Handout # 01

Definitional Analysis of Economics:

Economics is a broad term referring to the scientific study of human action, particularly as it relates to human
choice and the utilization of scarce resources. Economic analysis often progresses through deductive processes,
much like mathematical logic, where the implications of specific human activities are considered in a "means-
ends" framework.

Economics is the study of how individuals, governments, business and other organizations make choices that
effect the allocation and distribution of scarce resources.

There are a variety of modern definitions of economics. Some of the differences may reflect evolving views of
the subject itself or different views among economists.

 The earlier term for 'economics' was political economy. It is adapted from the French Mercantilist usage of
économie politique, which extended economy from the ancient Greek term for household management to
the national realm as public administration of the affairs of state. Sir James Steuart (1767) wrote the first
book in English with 'political economy' in the title, explaining that just as:

Economy in general [is] the art of providing for all the wants of a family, [so the science of political
economy] seeks to secure a certain fund of subsistence for all the inhabitants, to obviate every circumstance
which may render it precarious; to provide everything necessary for supplying the wants of the society, and
to employ the inhabitants ... in such manner as naturally to create reciprocal relations and dependencies
between them, so as to supply one another with reciprocal wants.

The title page gave as its subject matter "population, agriculture, trade, industry, money, coin, interest,
circulation, banks, exchange, public credit and taxes".

 The philosopher Adam Smith (1776) defines the subject as "an inquiry into the nature and causes of the
wealth of nations," in particular as:

a branch of the science of a statesman or legislator [with the twofold objective of providing] a plentiful
revenue or subsistence for the people ... [and] to supply the state or commonwealth with a revenue for the
public services.

 J.B. Say (1803), distinguishing the subject from its public-policy uses, defines it as the science of
production, distribution, and consumption of wealth.

 On the satirical side, Thomas Carlyle (1849) coined 'the dismal science' as an epithet for classical
economics, in this context, commonly linked to the pessimistic analysis of Malthus (1798).

 John Stuart Mill (1844) defines the subject in a social context as:
 The science which traces the laws of such of the phenomena of society as arise from the combined
operations of mankind for the production of wealth, in so far as those phenomena are not modified by the
pursuit of any other object.

 The shift from the social to the individual level appears within the main works of the Marginal Revolution.
Carl Menger's definition reflects the focus on the economizing man:

For economic theory is concerned, not with practical rules for economic activity, but with the conditions
under which men engage in provident activity directed to the satisfaction of their needs.

 William Stanley Jevons, another very influential author of the Marginal Revolution defines economics
highlighting the hedonic and quantitative aspects of the science:

In this work I have attempted to treat Economy as a Calculus of Pleasure and Pain, and have sketched out,
almost irrespective of previous opinions, the form which the science, as it seems to me, must ultimately
take. I have long thought that as it deals throughout with quantities, it must be a mathematical science in
matter if not in language.

 Alfred Marshall provides a still widely cited definition in his textbook Principles of Economics (1890) that
extends analysis beyond wealth and from the societal to the microeconomic level, creating a certain
synthesis of the views of those still more sympathetic with the classical political economy (with social
wealth focus) and those early adopters of the views expressed in the Marginal Revolution (with individual
needs focus).

 Marshall's inclusion of the expression wellbeing was also very significant to the discussion on the nature of
economics:

Political Economy or Economics is a study of mankind in the ordinary business of life; it examines that part
of individual and social action which is most closely connected with the attainment and with the use of the
material requisites of wellbeing. Thus it is on the one side a study of wealth; and on the other, and more
important side, a part of the study of man.

 Lionel Robbins (1932) developed implications of what has been termed "perhaps the most commonly
accepted current definition of the subject":

Economics is a science which studies human behavior as a relationship between ends and scarce means
which have alternative uses.

 Robbins describes the definition as not classificatory in "picking out certain kinds of behavior" but rather
analytical in "focusing attention on a particular aspect of behavior, the form imposed by the influence of
scarcity."

Some subsequent comments criticized the definition as overly broad in failing to limit its subject matter to
analysis of markets. From the 1960s, however, such comments abated as the economic theory of maximizing
behavior and rational-choice modeling expanded the domain of the subject to areas previously treated in other
fields. There are other criticisms as well, such as in scarcity not accounting for the macroeconomics of high
unemployment.

 Gary Becker, a contributor to the expansion of economics into new areas, describes the approach he favors
as "combining the assumptions of maximizing behavior, stable preferences, and market equilibrium, used
relentlessly and unflinchingly." One commentary characterizes the remark as making economics an
approach rather than a subject matter but with great specificity as to the "choice process and the type of
social interaction that [such] analysis involves."

 John Neville Keynes regarded the discussion leading up to the definition of economics more important than
the definition itself. It would be a way to reveal the scope, direction and troubles the science faces.

A recent review of economics definitions includes a range of those in principles textbooks, such as descriptions
of the subject as the study of:

 the economy
 the coordination process
 the effects of scarcity
 the science of choice
 human behavior
 human beings as to how they coordinate wants and desires, given the decision-making mechanisms,
social customs, and political realities of society.

It concludes that the lack of agreement need not affect the subject-matter that the texts treat. Among economists
more generally, it argues that a particular definition presented may reflect the direction toward which the author
believes economics is evolving, or should evolve.

Historical Development of Economics:

The history of economic thought deals with different thinkers and theories in the subject that became political
economy and economics, from the ancient world to the present day. It encompasses many disparate schools of
economic thought. Ancient Greek writers such as the philosopher Aristotle examined ideas about the art of
wealth acquisition, and questioned whether property is best left in private or public hands. In the Middle Ages,
scholasticists such as Thomas Aquinas argued that it was a moral obligation of businesses to sell goods at a just
price.

In the Western world, economics was not a separate discipline, but part of philosophy until the 18th–19th
century Industrial Revolution and the 19th century Great Divergence, which accelerated economic growth.
Long before that, from the Renaissance at least, economics as an intellectual discipline or science was
dominated by Western thinkers and their academic institutions, schooling economists from outside the West,
although there are isolated instances in other societies.
Ramification of the Study of Economics:

The term economics, from the Greek ‘oikonomika’, means a science or art of managing the household. In
modern usage, it refers to the efficient allocation of scarce resources in the production, distribution, and
consumption of goods and services to satisfy various desires. As a branch of knowledge, economics or
economic science is the study of how to efficiently use limited resources—natural resources (land), capital,
labor, entrepreneurship, and information—to achieve maximum satisfaction of human material wants. Like
other social sciences, economics studies human behavior but focuses on maximizing satisfaction or benefit as
efficiently as possible or at minimum cost in the production, distribution, and consumption of goods and
services. Hence, economics deals with decision making, theory, and management of the economy or economic
systems. The decision makers or economic units of the economic system are households, businesses, and
government.

Microeconomics is the branch of economics that deals with individual or specific economic units such as an
individual industry, firm, or household and their interactions. In 1817, David Ricardo (1772–1823) wrote on the
forces that determine the functional distribution of income and the theories of value and price, and it was from
these theories that microeconomic theory originated. Microeconomics in the early twenty-first century includes
the theory of consumer behavior, theory of production, and the theory of markets. It deals with such topics as
prices of a specific product, the number of workers employed in a specific firm, the revenue or income of a
particular firm or household, and the expenditures of a specific firm, government entity, or family.
Microeconomic analysis focuses mostly on optimization and equilibrium analysis.

Macroeconomics deals with the aggregate economy and the behavior of its major units—households,
businesses, government, and the foreign sector. Developed in the 1930s, macroeconomics was practically
invented by the English economist John Maynard Keynes (1883–1946) in his attempt to develop an answer to
the Great Depression. Keynes argued that the Great Depression was a problem of insufficient aggregate demand
and that if the private economy could not generate sufficient demand, it was the government's responsibility to
do so. Macroeconomics focuses on such issues as growth, recessions, inflation, unemployment, and government
policy and deals with such topics as total output or gross domestic product (GDP), total employment, total
income, aggregate expenditure, and general level of prices.
Microeconomics: It is the study of how individual consumers and producers make their decisions. This
includes an individual, a household, a business or a governmental organization.

Microeconomics ranges from how these individuals trade with one another to how the prices are affected by the
supply and demand of goods. It also studies the following areas-

 the efficiency & costs associated with producing goods & services;
 how labor is divided and allocated;
 uncertainty, risk & strategic game theory;

Macroeconomics: It studies the overall, aggregate economy. It can include a distinct geographical region, a
country or even the whole world.

The topics studies under the category are the as follows-

 Governmental fiscal and monetary policy;

 Unemployment rates;
 Growth as reflected by changes in the Gross Domestic Product;
 Business cycles that result in expansion, booms, recessions and depressions;

Two of the most common schools of economic thought are –

i) Classical;
ii) Keynesian;

The Classical View:

The classical view believes that free markets are the best way to allocate resources and the government’s role
should be limited to that of a fair, strict referee.

The Keynesian View:

The Keynesian approach believes that market sometimes don’t work well at allocating resources, therefore, the
government must step in from time to time and reallocate resources efficiently.
Terminology: The 10 Principles

About Economic Models:

Most economics models are based on assumptions that humans act with rational behavior, seeking the most
optimal level of benefit or utility, even though this means that some economic models may be unattainable or
impossible. Still these models provide key insights for understanding the behavior of –

 financial markets;
 governments;
 economies;
 human decisions;

End