Philosophy of Economics

The philosophy of economics is the branch of philosophy which studies philosophical issues relating to economics. It can also be defined as the branch of economics which studies its own foundations and status as a moral science.

Scope of the philosophy of economics

Definition and ontology of economics

The first question usually addressed in any subfield of philosophy (the philosophy of X) is "what is X?" A philosophical approach to the question "what is economics?" is less likely to produce an answer than it is to produce a survey of the definitional and territorial difficulties and controversies.

Ontological questions continue with further "what is..." questions addressed at fundamental economic phenomena, such as "what is (economic) value?", "what is a market?". While it is possible to respond to such questions with real verbal definitions, the philosophical value of posing such questions actually aims at shifting entire perspectives as to the nature of the foundations of economics. In the rare cases that attempts at ontological shifts gain wide acceptance, their ripple effects can spread throughout the entire field of economics.

Methodology and epistemology of economics

An epistemology deals with how we know things. In the philosophy of economics this means asking questions such as: what kind of a "truth claim" is made by economic theories - for example, are we claiming that the theories relate to reality or perceptions? How can or should we prove economic theories - for example, must every economic theory be empirically verifiable? How exact are economic theories and can they lay claim to the status of an exact science - for example, are economic predictions as reliable as predictions in the natural sciences, and why or why not? Another way of expressing this issue is to ask whether economic theories can state "laws". Philosophers of science have explored these issues intensively since the work of Alexander Rosenberg and Daniel Hausman in the 1970s.

Game theory and economic agents

Game theory is shared between a number of disciplines, but especially mathematics, economics and philosophy. Game theory is still extensively discussed within the field of the philosophy of economics. Decision theory is closely related to game theory and is likewise very strongly interdisciplinary. Philosophical approaches in decision theory focus on foundational concepts in decision theory - for example, on the natures of choice or preference, rationality, risk and uncertainty, economic agents.

Ethics of economic systems

The ethics of economic systems deals with the issues such as how it is right (just, fair) to keep or distribute economic goods. This area overlaps strongly with other disciplines. Approaches are regarded as more philosophical when they study the fundamentals - for example, John Rawls' A Theory of Justice (1971) and Robert Nozick's Anarchy, State and Utopia (1974).

Utilitarianism, one of the ethical methodologies, has its origins inextricably interwoven with the emergence of modern economic thought. Today utilitarianism has spread throughout applied ethics as one of a number of approaches. Non-utilitarian approaches in applied ethics are also now used when questioning th e ethics of economic systems - e.g. rights-based (deontological) approaches.

Many political ideologies have been an immediate outgrowth of reflection on the ethics of economic systems. Marx, for example, is generally regarded primarily as a philosopher, his most notable work being on the philosophy of economics.

Non-mainstream economic thinking

The philosophy of economics defines itself as including the questioning of foundations or assumptions of economics. The foundations and assumption of economics have been questioned from the perspective of noteworthy but typically under-represented groups. These areas are therefore to be included within the philosophy of economics.

Environmental Economics

Environmental economics is a subfield of economics concerned with environmental issues. Central to environmental economics is the concept of market failure. Market failure means that markets fail to allocate resources efficiently. As stated by Hanley, Shogren, and White (2007) in their textbook Environmental Economics: "A market failure occurs when the market does not allocate scarce resources to generate the greatest social welfare. A wedge exists between what a private person does given market prices and what society might want him or her to do to protect the environment. Such a wedge implies wastefulness or economic inefficiency; resources can be reallocated to make at least one person better off without making anyone else worse off." Common forms of market failure include externalities, non excludability and non rivalry.

Externality: the basic idea is that an externality exists when a person makes a choice that affects other people that are not accounted for in the market price. For instance, a firm emitting pollution will typically not take into account the costs that its pollution imposes on others. As a result, pollution in excess of the 'socially efficient' level may occur. A classic definition is provided by Kenneth Arrow (1969), who defines an externality as “a situation in which a private economy lacks sufficient incentives to create a potential market in some good, and the nonexistence of this market results in the loss of efficiency.” In economic terminology, externalities are examples of market failures, in which the unfettered market does not lead to an efficient outcome.

Common property and non-exclusion: When it is too costly to exclude people from accessing a rivalrous environmental resource, market allocation is likely to be inefficient. The challenges related with common property and non-exclusion have long been recognized. Hardin's (1968) concept of the tragedy of the commons popularized the challenges involved in non-exclusion and common property. "commons" refers to the environmental asset itself, "common property resource" or "common pool resource" refers to a property right regime that allows for some collective body to devise schemes to exclude others, thereby allowing the capture of future benefit streams; and "open-access" implies no ownership in th e sense that property everyone owns nobody owns. The basic problem is that if people ignore the scarcity value of the commons, they can end up expending too much effort, over harvesting a resource (e.g., a fishery). Hardin theorizes that in the absence of restrictions, users of an open-access resource will use it more than if they had to pay for it and had exclusive rights, leading to environmental degradation. See, however, Ostrom's (1990) work on how people using real common property resources have worked to establish self-governing rules to reduce the risk of the tragedy of the commons.

Public goods and non-rivalry: Public goods are another type of market failure, in which the market price does not capture the social benefits of its provision. For example, protection from the risks of climate change is a public good since its provision is both non-rival and non-excludable. Non-rival means climate protection provided to one country does not reduce the level of protection to another country; non-excludable means it is too costly to exclude any one from receiving climate protection. A country's incentive to invest in carbon abatement is reduced because it can "free ride" off the efforts of other countries. Over a century ago, Swedish economist Knut Wicksell (1896) first discussed how public goods can be under-provided by the market because people might conceal their preferences for the good, but still enjoy the benefits without paying for them.

Economic Theory

Economics is the social science that is concerned with the production, distribution, and consumption of goods and services. The term ecomomics comes from the Ancient Greek οἰκονομία (oikonomia, "management of a household, administration") from oikos (oikos, "house") + νόμος (nomos, "custom" or "law"), hence "rules of the house(hold)". Current economic models developed out of the broader field of political economy in the late 19th century, owing to a desire to use an empirical approach more akin to the physical sciences.

Economics aims to explain how economies work and how economic agents interact. Economic analysis is applied throughout society, in business, finance and government, but also in crime, education, the family, health, law, politics, religion, social institutions, war, and science. The expanding domain of economics in the social sciences has been described as economic imperialism.

Common distinctions are drawn between various dimensions of economics: between positive economics (describing "what is") and normative economics (advocating "what ought to be"); between economic theory and applied economics; and between mainstream economics (more "orthodox" dealing with the "rationality-individualism-equilibrium nexus") and heterodox economics (more "radical" dealing with the "institutions-history-social structure nexus"). However the primary textbook distinction is between microeconomics, which examines the economic behavior of agents (including individuals and firms, consumers and producers), and macroeconomics, addressing issues of unemployment, inflation, economic growth, and monetary and fiscal policy for an entire economy.

Industrial Ecunomics

Industrial economics is a field of economics that studies the strategic behavior of firms, the structure of markets and their interactions. The study of industrial organization adds to the perfectly competitive model real-world frictions such as limited information, transaction cost, cost of adjusting prices, government actions, and barriers to entry by new firms into a market. It then considers how firms are organized and how they compete. Perhaps a most appropriate term is the "Economics of Imperfect Competition". The development of industrial organization as a separate field owed much to Edward Chamberlin, Edward S. Mason and Joe S. Bain.

There are two major approaches to the study of industrial organization: the first approach is primarily descriptive and provides an overview of industrial organization. The second, price theory, uses microeconomic models to explain firm behavior and market structure.

Business Economics

Business economics is that part of economic theory which focuses on business enterprises and inquires into the factors contributing to the diversity of organizational structures and to the relationships of firms with labour, capital and product markets.

Business Economics is concerned with economic issue and problems related to business organization, management and strategy. Issues and problems such as the following:an explanation of why firms emerge and exist; why they expand: horizontally, vertically and specially; the role of entrepreneurs and entrepreneurship; the significance of organizational structure; the relationship of firms with employees, the employees, the providers of capital, the customers, the government; the interactions between firms and the business environment. The term Business Economics is used in a variety of ways. Sometimes it used as synonymously with - Industrial Economics - Industrial Organisation - Managerial Economics - Economics for Business. Industrial Economics is the mostly closely over-lapping of these terms whilst there may be more substantial differences with Economics for Business and Managerial Economics. One view of the distinctions between these would be that Business Economics is wider in its scope than Industrial Economics in that it would be concerned not only with "Industry" but also businesses in the service sector and that it also takes seriously the insights of the "business strategy" literature. Economics for business looks at the major principles of economics but focuses on applying these economic principles to the real world of business. Managerial economics is the application of economic methods in the managerial decision-making process.

Many universities offer courses in Business Economics and offer a range of interpretations as to the meaning of Business Economics. The University of East London defines the subject matter of its degree as looking at the application of economic theory to business activities and organizations arguing that "In general terms, Business Economics deals with issues such as: the ways markets work; what firms do, what their motives are, how they perform; and the role of government in regulating business activity". The program at Harvard University uses economic methods to analyze practical aspects of business, including business administration, management, and related fields of economics. The University of Miami defines Business Economics as involving the study of how we use our resources for the production, distribution, and consumption of goods and services. This requires business economists to analyze social institutions, banks, the stock market, the government and they look at problems connected with labor negotiations, taxes, international trade, and urban and environmental issues. Courses at the University of Manchester interpret Business Economics to be concerned with the economic analysis of how businesses contribute to welfare of society rather than on the welfare of an individual or a business. This is done via an examination of the relationship between ownership, control and firm objectives; theories of the growth of the firm; the behavioural theory of the firm; theories of entrepreneurship; the factors that influence the structure, conduct and performance of business at the industry level.

Agricultural Economics

Agricultural economics originally applied the principles of economics to the production of crops and livestock — a discipline known as agronomics. Agronomics was a branch of economics that specifically dealt with land usage. It focused on maximizing the crop yield while maintaining a good soil ecosystem. Throughout the 20th century the discipline expanded and the current scope of the discipline is much broader. Agricultural economics today includes a variety of applied areas, having considerable overlap with conventional economics.

The field of agricultural economics has evolved over many decades. One scholar summarizes its development as follows:

"Agricultural economics arose in the late 19th century, combined the theory of the firm with marketing and organization theory, and developed throughout the 20th century largely as an empirical branch of general economics. The discipline was closely linked to empirical applications of mathematical statistics and made early and significant contributions to econometric methods. In the 1960's and afterwards, as agricultural sectors in the OECD countries contracted, agricultural economists were drawn to the development problems of poor countries, to the trade and macroeconomic policy implications of agriculture in rich countries, and to a variety of production, consumption, and environmental and resource problems."

Agricultural economists have made many well-known contributions to the economics field with such models as the cobweb model, hedonistic regression pricing models, new technology and diffusion models (Zvi Griliches), multifactor productivity and efficiency theory and measurement, and the random coefficients regression. The farm sector is frequently cited as a prime example of the perfect competition economic paradigm.

Since the 1970s, agricultural economics has primarily focused on seven main topics, according to a scholar in the field: technical change and human capital; agricultural environment and resources; risk and uncertainty; consumption and food supply chains; prices and incomes; market structures; and trade and development.

Economic Welfare

Welfare economics is a branch of economics. It uses microeconomic techniques to evaluate economic well-being, especially relative to competitive general equilibrium within an economy as to economic efficiency and the resulting income distribution. associated with it. It analyzes social welfare , however measured, in terms of economic activities of the individuals that comprise the theoretical society considered. As such, 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. Welfare economics.

Welfare economics typically takes individual preferences as given and stipulates a welfare improvement in Pareto efficiency terms from social state A to social state B if at least one person prefers B and no one else opposes it. There is no requirement of a unique quantitative measure of the welfare improvement implied by this. Another aspect of welfare treats income/goods distribution, including equality, as a further dimension of welfare.

Social welfare refers to the overall welfare of society. With sufficiently strong assumptions, it can be specified as the summation of the welfare of all the individuals in the society. Welfare may be measured either cardinally in terms of "utils" or dollars, or measured ordinarily in terms of Pareto efficiency. The cardinal method in "utils" is seldom used in pure theory today because of aggregation problems that make the meaning of the method doubtful, except on widely challenged underlying assumptions. In applied welfare economics, such as in cost-benefit analysis, money-value estimates are often used, particularly where income-distribution effects are factored into the analysis or seem unlikely to undercut the analysis.

Since the early 1980s economists have been interested in a number of new approaches and issues in welfare economics. The capabilities approach to welfare argues that what people are free to do or be should also be included in welfare assessments and the approach has been particularly influential in development policy circles where the emphasis on multi-dimensionality and freedom has shaped the evolution of the Human Development Index.

Economists have also been interested in using life satisfaction to measure what Kahneman and colleagues call experienced utility.

What follows, for the most part, therefore refers to a particular approach to welfare economics, possibly best referred to as 'neo-classical' or 'traditional' welfare economics.

Economic Development

Economic development explain why some countries are so much poor than others and prescribing ways for poor countries to become rich. Development must, therefore, be conceived of as a multi-dimensional process involving major changes in social structure, popular attitudes and national institutions as well as the acceleration of economic growth, the reduction of inequality and the eradication of absolute poverty. Economic development is the increase in the amount of people in a nation's population with sustained growth from a simple, low-income economy to a modern, high-income economy. Its scope includes the process and policies by which a nation improves the economic, political, and social well-being of its people. The study of economic development by social scientists encompasses theories of the causes of industrial-economic modernization, plus organizational and related aspects of enterprise development in modern societies. It embraces sociological research on business organization and enterprise development from a historical and comparative perspective; specific processes of the evolution (growth, modernization) of markets and management-employee relations; and culturally related cross-national similarities and differences in patterns of industrial organization in contemporary Western societies. On the subject of the nature and causes of the considerable variations that exist in levels of industrial-economic growth and performance internationally, it seeks answers to such questions as: "Why are levels of direct foreign investment and labour productivity significantly higher in some countries than in others?"

Economic Planning

Economic planning can be defined as the making of major economic decisions: what and how much is to be allocated by the conscious decisions of a determinate authority on the basis of a comprehensive survey of the economy as a whole. It is deliberate governmental attempt to coordinate economic decision making over the long run and to influence, direct and in some cases even control the level and growth of a nation's principal economic variables [ income, consumption, employment, savings, exports, imports etc.] in order to achieve a predetermined set of development objectives.

Classical socialists and Marxists define economic planning as directing production to maximize use-values and coordination of production, and consider this to be a fundamental element of a socialist economy. For Marxists in particular, planning also entails control of the surplus product (profit) by the associated producers in a democratic fashion.

State-oriented and technocratic socialists hold the view that in a socialist society based on economic planning, the primary function of the state apparatus will change from one of political rule over men (via the creation and enforcement of laws) into a scientific administration of things and a direction of processes of production; that is the state would become a coordinating economic entity rather than a mechanism of class or political control

Other socialists, such as Libertarian socialists, Syndicalists and democratic socialists, advocate de-centralized democratic planning. In a de-centralized planned economy, economic decision-making takes place in a democratic manner in every cooperative enterprise in the economy.

In some socialist theories, economic planning completely substitutes the market mechanism and supposedly renders monetary relations and the price system obsolete. In other theories, planning is utilized as a complement to markets. Polish economist Oskar Lange and American economist Abba Lerner proposed a form of market socialism where a central planning board would adjust prices of publicly-owned firms to equal marginal cost to enhance the market mechanism by achieving pareto efficient outcomes.

In general, the various types of socialist economic planning listed above exist as theoretical constructs that have not been implemented fully by any economy, partially because they depend on vast changes in social and economic development on a global scale . In the context of mainstream economics, socialist planning usually refers to the Soviet-type command economies, regardless of whether or not they actually constituted a type of state capitalism.

Circular Flow of Income

According to neoclassical economics, the terms circular flow of income is described as the reciprocal circulation of income between producers and consumers. In the circular flow model, the inter-dependent entities of producer and consumer are referred to as "firms" and "households" respectively and provide each other with factors in order to facilitate the flow of income. Firms provide consumers with goods and services in exchange for consumer expenditure and "factors of production" from households. The circular flow model has been criticized by ecological economists for failing to show that the economy has a physical root in its larger environment, and hence for being at the root of the neoclassical models' inability to conceptualize effectively environmental constraints and costs, such as global climate change and the loss of ecosystem services that leads to uneconomic growth. Economists advancing this idea include Herman Daly; Joshua Farley; Robert Costanza; and political theorist Eric Zencey .

The circle of money flowing through the economy is as follows: total income is spent (with the exception of "leakages" such as consumer saving), while that expenditure allows the sale of goods and services, which in turn allows the payment of income (such as wages and salaries). Expenditure based on borrowings and existing wealth – i.e., "injections" such as fixed investment – can add to total spending.

In equilibrium, leakages equal injections and the circular flow stays the same size. If injections exceed leakages, the circular flow grows (i.e., there is economic prosperity), while if they are less than leakages, the circular flow shrinks (i.e., there is a recession).

More complete and realistic circular flow models are more complex. They would explicitly include the roles of government and financial markets, along with imports and exports. To the extent that they remain circular flow models, however, they do not effectively model the one-way flow of energy through the economy. (That energy flow must be one-way and not a circular flow is a consequence of the second law of thermodynamics, the law of entropy. This failure ultimately allows neoclassical models to treat environmental values as a subcategory of economic values, rather than seeing economic activity em placed as a subcategory of human activity which in turn is a subcategory of activity within ecosystems.

Labor and other "factors of production" supplied by households are sold on resource markets. These resources, purchased by firms, are then used to produce goods and services. The latter are sold on product markets, ending up in the hands of the households, helping them to supply resources. Again, critics say that it is unrealistic and dysfunctional to model the economy as if energy and other resources were extracted from households instead of planetary systems. This criticism is further elaborated within an article in the Encyclopedia of Earth .

Inflation and Monetary Policy

In my opinion,in most price system economies, money is a means of final payment for goods and also money can be defined as the unit of account in which prices are typically stated. It includes currency held by the non bank public and check able deposits. It has been described as a social convention, like language, useful to one largely because it is useful to others. Nowadays, it becomes very useful for us. Without money, it is very difficult to exchange goods.

Money facilitates trade as a medium of exchange. 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.

The Business Cycle

The term business cycle refers to economy-wide fluctuations economic activity over several months or years. These fluctuations occur around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid economic growth and periods of relative stagnation or decline.

These fluctuations are often measured using the growth rate of real gross domestic product. Despite being termed cycles, most of these fluctuations in economic activity do not follow a mechanical or predictable periodic pattern.

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 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 Thus, a central conclusion of Keynesian economics is that, in some situations, no strong automatic mechanism moves output and employment towards full employment levels. John Hicks' IS/LM model has been the most influential interpretation of The General Theory.

Over the years, the understanding of the business cycle has branched into various schools, related to or opposed to Keynesianism. The neoclassical synthesis refers to the reconciliation of Keynesian economics with neoclassical economics, stating that Keynesianism is correct in the short run, with the economy following neoclassical theory in the long run.

The New classical school critiques the Keynesian view of the business cycle. It includes Friedman's permanent income hypothesis view on consumption, the "rational expectations revolution" spearheaded by Robert Lucas, and real business cycle theory.

In contrast, the New Keynesian school retains the rational expectations assumption, however it assumes a variety of market failures. In particular, New Keynesians assume prices and wages are "sticky", which means they do not adjust instantaneously to changes in economic conditions.

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.

Growth in Economics

Growth means increase in some quantity over time. The quantity can be physical(growth in an amount of money,growth in height) and abstract (a system becoming more complex, an organism becoming more mature).

It can also refer to the mode of growth, i.e. numeric models for describing how much a particular quantity grows over time. Growth economics studies those factors which 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, in particular why some countries grow faster than others, and whether countries converge at the same rates of growth.

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 and endogenous growth models) and in growth accounting.

Macroeconomics

Macroeconomics study aggregated indicators . It studies 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.

Firm in Economics

One of the assumptions of perfectly compatitive markets is that there are many producers, none of which can influence prices or act independently of market forces. In reality, however, people do not simply trade of 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 organize 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.

Market Failure in Economics

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.

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 or market solutions that change incentives, such as emission fees or redefinition of property rights.

Supply and Demand in Economics

I think that, the theory of demand and supply is an organizing principle to explain prices and quantities of goods sold changes thereof in a market . In microeconomics theory, it refers to price and output determination in a perfectly competitive market. This has served as a building block for modeling other market structures and for other theoretical approaches.

For a given of a commodity, demand shows the quantity all prospective buyers be to purchase at each the of the good. Demand is often represented using a table or a graph relating price and quantity demanded . Demand theory describes individual consumers as rationally choosing the most preferred quantity of each good, given income, prices, tastes, etc. A term for this is 'constrained utility maximization' (with income as the constraint on demand). Here, utility refers to the (hypothesized) preference relation for individual consumers. Utility and income are then used to model hypothesized properties about the effect of a price on the quantity demanded.

The law of demand states that, in general, price and quantity demanded in a given market are related. In other words, the higher the price of a product, the less of it people would be able and willing to buy of it (other things unchanged). As price of a commodity rises, overall purchasing power decreases (the income effect) and consumers move relatively less expensive goods (the substitution effect). Other factor can also affect demand; for example an increase in income will shift the demand curve outward relative to the origin.Demand is also affected by change in season, fashion, festival,consumers thought etc.

Supply is the relation between the price of a good and the quantity for sale from suppliers (such as producers) at that price. Supply is often represented using a table or graph relating price and quantity supplied. Producers are hypothesized to be profit-maximizes, meaning that they attempt to produce the amount of goods that will bring them the highest profit. Supply is typically represented as a directly proportional relation between price and quantity supplied (other things unchanged).

In other words, the higher the price at which the good can be sold, the more of it producers will supply. The higher price makes it profitable to increase production. At a price above equilibrium, there is a shortage of quantity supplied compared to quantity demanded. This pulls the price up. At a price above equilibrium, there is a surplus of quantity supplied compared to quantity demanded. This pushes the price down. The 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. This is at the intersection of the two curves in the graph above, market equilibrium.

For a given quantity of a good, the price point on the demand curve indicates the value, or marginal utility 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 labor and capital, through factor markets. In a labor market for example, the quantity of labor employed and the price of labor (the wage rate) are modeled as set by the demand for labor (from business firms etc. for production) and supply of labor (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.

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. 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.

Specialization in Economics

Specialization is considered key to economic efficiency because different individuals or countries have different comparative advantages. While one country may have an absolute advantage in every area over other countries, it could nonetheless specialize in the area which it has a relative comparative advantage, and thereby gain from trading with countries which have no absolute advantages. For example, a country may specialize in the production of high-tech knowledge products, as developed countries do, and trade with developing nations for goods produced in factories, where labor is cheap and plentiful.

According to theory, in this way more total products and utility can be achieved than if countries produced their own high-tech and low-tech products. The theory of comparative advantage is largely the basis for the typical economist's belief in the benefits of free trade. This concept applies to individuals, farms, manufacturers, service providers, and economies. Among each of these production systems, there may be a corresponding division of labour with each worker having a distinct occupation or doing a specialized task as part of the production effort, or correspondingly different types of capital equipment and differentiated land uses.

Adam Smith's Wealth of Nations (1776) discusses the benefits of the division of labour Smith noted that an individual should invest a resource, for example, land or labour so as to earn the highest possible return on it. Consequently, all uses of the resource should yield an equal rate of return (adjusted for the relative riskiness of each enterprise). Otherwise reallocation would result. This idea, wrote George Stigle, is the central proposition of economic theory, and is today called the marginal productivity theory of income distribution. French economist Turgot had made the same point in 1766.

In more general terms, it is theorized that market incentives, including prices of outputs and productive inputs, select the allocation of factors of production by comparative advantage, that is, so that (relatively) low-cost inputs are employed to keep down the opportunity cost of a given type of output. In the process, aggregate output increases as a by product or by design. 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 output (formally, the sum of increased consumer surplus and producer profits) from specialization in production and resulting trade.

Markets in Economics

In microeconomics, production is the conversion of inputs into outputs. It is an economic process that uses resources to create a commodity that is suitable for exchange. This can include manufacturing, warehousing, shipping, and packaging. Some economists define production broadly as all economic activity other than consumption. They see every commercial activity other than the final purchase as some form of production. Production is a process, and as such it occurs through time and space. Because it is a flow concept, production is measured as a "rate of output per period of time".

There are three aspects to production processes, including the quantity of the commodity produced, the form of the good created and the temporal and spatial distribution of the commodity produced. Opportunity cost expresses the idea that for every choice, the true economic cost is the next best opportunity. Choices must be made between desirable mutually exclusive actions. It has been described as expressing "the basic relationship between scarcity and choice.". The notion of opportunity cost plays a part in ensuring that scarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered.

The inputs or resources used in the production process are called factors of production. Possible inputs are typically grouped into six categories. These factors are raw materials, machinery, labor services, capital goods, land, and enterprise. In the short-run, as opposed to the long-run, at least one of these factors of is fixed. Examples include major of equipment, suitable space, and key personnel.

A variable factor of production is one whose usage rate can be changed easily. Examples include electrical power consumption, transportation services, and most raw material inputs. In the "long-run", all of these factors of production can be adjusted by management. In the short run, a firm's "scale of operations" determines the maximum number of outputs that can be produced, but in the long run, there are no scale limitations. Long-run and short-run changes play an important part in economic models.

Economic efficiency describes how well a system generates the maximum desired output a with a given set of inputs and available technology. Efficiency is improved if more output is generated without changing inputs, or in other words, the amount of "friction" or "waste" is reduced. Economists look for Pareto efficiency, which is reached when a change cannot make someone better off without making someone else worse off.

Economic efficiency is used to refer to a number of related concepts. A system can be called economically efficient if: No one can be made better off without making someone else worse off, more output cannot be obtained without increasing the amount of inputs, production ensures the lowest possible per unit cost. These definitions of efficiency are not exactly equivalent. However, they are all encompassed by the idea that nothing more can be achieved given the resources available.

Microeconomics

Microeconomics looks at interactions through individual markets, given scarcity and government regulation. A given market might be for a product, say fresh corn, or the services of a factor of production, say bricklaying. The theory considers aggregates of quantity demanded by buyers and quantity supplied by sellers at each possible price per unit. It weaves these together to describe how the market may reach equilibrium as to price and quantity or respond to market changes over time.

This is broadly termed supply and demand analysis. Market structures, such as perfect competition and monopoly, are examined as to implications for behavior and economic efficiency. Analysis of change in a single market often proceeds from the simplifying assumption that behavioral relations in other markets remain unchanged, that is, partial-equilibrium analysis. General-equilibrium theory allows for changes in different markets and aggregates across all markets, including their movements and interactions toward equilibrium.

Schools of Economics

Chicago School The Chicago School of economics is best known for its free market advocacy and monetarist ideas. According to Milton Friedman and monetarists, market economies are inherently stable if left to themselves and depressions result only from government intervention.For example, Friedman, argued that the Great Depression was result of a contraction of the money supply, controlled by the Federal Reserve, and not by the lack of investment as Keynes had argued. Ben Bernanke, current Chairman of the Federal Reserve, is among the economists today generally accepting Friedman's analysis of the causes of the Great Depression.
Milton Friedman effectively took many of the basic principles set forth by Adam Smith and the classical economists and modernized them. One example of this is his article in the September 1970 issue of The New York Times Magazine, where he claims that the social responsibility of business should be “to use its resources and engage in activities designed to increase its profits...(through) open and free competition without deception or fraud.”

Other schools and approaches

Other well-known schools or trends of thought referring to a particular style of economics practiced at and disseminated from well-defined groups of academicians that have become known worldwide, include the Austrian School, the Freiburg School, the School of Lausanne, post-Keynesian economics and the Stockholm school. Contemporary mainstream economics is sometimes separated into the Saltwater approach of those universities along the Eastern and Western coasts of the US, and the Freshwater, or Chicago-school approach.
Within macroeconomics there is, in general order of their appearance in the literature; classical economics, Keynesian economics, the neoclassical synthesis, post-Keynesian economics, monetarism, new classical economics, and supply-side economics. Alternative developments include ecological economics, institutional economics, evolutionary economics, dependency theory, structuralist economics, world systems theory, econophysics, and biophysical economics.

Keynesian Economics

Keynesian economics derives from J M. Keynes, in particular his published a book The General Theory of Employment, Interest and Money in 1936, which ushered in contemporary macroeconomics as a distinct field. 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. Such terms as "revolutionary" have been applied to the book in its impact on economic analysis.
Keynesian economics has two successors. Post-Keynesian economics also concentrates on macroeconomic rigidities and adjustment processes. Research on micro foundations for their models is represented as based on real-life practices rather than simple optimizing models. It is generally associated with the University of Cambridge and the work of Joan Robinson.
New-Keynesian economics is also associated with developments in the Keynesian fashion. Within this group researchers tend to share with other economists the emphasis on models employing micro foundations and optimizing behavior but with a narrower focus on standard Keynesian themes such as price and wage rigidity. These are usually made to be endogenous features of the models, rather than simply assumed as in older Keynesian-style ones.

Marxian Economics

Later Marxian, Marxist economics descends from classical economics. It derives from the work of Karl Marx. The first volume of Marx's major work, Das Kapital, was published in German in 1867. It includes the Marx focused on the labour theory of value and what he considered to be the exploitation of labour by capital. The labour theory of value held that the value of an exchanged commodity was determined by the labor that went into its production.

Classical Political Economy

Adam Smith published his book The Wealth of Nations in 1776. It has been described as the effective birth of economics as a separate discipline. The book identified land, labor, and capital as the three factors of production and the major contributors to a nation's wealth.

Adam Smith also wrote The Wealth of Nations.According to this book, the ideal economy is a self-regulating market system that automatically satisfies the economic needs of the populace. He also described the market mechanism as an invisible hand that leads all individuals, in pursuit of their own self-interests, to produce the greatest benefit for society as a whole. Smith incorporated some of the Physiocrats' ideas, including laissez-faire, into his own economic theories, but rejected the idea that only agriculture was productive.
In his famous invisible-hand analogy, Smith argued for the seemingly paradoxical notion that competitive markets tended to advance broader social interests, although driven by narrower self-interest. The general approach that Smith helped initiate was called political economy and later classical economics. It included such notables as Thomas Malthus, David Ricardo, and John Stuart Mill writing from about 1770 to 1870. The period from 1815 to 1845 was one of the richest in the history of economic thought.
While Adam Smith emphasized the production of income, David Ricardo focused on the distribution of income among landowners, workers, and capitalists. Ricardo saw an inherent conflict between landowners on the one hand and labor 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.

Malthus cautioned law makers on the effects of poverty reduction policies
Thomas Robert Malthus used the idea of diminishing returns to explain low living standards. Human population, he argued, tended to increase geometrically, outstripping the production of food, which increased arithmetically. The force of a rapidly growing population against a limited amount of land meant diminishing returns to labor. The result, he claimed, was chronically low wages, which prevented the standard of living for most of the population from rising above the subsistence level.
Malthus also questioned the automatic tendency of a market economy to produce full employment. He blamed unemployment upon the economy's tendency to limit its spending by saving too much, a theme that lay forgotten until John Maynard Keynes revived it in the 1930s.
Coming at the end of the Classical tradition, John Stuart Mill 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.
Value theory was important in classical theory. Smith wrote that the "real price of every thing ... is the toil and trouble of acquiring it" as influenced by its scarcity. Smith maintained that, with rent and profit, other costs besides wages also enter the price of a commodity. Other classical economists presented variations on Smith, termed the 'labour theory of value'. Classical economics focused on the tendency of markets to move to long-run equilibrium.

History of Economic Thought

City states of Sumer developed a trade and market economy based originally on the commodity money of Shekel which was a certain weight measure of barley, while the Babylonians and their city state neighbors later developed earliest system of economics using a metric of various commodities, which was fixed in a legal code. The early law codes from Sumer could be considered as first economic formula, and it had many attributes still in use in the current price system today. Such as codified amounts of money for business deals , fines in money for 'wrong doing', inheritance rules, laws concerning how private property is to be taxed or divided, etc.
The modern economic theory is customarily said to have begun with Adam Smith . A wide number of economic thinkers, going all the way back to the ancient Greek philosophers influenced Adam smith. The works of Aristotle had a profound influence on Thomas Aquinas and, through Aquinas, on subsequent scholastic thinking.
Economic thought dates from earlier Mesopotamian, Greek, Roman, Indian, Chinese, Persian and Arab civilizations. Notable writers include Aristotle, Chanakya (also known as Kautilya), Qin Shi Huang, Thomas Aquinas and Ibn Khaldun through to the 14th century. Bryson of Heraclea was a neo-platonic who is cited as having heavily influenced early Muslim economic scholarship. Joseph Schumpeter initially considered the late scholastics of the 14th to 17th centuries 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. After discovering Ibn Khaldun's Muqaddimah, however, Schumpeter later viewed Ibn Khaldun as being the closest forerunner of modern economics, as many of his economic theories were not known in Europe until relatively modern times but Ibn Khaldun's ideas were not absorbed by his society, nor were they carried forward by its future generations.
Nonetheless, recent research indicates that the Indian scholar-philosopher Chanakya (c. 340-293 BCE) predates Ibn Khaldun by a millennium and a half as the forerunner of modern economics, and has written more expansively on this subject, particularly on political economy. His magnum opus, the Arthashastra (The Science of Wealth and Welfare), is the genesis of economic concepts that include the opportunity cost, the demand-supply framework, diminishing returns, marginal analysis, public goods, the distinction between the short run and the long run, asymmetric information and the producer surplus. In his capacity as an advisor to the throne of the Maurya Empire of ancient India, he has also advised on the sources and prerequisites of economic growth, obstacles to it and on tax incentives to encourage economic growth. However, it does not seem likely that modern economics has any important indebtedness to Chanakya.

1638 painting of a French seaport during the heyday of mercantilism
Later, two other groups 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.
Physiocrats, a group of 18th century French thinkers and writers, developed the idea of the economy as a circular flow of income and output. Adam Smith described their system "with all its imperfections" as "perhaps the purest approximation to the truth that has yet been published" on the subject. Physiocrats believed that only agricultural production generated a clear surplus over cost, so that agriculture was the basis of all wealth.
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. Variations on such a land tax were taken up by subsequent economists (including Henry George a century later) as a relatively non-distortionary source of tax revenue. In reaction against copious mercantilist trade regulations, the physiocrats advocated a policy of laissez-faire, which called for minimal government intervention in the economy.

Fiscal Policy

Fiscal policy is a policy under which the government uses its expenditure and revenue programmes to produce desirable effects and avoid undersirable effect on national income, production and unemployment. It uses public finance to further national economic objectives. The objectives of fiscal policy are capital formation, full employment, mobilization of the resources, economic stability, economic development and curd inflation.

Public Debt

For public expenditure government needs public debt. The public debt borrowed by government is known as public devt. . Public debt is used for implement development plans, expand public sector, control economic depression, curb inflation, expansion of education and health services, solve the problem of war and crises, reduce the burden of taxation and fulfil deficit budget. The sources of public debt is classified into two parts . The are internal and external debt. Internal debt includes the debt from individuals, from financial institution, from commercial banks, from central bank. On the other hand, external sources includes the debt from foreign government and debt from international financial agencies.

Public Revenue

Any kind of income for government is known as public revenue. The income of public authority may be defined either in a broad or narrow sense. In the broad sense, it included all incomes or receipt, in narrow sense only those incomes which are included in the ordinary conception of revenue. Public revenue is necessary for production, equal distribution of national income, increase of capital formation, increase in employment, increase in economic development, increase in national income, control inflation, implementation of economic planning, poverty alleviation, remove regional imbalance and social function.

Public Expenditure

To fulfil the needs of citizens, every state invest money. Such invest is known as public expenditure. Government should invest for social security, security of administrative employment, increment in employment, establishment publics corporation, removal of trade cycle in economy, utilization of natural resources, economic development of the country, equal distribution of income foreign connection. There are many effects of public expenditure . It effects on production, on distribution on employment, on economic growth, on economic stability etc.

Public Finance

Public finance is a field of inquiry that treats of income and outgo of governments. In modern time, this contains some major divisions ; public revenue, public expenditure, public debt a certain problems of the fiscal system as a whole, such as fiscal policy. The government,considered as the subject of the study of public finance. more specially, public finance studies the economic activity of government as unit. It also studies about the monetary and credit resources of the state. Subject matters of public finance are public revenue, public expenditure, public debt, financial administration, economice stability and economic growth.