Economics

• 1. Introduction

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  Economics begins with a word for the kitchen table. The term comes from the Ancient Greek oikonomia, the know-how of an oikonomikos, a household or homestead manager. The phrase meant the way to run a household, and by extension a polis or state. From that domestic root grew a social science studying the production, distribution, and consumption of goods and services. So how did managing a home become a discipline that claims authority over crime, war, education, the family, religion, and the environment? Why do its own practitioners still argue over what their field actually is? And what makes one philosopher call it the dismal science while another insists it is a genuine science? The answers run through a parade of definitions, a long fight over wealth versus scarcity, and a set of curves that try to draw the limits of what any society can have.

• 2. The Argument Over Definitions

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  Adam Smith in 1776 called the subject, then named political economy, an inquiry into the nature and causes of the wealth of nations. He framed it as a branch of the science of a statesman or legislator, meant to provide subsistence for the people and revenue for the state. Jean-Baptiste Say in 1803 trimmed this to the science of production, distribution, and consumption of wealth. John Stuart Mill in 1844 narrowed it again, to the laws of social phenomena arising from the combined operations of mankind for the production of wealth.

  Alfred Marshall shifted the ground. In his 1890 textbook Principles of Economics, he called it a study of man in the ordinary business of life, asking how he gets his income and how he uses it. Marshall pushed analysis beyond wealth and down to the microeconomic level, and treated the study of man as the more important side.

  Lionel Robbins in 1932 wrote what has been termed perhaps the most commonly accepted current definition: the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses. Robbins said this was analytical, not classificatory. It picked out an aspect of behaviour, the form imposed by scarcity, rather than a list of subjects. War, he argued, could fall under economics because it has a sought-after end, generates costs and benefits, and uses resources.

  Not everyone accepted the switch from subject to method. Nobel Prize winners James M. Buchanan and Ronald Coase rejected Robbins and preferred definitions like Say's. Ha-Joon Chang argued that no other science defines itself by methodology. In the biology department, he noted, nobody insists all biology be studied through DNA analysis. People dissect anatomy, build game-theoretic models of animal behaviour, and run DNA tests, and it is all biology because it all studies living organisms. Gary Becker took the opposite view, favouring an approach of maximizing behaviour, stable preferences, and market equilibrium, used relentlessly and unflinchingly.

• 3. From Hesiod To Laissez-Faire

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  The Boeotian poet Hesiod has been called the first economist by several economic historians, for his concern with the distribution of resources. Yet the Greek word oikos referred to a household, understood as the landowner, his family, and his slaves, not a societal system of distribution. Xenophon, author of the Oeconomicus, is credited by philologues with the word economy. Modern scholarship often credits Aristotle as the first to write on economics proper, in scattered passages of the Nicomachean Ethics that weigh use value against exchange value.

  Joseph Schumpeter pointed to 16th and 17th century scholastic writers, including Tomas de Mercado, Luis de Molina, and Juan de Lugo, as coming nearer than any other group to founding scientific economics within a natural-law view of money, interest, and value. Two later groups shaped the field more directly. Mercantilism flourished from the 16th to the 18th century in a flood of pamphlets, holding that a nation's wealth lay in its hoard of gold and silver. It called for selling goods abroad, restricting imports, importing cheap raw materials, and barring manufacturing in the colonies.

  The physiocrats, French thinkers of the 18th century, saw the economy as a circular flow of income and output. They believed only agricultural production yielded a clear surplus over cost, so they opposed favouring manufacturing and trade. They wanted to replace costly tax collection with a single tax on landowners' income, and in reaction to mercantilist regulation they advocated laissez-faire. Adam Smith, who lived from 1723 to 1790, was harsh on the mercantilists but praised the physiocratic system, with all its imperfections, as perhaps the purest approximation to the truth yet published on the subject.

• 4. Wealth, Labour, And Surplus

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  The Wealth of Nations, published in 1776, has been described as the effective birth of economics as a separate discipline. Smith named land, labour, and capital as the three factors of production. He argued that the division of labor is limited by the extent of the market, a line called the core of a theory of the functions of firm and industry. His most famous passage describes an individual who intends only his own gain yet is led by an invisible hand to promote an end which was no part of his intention.

  The Reverend Thomas Robert Malthus in 1798 used diminishing returns to explain low living standards. Population, he argued, grows geometrically while food grows arithmetically, so a swelling population pressing on limited land drives wages down to subsistence. Thomas Carlyle in 1849 coined the dismal science as an epithet for classical economics, a phrase commonly linked to Malthus.

  David Ricardo in 1817 turned from production to the distribution of income among landowners, workers, and capitalists. He saw conflict between landowners and the rest, as population and capital pressing on fixed land push rents up and wages and profits down. Ricardo was the first to state and prove comparative advantage, the rule that a country should specialise in goods it can produce at a lower relative cost. John Stuart Mill in 1848 broke with earlier classical economists, distinguishing the market's efficiency in allocating resources from its weakness in distributing income, which he said made intervention necessary.

  Karl Marx built on this tradition. The first volume of Das Kapital appeared in 1867, centred on the labour theory of value and the theory of surplus value, which he described as mechanisms capital used to exploit labour. Marxian economics was carried forward by Karl Kautsky, Rudolf Hilferding, Vladimir Lenin, and Rosa Luxemburg, whose The Accumulation of Capital extended the line of thought.

• 5. The Marginal Turn

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  Neoclassical economics formed from about 1870 to 1910. Alfred Marshall and Mary Paley Marshall popularised the word economics as a concise synonym for economic science, replacing political economy. The shift mirrored the influence of mathematical methods drawn from the natural sciences.

  The new theory integrated supply and demand as joint determinants of price and quantity in market equilibrium. It rejected the labour theory of value in favour of a marginal utility theory on the demand side and a fuller theory of costs on the supply side. In the 20th century, neoclassical theorists dropped the idea of measuring total utility for a society and adopted ordinal utility instead. Agents are assumed to act rationally, with stable preferences, limited resources, a guiding objective, and the capacity to choose.

  Paul Samuelson's 1947 treatise Foundations of Economic Analysis exemplifies the mathematical method, especially in treating maximizing relations among agents reaching equilibrium. The book examined operationally meaningful theorems, statements that could conceivably be refuted by empirical data. That standard of falsifiability runs through how economists test their claims.

• 6. Depression And The Keynesian Revolution

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  The General Theory of Employment, Interest and Money, published by John Maynard Keynes in 1936, ushered in contemporary macroeconomics. The book focused on the determinants of national income in the short run, when prices are relatively inflexible. Keynes argued that high unemployment might not be self-correcting because of low effective demand, and that even price flexibility and monetary policy might be unavailing. The term revolutionary has been applied to the book's impact.

  Keynes wrote during the Great Depression of the 1930s, when he held that aggregate demand might fall short during downturns, raising unemployment and wasting potential output. He urged active responses from the public sector, both monetary policy from the central bank and fiscal policy from the government. John Hicks and Alvin Hansen developed the IS-LM model to formalise his insights into short-run equilibrium. Franco Modigliani and James Tobin built theories of consumption and investment, while Lawrence Klein built the first large-scale macroeconometric model and applied Keynesian thinking to the US economy.

  Challengers followed. Monetarism emerged in the 1950s and 1960s under Milton Friedman, who held that money-stock growth was a major cause of fluctuations and favoured simple rules like a steady rate of money growth. It rose in the 1970s and 1980s, then was abandoned as results disappointed. New classical economists Robert Lucas, Thomas Sargent, and Edward Prescott introduced rational expectations, the Lucas critique, and real business cycle models. New Keynesians of the 1980s, including George Akerlof, Janet Yellen, Gregory Mankiw, and Olivier Blanchard, kept rational expectations but stressed sticky prices and wages and various market failures. By the 2000s these arguments produced the new neoclassical synthesis, whose dynamic stochastic general equilibrium models became standard workhorses in most central banks.

• 7. Drawing The Limits

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  The production-possibility frontier puts scarcity on a graph. Picture an economy that produces only two goods, guns and butter. The frontier shows the combinations possible with a given technology and total inputs. Its negative slope means that producing more of one good requires producing less of the other, an inverse relationship. If one more gun costs 100 units of butter, then 100 units of butter is the opportunity cost of that gun.

  A point inside the curve, such as A, is feasible but wasteful, the kind of inefficiency seen in high unemployment during a recession. A point like X beyond the curve is wanted but unreachable. Recognizing scarcity and organising society to use resources efficiently has been described as the essence of economics, where the subject makes its unique contribution.

  Supply and demand coordinate prices and quantities, the most directly observable attributes of goods in a market economy. The law of demand holds that price and quantity demanded are inversely related, shaped by the substitution effect and the income effect. The law of supply holds that a rise in price expands supply. Market equilibrium sits where quantity supplied equals quantity demanded. Below it a shortage bids the price up, above it a surplus pushes the price down.

  Where these tidy assumptions break, economists speak of market failure. Natural monopoly, public goods that people consume without paying, and externalities like air pollution or the lower crime that education may bring all distort prices. Information asymmetry runs through George Akerlof's Market for Lemons, where buyers who cannot tell a lemon from a sound second-hand car depress the price of both. Insurance brings adverse selection, where the riskiest are likeliest to insure, and moral hazard, where coverage encourages reckless behaviour.

• 8. The Reach Of The Discipline

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  Game theory dates from the 1944 classic Theory of Games and Economic Behavior by John von Neumann and Oskar Morgenstern. It models strategic interaction among agents few enough to affect one another, from wage negotiations to contract design. Its applications reach seemingly outside economics, into the formulation of nuclear strategies, ethics, political science, and evolutionary biology.

  Empirical testing has narrowed the gap between economics and the natural sciences. In behavioural economics, the psychologist Daniel Kahneman won the Nobel Prize in economics in 2002 for the empirical discovery, with Amos Tversky, of several cognitive biases and heuristics. Controlled experiments, once rare in a field that relied on observing broad data, have begun to test what were treated as axioms, and in some cases found them not entirely correct.

  The field branches across society. Okun's law captures the empirical link between unemployment and growth, with the original version holding that a 3% rise in output leads to a 1% fall in unemployment. The 19th-century economist Francis Amasa Walker summed up his subject with the line Money is what money does. Heterodox schools push against the mainstream, from the Austrian School of Friedrich Hayek and Ludwig von Mises to the post-Keynesian work associated with Joan Robinson at the University of Cambridge, to feminist economics, which challenges analyses that render gender invisible. Nicholas Georgescu-Roegen reintroduced entropy into economics, drawing on thermodynamics against a neoclassical foundation rooted in Newtonian physics, and his work fed into thermoeconomics, ecological economics, and evolutionary economics.