cost, budget constraints, utility, and the theory of the firm. Early macroeconomic models focused on modeling the relationships between aggregate variables, but as the relationships appeared to change over time macroeconomists were pressured to base their models in microfoundations. The aforementioned microeconomic concepts play a major part in macroeconomic models – for instance, in monetary theory, the quantity theory of money predicts that increases in the money supply increase inflation, and inflation is assumed to be influenced by rational expectations. In development economics, slower growth in developed nations has been sometimes predicted because of the declining marginal returns of investment and capital, and this has been observed in the Four Asian Tigers. Sometimes an economic hypothesis is only qualitative, not quantitative.

 

Expositions of economic reasoning often use two-dimensional graphs to illustrate theoretical relationships. At a higher level of generality, Paul Samuelson's treatise Foundations of Economic Analysis (1947) used mathematical methods to represent the theory, 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.

 

Empirical investigation

 

Economic theories are sometimes tested empirically, largely through the use of econometrics using economic data. The controlled experiments common to the physical sciences are difficult and uncommon in economics, and instead broad data is observationally studied; this type of testing is typically regarded as less rigorous than controlled experimentation, and the conclusions typically more tentative. 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.

 

Criticism based on professional standards and non-replicability of results serve as further checks against bias, errors, and over-generalization, although much economic research has been accused of being non-replicable, and prestigious journals have been accused of not facilitating replication through the provision of the code and data. Like theories, uses of test statistics are themselves open to critical analysis, although critical commentary on papers in economics in prestigious journals such as the American Economic Review has declined precipitously in the past 40 years This has been attributed to journals' incentives to maximize citations in order to rank higher on the Social Science Citation Index (SSCI).

 

In applied economics, input-output models employing linear programming methods are quite common. Large amounts of data are run through computer programs to analyze the impact of certain policies; IMPLAN is one well-known example.

 

Experimental economics has promoted the use of scientifically controlled experiments. This has reduced long-noted distinction of economics from natural sciences allowed direct tests of what were previously taken as axioms. In some cases these have found that the axioms are not entirely correct; for example, the ultimatum game has revealed that people reject unequal offers. In behavioral economics, psychologists Daniel Kahneman and Amos Tversky have won Nobel Prizes in economics for their empirical discovery of several cognitive biases and 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. These techniques have led some to argue that economics is a "genuine science.".

 

 

 

 

 

Game theory

 

Game theory is a branch of applied mathematics that studies strategic interactions between agents. In strategic games, agents choose strategies that will maximize their payoff, given the strategies the other agents choose. It provides a formal modeling approach to social situations in which decision makers interact with other agents. Game theory generalizes maximization approaches developed to analyze markets such as the supply and demand model. The field dates from the 1944 classic Theory of Games and Economic Behavior by John von Neumann and Oskar Morgenstern. It has found significant applications in many areas outside economics as usually construed, including formulation of nuclear strategies, ethics, political science, and evolutionary theory.

 

Profession

 

The professionalization of economics, reflected in the growth of graduate programs on the subject, has been described as "the main change in economics since around 1900". Most major universities and many colleges have a major, school, or department in which academic degrees are awarded in the subject, whether in the liberal arts, business, or for professional study. The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel (colloquially, the Nobel Prize in Economics) is a prize awarded to economists each year for outstanding intellectual contributions in the field. In the private sector, professional economists are employed as consultants and in industry, including banking and finance. Economists also work for various government departments and agencies, for example, the national Treasury, Central Bank or Bureau of Statistics.

 

Economics and other subjects

 

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, 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 economically efficient, and to predict what the legal rules will be. A seminal article by Ronald Coase published in 1961 suggested that well-defined property rights could overcome the problems of externalities.

 

The relationship between economics and ethics is complex. Many economists consider normative choices and value judgments, like what needs or wants, or what is good for society, to be political or personal questions outside the scope of economics. Once a person or government has established a set of goals, however, economics can provide insight as to how they might best be achieved.

 

Others see the influence of economic ideas, such as those underlying modern capitalism, to promote a certain system of values with which they may or may not agree. (See, for example, consumerism and Buy Nothing Day.) According to some thinkers, a theory of economics is also, or implies also, a theory of moral reasoning.

 

The premise of ethical consumerism is that one should take into account ethical and environmental concerns, in addition to financial and traditional economic considerations, when making buying decisions.

 

On the other hand, the rational allocation of limited resources toward public welfare and safety is also an area of economics. Some have pointed out that not studying the best ways to allocate resources toward goals like health and safety, the environment, justice, or disaster assistance is a sort of willful ignorance that results in less public welfare or even increased suffering. In this sense, it would be unethical not to assess the economics of such issues. In fact, state agencies all over the world, including the federal agencies in the United States, routinely conduct economic analysis studies toward that end.