Nature of Economics
Nature of Economics
Nature of Economics
Economics
Definition: Economics is that branch of social science which is concerned with the study of
how individuals, households, firms, industries and government take decision relating to the
allocation of limited resources to productive uses, so as to derive maximum gain or
satisfaction. Simply put, it is all about the choices we make concerning the use of scarce resources
that have alternative uses, with the aim of satisfying our most pressing infinite wants and distribute it
among ourselves.
Nature of Economics
1. Economics is a science: Science is an organised branch of knowledge, that
analyses cause and effect relationship between economic agents. Further,
economics helps in integrating various sciences such as mathematics,
statistics, etc. to identify the relationship between price, demand, supply and
other economic factors.
Positive Economics: A positive science is one that studies the relationship
between two variables but does not give any value judgment, i.e. it states
‘what is’. It deals with facts about the entire economy.
Normative Economics: As a normative science, economics passes value
judgement, i.e. ‘what ought to be’. It is concerned with economic goals and
policies to attain these goals.
Economics is an art: Art is a discipline that expresses the way things are to
be done, so as to achieve the desired end. Economics has various branches
like production, distribution, consumption and economics, that provide general
rules and laws that are capable of solving different problems of society.
Adam Smith was a Scottish philosopher, widely considered as the first modern
economist. Smith defined economics as “an inquiry into the nature and causes of the
wealth of nations.”
Criticism of Smith’s Definition
1. The wealth-centric definition of economics limited its scope as a subject and was
seen as narrow and inaccurate. Smith’s definition forced the subject to ignore all
non-wealth aspects of human existence.
2. The Smithian definition over-emphasized the material aspects of well-being and
ignored the non-material aspects. It was assumed that human beings acted as
rational economic agents who mindlessly strived to maximize their own well-
being.
3. The Smithian definition prevents the subject from exploring the concept of
resource scarcity. The allocation and use of scarce resources are seen as a central
topic of analysis in modern economics.
British economist Alfred Marshall defined economics as the study of man in the ordinary
business of life. Marshall argued that the subject was both the study of wealth and the
study of mankind. He believed it was not a natural science such as physics or chemistry,
but rather a social science.
1. The Marshallian definition, like the Smithian definition, ignored the problem of
scarce resources, which possess unlimited potential uses.
2. Marshall’s definition restricted economics as a subject to only analyze the
material aspects of human welfare. Non-material aspects of welfare were ignored.
Critics of the Marshallian definition asserted that it was difficult to separate
material and non-material aspects of welfare.
3. The Marshallian definition does not provide a clear link between the acquisition
of wealth and welfare. Marshall’s critics claimed that it left the subject in a state of
perpetual confusion. For instance, there are plenty of activities that might
generate wealth but that can reduce human welfare.
Lionel Robbin, another British economist, defined economics as the subject that studies
the allocation of scarce resources with countless possible uses. In his 1932 text, “An Essay
on the Nature and Significance of Economic Science,” Robbins said the following about
the subject: “Economics is the science which studies human behaviour as a relationship
between ends and scarce means which have alternative uses.”
Criticism of Robbin’s Definition
The modern definition, attributed to the 20th-century economist, Paul Samuelson, builds
upon the definitions of the past and defines the subject as a social science. According to
Samuelson, “Economics is the study of how people and society choose, with or without
the use of money, to employ scarce productive resources which could have alternative
uses, to produce various commodities over time and distribute them for consumption
now and in the future among various persons and groups of society.”
In terms of methodology, economists, like other social scientists, are not able to undertake
controlled experiments in the way that chemists and biologists are. Hence, economists have
to employ different methods, based primarily on observation and deduction and the
construction of abstract models.
As the social sciences have evolved over the last 100 years, they have become increasingly
specialised. This is true for economics, as witnessed by the development of many different
strands of investigation including micro and macro economics, pure and applied economics,
and industrial and financial economics. What links them all is the attempt to understand how
and why exchange takes place, and how exchange creates benefits and costs for the
participants.
This micro economic analysis shows that the increased demand leads to
higher price and higher quantity.
The main difference is that micro looks at small segments and macro looks at
the whole economy. But, there are other differences.
Equilibrium – Disequilibrium
Classical economic analysis assumes that markets return to equilibrium (S=D). If
demand increases faster than supply, this causes price to rise, and firms
respond by increasing supply. For a long time, it was assumed that the macro
economy behaved in the same way as micro economic analysis. Before, the
1930s, there wasn’t really a separate branch of economics called
macroeconomics.
Great Depression and birth of Macroeconomics
In the 1930s, economies were clearly not in equilibrium. There was high
unemployment, output was below capacity, and there was a state of
disequilibrium. Classical economics didn’t really have an explanation for this
dis-equilibrium, which from a micro perspective, shouldn’t occur.
3) Formulating Hypothesis:
The next step is to formulate a hypothesis on the basis of logical
reasoning whereby conclusions are drawn from the propositions.
This is done in two ways: First, through logical deduction. If and
because relationships (p) and (q) all exist, then this necessarily
implies that relationship (r) exists as well. Mathematics is mostly
used in these methods of logical deduction.
Under these conditions, the hypothesis may turn out to the wrong.
In economics, most hypotheses remain unverified because of the
complexity of factors involved in human behaviour which, in turn,
depend upon social, political and economic factors. Moreover,
controlled experiments in a laboratory are not possible in
economics. So the majority of hypotheses remain untested and
unverified in economics.
(1) Real:
It is the method of “intellectual experiment,” according to Boulding.
Since the actual world is very complicated, “what we do is to
postulate in our own minds economic systems which are simpler
than reality but more easy to grasp. We then work out the
relationship in these simplified systems and by introducing more
and more complete assumptions, finally work up to the
consideration of reality itself.” Thus, this method is nearer to
reality.
(2) Simple:
The deductive method is simple because it is analytical. It involves
abstraction and simplifies a complex problem by dividing it into
component parts. Further, the hypothetical conditions are so
chosen as to make the problem very simple, and then inferences are
deduced from them.
(3) Powerful:
It is a powerful method of analysis for deducing conclusions from
certain facts. As pointed out by Cairnes, The method of deduction is
incomparably, when conducted under proper checks, the most
powerful instrument of discovery ever wielded by human
intelligence.
(4) Exact:
The use of statistics, mathematics and econometrics in deduction
brings exactness and clarity in economic analysis. The
mathematically trained economist is able to deduce inferences in a
short time and make analogies with other generalisations and
theories. Further, the use of the mathematical-deductive method
helps in revealing inconsistencies in economic analysis.
(5) Indispensable:
The use of deductive method is indispensable in sciences like
economics where experimentation is not possible. As pointed out by
Gide and Rist, “In a science like political economy, where
experiment is practically impossible, abstraction and analysis afford
the only means of escape from those other influences which
complicate the problem so much.”
(6) Universal:
The deductive method helps in drawing inferences which are of
universal validity because they are based on general principles, such
as the law of diminishing returns.
1 .Unrealistic Assumption:
Every hypothesis is based on a set of assumptions. When a
hypothesis is tested, assumptions are indirectly tested by comparing
their implications with facts. But when facts refute the theory based
on the tested hypothesis, the assumptions are also indirectly
refuted. So deduction depends upon the nature of assumptions. If
they are unrealistic, in this method, economists use the ceteris
paribus assumption. But other things seldom remain the same
which tend to refute theories.
3. Incorrect Verification:
The verification of theories, generalisations or laws in economics is
based on observation. And right observation depends upon data
which must be correct and adequate. If a hypothesis is deduced
from wrong or inadequate data, the theory will not correspond with
facts and will be refuted. For instance, the generalisations of the
classicists were based on inadequate data and their theories were
refuted. As pointed out by ircholson, “the great danger of the
deductive method lies in the natural aversion to the labour of
verification.”
4. Abstract Method:
The deductive method is highly abstract and requires great skill in
drawing inferences for various premises. Due to the complexity of
certain economic problems, it becomes difficult to apply this
method even at the hands of an expert researcher. More so, when he
uses mathematics or econometrics.
5. Static Method:
This method of analysis is based on the assumption that economic
conditions remain constant. But economic conditions are
continuously changing. Thus this is a static method which fails to
make correct analysis.
6. Intellectually:
The chief defect of the deductive method “lies in the fact that those
who follow this method may be absorbed in the framing of
intellectual toys and the real world may be forgotten in the
intellectual gymnastics and mathematical treatment.”
1. The Problem:
In order to arrive at a generalisation concerning an economic
phenomenon, the problem should be properly selected and clearly
stated.
2. Data:
The second step is the collection, enumeration, classification and
analysis of data by using appropriate statistical techniques.
3. Observation:
Data are used to make observation about particular facts concerning
the problem.
4. Generalisation:
On the basis of observation, generalisation is logically derived which
establishes a general truth from particular facts.
(1) Realistic:
The inductive method is realistic because it is based on facts and
explains them as they actually are. It is concrete and synthetic
because it deals with the subject as a whole and does not divide it
into component parts artificially
(2) Future Enquiries:
Induction helps in future enquiries. By discovering and providing
general principles, induction helps future investigations. Once a
generalisation is established, it becomes the starting point of future
enquiries.
(4) Dynamic:
The inductive method is dynamic. In this, changing economic
phenomena can be analysed on the basis of experiences,
conclusions can be drawn, and appropriate remedial measures can
be taken. Thus, induction suggests new problems to pure theory for
their solution from time to time.
(5) Histrico-Relative:
A generalisation drawn under the inductive method is often
histrico-relative in economics. Since it is drawn from a particular
historical situation, it cannot be applied to all situations unless they
are exactly similar. For instance, India and America differ in their
factor endowments. Therefore, it would be wrong to apply the
industrial policy which was followed in America in the late
nineteenth century to present day India. Thus, the inductive
method has the merit of applying generalisations only to related
situations or phenomena.
Conclusion:
The above analysis reveals that independently neither deduction
nor induction is helpful in scientific enquiry. In reality, both
deduction and induction are related to each other because of some
facts. They are the two forms of logic that are complementary and
co-relative and help establish the truth.
Marshall also supported the complementary nature of the two
methods when he quoted Schmoller: “Induction and deduction are
both needed for scientific thought as the right and left foot are
needed for walking.” And then Marshall stressed the need and use
of integrating these methods.
Normative Economics
Normative economics focuses on the ideological, opinion-oriented,
prescriptive, value judgments, and "what should be" statements aimed toward
economic development, investment projects, and scenarios. Its goal is to
summarize people's desirability (or the lack thereof) to various economic
developments, situations, and programs by asking or quoting what should
happen or what ought to be.
2. Process of Change:
Another difference between static economics and dynamic
economics is that static analysis does not show the path of change.
It only tells about the conditions of equilibrium. On the contrary,
dynamic economic analysis also shows the path of change. Static
economics is called a ‘still picture’ whereas the dynamic economics
is called a ‘movie’ of the market.
3. Equilibrium:
Static economics studies only a particular point of equilibrium. But
dynamic economics also studies the process by which equilibrium is
achieved. As a result, there may be equilibrium or may be
disequilibrium. Therefore, static analysis is a study of equilibrium
only whereas dynamic analysis studies both equilibrium and
disequilibrium.
4. Study of Reality:
Static analysis is far from reality while dynamic analysis is nearer to
reality. Static analysis is based on the unrealistic assumptions of
perfect competition, perfect knowledge, etc. Here all the important
economic variables like fashions, population, models of production,
etc. are assumed to be constant. On the contrary, dynamic analysis
takes these economic variables as changeable.