Emmanuel Nnadozie. New Dictionary of the History of Ideas. Editor: Maryanne Cline Horowitz. Volume 2. Detroit: Charles Scribner’s Sons, 2005.
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.
Although economics originally referred to the management of the affairs of the household (oikonomia in Greek), its meaning evolved into political economy—”[t]he financial branch of the art or business of government” (Milgate et al., eds., vol. 2, p. 58)—then into how to make a country wealthy, and finally into a social science that studies the production, distribution, and consumption of commodities.
The economic problem or the objective of the economic arrangement, be it in a primitive hunting and gathering society or in the most sophisticated modern industrial society, is that of provision—how to use scarce resources to produce goods and services and how to appropriately distribute the product. This problem has remained basically unchanged in human history. Over time, what has differed or changed are the modes of economic organization that correspond to the cultural arrangements in human societies. But the existence of the economic problem is different from an analysis of the economic problem. Organized economic systems existed in ancient Egypt, the great African empires of Western Sudan, the Aztec and Incan civilizations of the Americas, and the Assyrian and Babylonian theocracies. But according to Joseph Schumpeter, there is no trace of analytic effort until Greece. Even the beginning of the analytic effort did not become systematic until the eighteenth century. Hence, as a field of study, economics is relatively young, and only emerged as a full-fledged separate discipline following the publication of Adam Smith’s The Wealth of Nations in 1776.
In Western civilization wealth was the primary and original concern of economics, and in economics the questions about wealth concerned the means of acquiring, maintaining, and increasing it. Wealth was seen by Aristotle not as an end, but as a means of achieving ethical and political ends. Whereas the treatment of wealth in the noneconomic fields of religion, history, politics, and the like focused mostly on its distribution and its effect on affluence, poverty, and the state, the approach of the economists was to focus on the means to wealth.
In addition to the attempts to understand the sources of wealth, pioneer economists sought to understand human nature and the sources of value. Human nature has been viewed both in the traditional conservative view as natural and pre-ordained and in the critical liberal view as socially determined. The traditional conservative view from the Middle Ages through slavery in the Americas and the industrial revolution sees ideas, drives, and practices as natural, inherent, God-given, or innate. Hence, the classical and neoclassical economists believed that capitalism was natural and eternal and consumer preferences were given, since individuals were born with them in the same manner that the conservative religious leaders believed that serfdom was natural and the American conservative southerners believed that slavery was ordained by God. Critical economists or the liberal view originating from Karl Marx (1818-1883), Thorstein Veblen (1857-1929), and John Maynard Keynes focused more on the evolution and transformation of economic systems and their impact on people’s ideas and preferences. This premise was based on the belief that ideas and preferences are shaped by the society in which people live (Hunt and Sherman).
With all its accomplishments, economics is plagued with a crisis of identity and dissension and disagreements on how it should be taught, how it should be practiced, and how it should be used. Furthermore, the field of economics has been slow in reintegrating itself into the social sciences to become, once again, more problem-driven and more eclectic. Indeed the shift to abstraction and quantification that was started by David Ricardo continued until relatively recently and is at the source of the dispute about the usefulness of economics in modern society. Many economists complain about an undue attention paid to esoteric models, and the tendency by some economists, mostly of the orthodox school, to provide a uniquely economic answer to such social questions as the causes of growth and why some countries are underdeveloped.
Undeniably, as the twentieth century drew to a close, there was a greater recognition of the importance of noneconomic factors in explaining major economic questions and problems. For instance, mainstream economics has come to acknowledge the importance of history, political conditions, sociocultural factors, the environment, geography, and international variables in explaining such economic problems as lack of growth, underdevelopment, inequality, and poverty. This recognition notwithstanding, the field of economics has still not seriously focused on the critical and endemic problems that plague the world. For instance, despite being the least developed continent in the world representing arguably the most daunting economic challenge in modern history, Africa has been all but ignored by economics. This is amazing in light of the fact that the field’s supposedly central preoccupation is the problems of income, growth, distribution, and human welfare.
Notable contributions to the field of economics include Richard Cantillon’s Essay on the Nature of Commerce (1755), Adam Smith’s Wealth of Nations (1776), Karl Marx’s Das Capital (1867), Thorstein Veblen’s The Theory of the Leisure Class (1899), and John Maynard Keynes’s General Theory of Employment, Interest, and Money (1936). Before the publication of the Wealth of Nations, there were other schools of thought whose main preoccupation was wealth creation and the organization of the economy, most prominently, mercantilism and physiocracy.
Mercantilism or Bullionism
Mercantilism or bullionism is a loose economic school of thought whose basic belief is that a nation’s wealth originated from gold and silver bullion and other forms of treasure. The mercantilist ideas were spread in an uncoordinated three-hundred-year effort, mostly through the English pamphlet writers of the seventeenth and eighteenth centuries, a period marked by significant shortages of gold and silver bullion in Europe. Mercantilism believed in trade regulation, industrial promotion, imposition of protective duties on imports of manufactures, encouragement of exports, population growth, and low wages. This belief in regulating wealth was grounded in the conviction that favorable balance of trade leads to national prosperity.
Mercantilists assumed that the total wealth of the world was fixed and reasoned that trade would lead to a zero-sum game. Consequently, they surmised that any increase in the wealth and economic power of one nation was necessarily at the expense of other nations. Hence, they emphasized balance of trade as a means of increasing the wealth and power of a nation.
The term Physiocracy (the order or rule of nature) developed for less than two decades as a reaction against the doctrines and restrictive policies of mercantilism. Founded on a doctrine of noninterference, the physiocratic ideas were first enunciated by the Frenchman François Quesnay (1694-1774). Quesnay argued that only agriculture can produce net output (produit net). According to Physiocracy, the farmers and landowners were considered to be the productive classes whereas the merchants and industrialists were not. The Physiocrats believed in natural laws, the free enterprise system, and the free operation of the natural order of things. Quesnay also developed the famous Tableau Economique(economic table) in an attempt to establish a general equilibrium through a basic input-output model. The main ideas of Physiocracy that were promoted by the intellectual disciples of Quesnay—a group of French social reformers—came directly or indirectly from his Tableau Economique. Another important contributor to Physiocracy is Anne-Robert-Jacques Turgot (1727-1781), whose Reflections on the Formation and the Distribution of Wealth (1769-1770) was one of the most important general treatises on political economy written before Smith’s Wealth of Nations.
The study of economics is driven by theories of economic behavior and economic performance, which have developed along the lines of the classical ideas, the Marxist idea, or a combination of both. In the process, various models were developed, each trying to explain such economic phenomena as wealth creation, value, prices, and growth from a separate intellectual and cultural setting, each considering certain variables and relationships more important than others. Within the aforementioned historical framework, economics has followed a trajectory that is characterized by a multiplicity of doctrines and schools of thought, usually identifiable with a thinker or thinkers whose ideas and theories form the foundation of the doctrine.
Classical economic doctrine descended from Adam Smith and developed in the nineteenth century. It asserts that the power of the market system, if left alone, will ensure full employment of economic resources. Classical economists believed that although occasional deviations from full employment result from economic and political events, automatic adjustments in market prices, wages, and interest rates will restore the economy to full employment. The philosophical foundation of classical economics was provided by John Locke’s (1632-1704) conception of the natural order, while the economic foundation was based on Adam Smith’s theory of self-interest and Jean-Baptiste Say’s (1767-1832) law of the equality of market demand and supply.
Classical economic theory is founded on two maxims. First, it presupposes that each individual maximizes his or her preference function under some constraints, where preferences and constraints are considered as given. Second, it presupposes the existence of interdependencies—expressed in the markets—between the actions of all individuals. Under the assumption of perfect and pure competition, these two features will determine resource allocation and income distribution. That is, they will regulate demand and supply, allocation of production, and the optimization of social organization.
Led by Adam Smith and David Ricardo with the support of Jean-Baptiste Say and Thomas Robert Malthus (1766-1834), the classical economists believed in Smith’s invisible hand, self-interest, and a self-regulating economic system, as well as in the development of monetary institutions, capital accumulation based on surplus production, and free trade. They also believed in division of labor, the law of diminishing returns, and the ability of the economy to self-adjust in a laissez-faire system devoid of government intervention. The circular flow of the classical model indicates that wages may deviate, but will eventually return to their natural rate of subsistence.
Because of the social cost of capitalism as proposed by classical economics and the industrial revolution, socialist thought emerged within the classical liberal thought. To address the problems of classical capitalist economics, especially what he perceived as the neglect of history, Karl Marx (1818-1883), a German economic, social, and political philosopher, in his famous book titled Das Kapital or Capital (1867-1894) advanced his doctrine of dialectical materialism. Marx’s dialectics was a dynamic system in which societies would evolve from primitive society to feudalism to capitalism to socialism and to communism. The basis of Marx’s dialectical materialism was the application of history derived from Georg Wilhelm Friedrich Hegel (1770-1831), which maintained that history proceeds linearly by the triad of forces or dialectics called thesis, antithesis, and synthesis. This transition, in Marx’s view, will result from changes in the ruling and the oppressed classes and their relationship with each other. He then envisaged conflict between forces of production, organization of production, relations of production, and societal thinking and ideology.
Marx predicts capitalist cycles that will ultimately lead to the collapse of capitalism. According to him, these cycles will be characterized by a reserve army of the unemployed, falling rate of profits, business crises, increasing concentration of industry into a few hands, and mounting misery and alienation of the proletariat. Whereas Adam Smith and David Ricardo had argued that the rational and calculating capitalists in following their self-interest promote social good, Marx argued that in rationally and purposefully pursuing their economic advantage, the capitalists will sow the seeds of their own destruction.
The economic thinking or school of economic thought that originated from Marx became known as Marxism. As the chief theorist of modern socialism and communism, Marx advocated fundamental revolution in society because of what he saw as the inherent exploitation of labor and economic injustice in the capitalist system. Marxist ideas were adopted as the political and economic systems in the former Soviet Union, China, Cuba, North Korea, and other parts of the world.
The neo-Marxist doctrines apply both the Marxist historical dimension and dialectics in their explanation of economic relationships, behavior, and outcome. For instance, the dependency theory articulates the need for the developing regions in Africa, Latin America, and Asia to rid themselves of their endemic dependence on more advanced countries. The dependency school believes that international links between developing (periphery) and industrialized (center) countries constitute a barrier to development through trade and investment.
The period that followed Ricardo, especially from 1870 to 1900, was full of criticism of classical economic theory and the capitalist system by humanists and socialists. The period was also characterized by the questioning of the classical assumption that laissez-faire was an ideal government policy and the eventual demise of classical economic theory and the transition to neoclassical economics. This transition was neither spontaneous nor automatic, but it was critical for the professionalization of economics.
Neoclassical economics is attributed with integrating the original classical cost of production theory with utility in a bid to explain commodity and factor prices and the allocation of resources using marginal analysis. Although David Ricardo provided the methodological rudiments of neoclassical economics through his move away from contextual analysis to more abstract deductive analysis, Alfred Marshall (1842-1924) was regarded as the father of neoclassicism and was credited with introducing such concepts as supply and demand, price-elasticity of demand, marginal utility, and costs of production.
Neoclassical or marginalist economic theories emphasized use value and demand and supply as determinants of exchange value. Likewise neoclassicals, William Stanley Jevons (1835-1882) in England; Karl Menger (1840-1925) in Austria; and Léon Walras (1834-1910) in Switzerland, independently developed and highlighted the role of marginal utility (and individual utility maximization), as opposed to cost of production, as the key to the problem of exchange valuation. Neoclassical models assume that everyone has free access to information they require for decision making. This assumption made it possible to reduce decision making to a mechanical application of mathematical rules for optimization. Hence, in the neoclassical view, people’s initial ability to maximize the value of output will, in turn, affect productivity and determine allocation of resources and income distribution. Neoclassical economics is grounded in the rejection of Marxist economics and on the belief that the market system will ensure a fair and just allocation of resources and income distribution.
Since its emergence, neoclassical economics has become the dominant economic doctrine in the study and teaching of economics in the West, especially in the United States. A host of economic theories have emerged from neoclassical economics: neoclassical growth theory, neoclassical trade theory, neoclassical theory of production, and so on. In the neoclassical growth theory, the determinants of output growth are technology, labor, and capital. The neoclassical growth theory stresses the importance of savings and capital accumulation together with exogenously determined technical progress as the sources of economic growth. If savings are larger, then capital per worker will grow, leading to rising income per capita and vice versa. The neoclassical thinking can be expressed as the Solow-Swan model of the production function type Y F (N, K) which is expanded to ΔY/Y = ΔA/A + ΔN/N + ΔK/K where Y represents total output, N and K represent the inputs of labor and capital, and A represents the productivity of capital and labor, and ΔY/Y, ΔA/A, ΔN/N, and K / K represent changes in these variables, respectively.
The Solow-Swan model asserts that because of the diminishing marginal product of inputs, sustained growth is possible only through technological change. The notion of diminishing marginal product is rooted in the belief that as more inputs are used to produce additional output under a fixed technology and fixed resource base, additional output per unit of input will decline (diminishing marginal product). This belief in the stationary state and diminishing marginal product led neoclassical economics to believe in the possibility of worldwide convergence of growth.
Known also as the neoliberal theory, neoclassical economics asserts that free movement of goods (free trade), services, and capital unimpeded by government regulation will lead to rapid economic growth. This, in the neoclassical view, will increase global output and international efficiency because the gains from division of labor according to comparative advantage and specialization will improve overall welfare. Even modern trade models (such as the Hecksche-Ohlin) are based on the neoclassical trade theory, which assumes perfect competition and concludes that trade generally improves welfare by improving the allocation of factors of production across sectors of the economy.
Rational expectation is the economic doctrine that emerged in the 1970s that asserts that people collect relevant information about the economy and behave rationally—that is, they weigh costs and benefits of actions and decisions. Rational expectation economics believes that because people act in response to their expectations, public policy will be offset by their action. Also known as the “new classical economics,” the rational expectation doctrine believes that markets are highly competitive and prices adjust to changes in aggregate demand. The extent to which people are actually well informed is questionable and prices tend to be sticky or inflexible in a downward direction because once they go up, prices rarely come down. In the rational expectation doctrine, expansionary policies will increase inflation without increasing employment because economic actors—households and businesses—acting in a rational manner will anticipate inflation and act in a manner that will cause prices and wages to rise.
Like rational expectations theory, monetarism represents a modern form of classical theory that believes in laissez-faire and in the flexibility of wages and prices. Like the classical theorists before them, they believe that government should stay out of economic stabilization since, in their view, markets are competitive with a high degree of macroeconomic stability. Such policies as expansionary monetary policy will, in their view, only lead to price instability. The U.S. economist Milton Friedman, who received the Nobel Prize in 1976, is widely regarded as the leader of the Chicago school of monetary economics.
Institutional economics focuses mainly on how institutions evolve and change and how these changes affect economic systems, economic performance, or outcomes. Both Frederick Hayek and Ronald Coase, major contributors to the Institutionalist School in the tradition of Karl Marx and Joseph Schumpeter, look at how institutions emerge. Hayek examines the temporal evolution and transformation of economic institutions and concludes that institutions result from human action. Hence, he suggests the existence of a spontaneous order in which workable institutions survive while nonworkable ones disappear. Coase believes that institutions are created according to rational economic logic when transaction costs are too high. Other notable contributors to institutionalism include Thorstein Veblen, Clarence Ayers, Gunnar Myrdal, John R. Commons, Wesley Cair Mitchell, and John Kenneth Galbraith.
The New Institutionalism, represented mostly by Douglas North, Gordon Tullock, and Mancur Olson, uses the classical notions of rationality and self-interest to explain the evolution and economic impact of institutions. It considers such issues as property rights, rent-seeking, and distributional coalitions and argues that institutional transformation can be explained in terms of changes in property rights, transaction costs, and information asymmetries.
As an academic discipline, economics encompasses a wide variety of themes that represent its historical and contemporary intellectual development. Some of the discipline’s major themes include economic methodology, development economics, Endogenous Growth theory, feminist economics, environmental economics, monetarist economics, and econometrics.
Economic methodology refers to the method of economic investigation. It mirrors and derives from economic theory and has come to be known as the formulation and testing of hypotheses of cause-and-effect relationship. Like the field itself, which is very much in dispute, economic methodology has evolved and transformed in time from a more formal scientific approach in which methodology was emphasized to a period of lesser emphasis on scientific methodology. Before the formalization of economic theory, economists employed discourse to state and test theories and hypotheses. This heuristic approach did not permit hypothesis to be tested in a manner acceptable as scientific.
In time, economics adopted the use of the scientific method to either formulate economic laws, theories, or principles or to ascertain their validity. The process involves observing facts, making assumptions and hypothesizing about facts, testing hypotheses (to compare outcomes with predictions), accepting or rejecting hypotheses, systematically arranging and interpreting facts to draw generalizations and establish laws, theories, or principles, and often formulating policies, addressing economic problems, or achieving specific economic goals.
At the two levels of microeconomics and macroeconomics, economic methodology can either be inductive or deductive, quantitative or qualitative, positive or normative. Economists express economic theory in terms of equations and relationships between economic variables in algebraic form and make inferences using mathematical operations. Over time, the economics discipline has witnessed an intensified mathematization of economic methodology and an increased role of abstraction and esoteric modeling that has, in effect, made it inaccessible to the untrained.
In this regard, econometrics, especially linear regression analysis, mathematical economics, game theory, and the like have played a great role. There has also been a move away from the scientific methodology involving data collection, hypothesis, analysis, and theory to an emphasis on modeling.
The 1960s and 1970s saw enormous advances in formal statistical testing and logical positivism and Popperian falsification, mostly in an attempt to establish one correct method of economics. Karl Raimund Popper (1902-1994) is one of the most influential philosophers of the twentieth century who produced influential works and political philosophy, particularly The Logic of Scientific Discovery (1959). Falsification is “a methodological standpoint that regards theories and hypotheses as scientific if and only if their prediction are at least in principle falsifiable, that is, if they forbid certain acts/states/events from occurring” (Blaug, 1992, p. xiii).
Development economics or the economics of development is the application of economic analysis to the understanding of the economies of developing countries in Africa, Asia, and Latin America. It is the subdiscipline of economics that deals with the study of the processes that create or prevent economic development or that result in the improvement of incomes, human welfare, and structural transformation from a predominantly agricultural to a more advanced industrial economy. The subfield of development economics was born in the 1940s and 1950s but only became firmly entrenched following the awarding of the Nobel Prize to W. Arthur Lewis and Theodore W. Schultz in 1979. Lewis provided the impetus for and was a prime mover in creating the subdiscipline of development economics.
As a subfield concerned with “how standards of living in the population are determined and how they change over time” (Stern), and how policy can or should be used to influence these processes, development economics cannot be considered independently of the historical, political, environmental, and sociocultural dimensions of the human experience. Hence development economics is a study of the multidimensional process involving acceleration of economic growth, the reduction of inequality, the eradication of poverty, as well as major changes in economic and social structures, popular attitudes, and national institutions.
Development economics covers a variety of issues, ranging from peasant agriculture to international finance, and touches on virtually every branch in economics: micro and macro, labor, industrial organization, public finance, resource economics, money and banking, economic growth, international trade, etc., as well as branches in history, sociology, and political science. It deals with the economic, social, political, and institutional framework in which economic development takes place.
The study of economic development has been driven by theories of economic development, which have developed along the lines of the classical ideas, the Marxist idea, or a combination of both. Some approaches have focused on the internal causes of development or underdevelopment, while others have focused on external causes. Economic growth—increase in output and income—has been used as a substitute for development and, in some cases, has been treated as synonymous with development. Economic growth and economic development have been mostly studied by means of cross-country econometric analysis.
Development economics has an assortment of theories and models to inform its teaching and research—neoclassical, Marxist, demand-driven, balanced growth, unbalanced growth, stages of growth, structuralist, dependency, neoclassical, and endogenous—each trying to explain development from a separate intellectual and cultural setting, each considering certain variables and relationships more important than others. Kaushik Basu identifies three major surges in economic growth theory in this century: the Harrod Domar model and the responses it orchestrated, the neoclassical response to Harrod Domar led by Solow (1956), and the works of Lucas (1986) and Romer (1988) that gave rise to the theory of endogenous growth.
Endogenous Growth Theory
Proponents of the endogenous growth theory focus on technological progress and innovation and believe that technological change is endogenous, not exogenous, as neoclassical economics claims. Originally developed by Frankel, and then Lucas and Romer, endogenous growth theory argues that in addition to the accumulation of capital, technical progress is not exogenous but is planned and produced through research and development efforts. It recognizes the role of private sector and free market enterprise as the engine of growth, but suggests an active role of public policy in promoting economic development. In sum, in endogenous growth economics, several factors come together to determine the level of output in a country: government policy, economic behavior, and technology, which are determined by the expenditure on research and development, the rate of accumulation of factors of production—land, labor, capital, entrepreneurship, and savings. One could summarize the entire focus as being to explain the existence of increasing returns to scale and divergent long-term growth patterns among countries.
Feminist economics is the branch of economics that advances a theory of economic equality of the sexes and deals with gender equality or the elimination of gender subordination. Feminist economics originated from the organized feminist activities and movement whose influence became more visible in the 1970s and 1990s on behalf of women’s rights and interest. It continues to exert an increasing influence on the field of economics by questioning the existing paradigms, approaches, and assumptions.
Through journals and feminist publications, feminist economists criticize what they refer to as the social construction of economics as a discipline, in particular neoclassical orthodoxy. They highlight what they consider to be the androcentric (male-centered) nature of conventional economic thinking, question its wisdom, and reveal biases in conventional microeconomic models. Feminist economists question the nature and functioning of the markets and the classical market society, especially with regard to economic rationality and maximizing behavior. They also highlight the absence of power relations and unequal exchanges, gender, and race in mainstream economic analysis. They question the focus on choices in mainstream analysis and advocate focusing, instead, on provisioning, which, in their view, would account for such social issues as poverty and income inequality. Feminist economics also indicts the lack of emphasis on women’s economic role and the noninclusion of domestic and other unpaid work in national income accounts and statistics.
Environmental economics is the branch of economics that deals with the application of economic tools and principles to the understanding and analysis of environmental issues and to solving environmental problems. Environmental economics draws from both microeconomics and macroeconomics, focusing on individual decisions that have environmental consequences and changes in institutions and policies to achieve desirable environmental goals.
A major preoccupation of environmental economics is the question of externalities or spillovers, especially negative externalities or spillover costs of human action. The cost of and responses to pollution, emissions, and other negative externalities as well as population, natural resources, energy, water, agriculture, forests, and wildlife are issues considered in environmental economics. Likewise, environmental economics deals with economic dimensions of problems of both regional and global pollutants, including acid rain, ozone depletion, and global warming.
Environmental economics involves the valuation of the environment and natural resources as well as the assessment of environmental damage, management, and regulation of environmental risk, and the markets for the environment. Environmental economics takes account of sustainable development and the impact on the environment of trade, transport, deforestation, water pollution, and climatic change. It also involves analysis of the costs and benefits of the environment.
Mathematics and Economics
Mathematical economics involves the use of formal and abstract analysis to develop hypotheses and analyze economic relationships. It refers to the application of mathematical techniques to the formulation of hypotheses and building economic models. The introduction of mathematics into economics by the Frenchman Antoine Augustin Cournot (1801-1877) in 1838 marked the beginning of a steady course that led to the emergence of mathematical economics. The antecedents of Léon Walras in 1874-1877 and Vilfredo Pareto in 1896-1897 were also essential in advancing mathematical economics. Henceforth, geometrical figures became conventional in economic literature and so did differential calculus and linear algebra. Game theory—the application of mathematics to the analysis of competitive situations and actions—has become a popular aspect of mathematical economics following the publication of The Theory of Games and Economic Behavior in 1944 by John von Neumann and Oskar Morgenstern.
Econometrics is the application of mathematical and statistical techniques to the testing of hypotheses and quantifying of economic theories and the solution of economic problems. Econometrics combines mathematical economics as it is applied to model-building and the hypothesis-formulation and statistical analysis involving data collection, analysis, and hypothesis-testing. The emergence of econometrics has provided economists with a tool for analyzing macroeconomic models for forecasting, simulation, and economic policy.
As the most widely used tool for empirical analysis and for constructing theories, econometrics provides a method that allows the expression of economic theory using statistical data or using statistical data to estimate economic theory. Estimation methods range from Ordinary Least Squares to panel data and time series analysis.
New methodological approaches have been developed to address some of the weaknesses of the traditional methodology. For instance, there is more emphasis on rigorous diagnostic testing, including coefficient, residual, and stability tests as well as Unit Root and Johansen tests for cointegration and Granger Causality test. Cointegration analysis of time series to determine whether a group of nonstationary series are cointe-grated is an important development in empirical modeling. Improvements in multiple regression analysis often involving tests of correlation and causality as well as linear and nonlinear regression methods have proved to be important for the development of econometrics.
Global Organization and Orientation
Between the two world wars, two important phenomena affected the organization and orientation of economics in the world. The first was the Bolshevik Revolution of 1917 and the exceptionally rapid industrialization of the Soviet Union. The second was the Great Depression of the 1930s. The former led to the development of the Marxist-Stalinist economic system and state-directed development, collectivization, and the establishment of a command economy. The Great Depression led to a declining faith in the classical (laissez-faire) self-regulating free market capitalism, and the emergence of government interventionism, following the publication, by John Maynard Keynes in 1936, of The General Theory of Money, Interest, and Employment.
The new field of development economics was born in the 1940s and 1950s with W. Arthur Lewis providing the impetus for and being a prime mover in creating the subdiscipline. The new Keynesian macroeconomics and development economics advocated widespread government intervention in the economic process. Likewise, the powerful and far-reaching movements of the developing countries in Africa, Asia, and Latin America in the 1940s gave rise to the rejection of free-market capitalism in those regions. In the 1940s and 1950s, economists advocated for a dominant role of the state and comprehensive national development planning was recommended as a way to eliminate the “vicious circle of poverty” and underdevelopment. The advocacy for dirigisme was founded on the notion of market segmentation and failures as well as on information asymmetries and resource constraints. Disappointing results after World War II forced a serious questioning and tempering of this development dirigisme.
As a social science, economics is subject to ideological manipulation. Aside from the orthodox (mainstream) and heterodox spheres, in the neoclassical intellectual tradition, there has been a split since the late nineteenth century as can be seen in the case of its liberal and conservative wings. Led by Paul Samuelson, liberal thinking is associated with advocacy for government intervention to correct market imperfections and market failures while conservatism or neoclassicism led by Milton Friedman is associated with a more pronounced advocacy for laissez-faire.
Impact of Influential Economic Ideas
Throughout the history of nations, economic ideas, notably those of Adam Smith, Karl Marx, and John Maynard Keynes, have had a profound influence on politics and society. Economics has influenced the emergence of political systems, political ideology, and the societal organization of production and distribution. The political and economic systems of democratic capitalism and socialism owe their existence to the ideas of Adam Smith and his followers and Karl Marx, respectively. Recognizing this fact, Keynes, in a famous passage from chapter 24 of General Theory of Employment, Interest, and Money, states: “The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”
Adam Smith’s invisible hand of competitive markets, self-interest, and division of labor gave rise to the American style of individualistic market capitalism. Smith’s notion of the natural tendency of an economic system to establish equilibrium through the pursuit of self-interest and competitive markets became the foundation of liberal economics in the nineteenth century. Likewise, Marx’s analysis of capitalism, his prediction of its ultimate demise, and the triumph of socialism and communism became the foundation for the socialist economic systems of the former Soviet Union and other Eastern European, African, and Asian countries. His idea of the inevitability of the historical evolution of societies from primitive society to feudalism to capitalism to socialism, and ultimately to communism due to the internal conflicts resulting from the exploitation of workers, led to socialist ideas of centralization, planning, and public ownership of resources.
The commitment by governments to macroeconomic policies that ensure full employment and economic growth; the establishment of social security systems; and even deposit insurance guarantees in the banking system are all by-products of influential economic ideas of Keynes. Keynes argued that the answer to the existence of the Great Depression was insufficient aggregate demand and recommended increase in public demand by the government as a means of increasing total demand and output. Since then, discretionary macroeconomic stabilization has become a policy goal of many countries.
Much of the distinction between political conservatism and liberalism is based on economics and in this regard, the differentiation lies on the belief of the role of government versus the market and what type of government intervention, if any, will bring about the most optimum outcomes. In the United States, for instance, liberal politicians tend to favor government spending over lower taxes, while conservative politicians tend to favor tax reductions over government spending as fiscal policy measures against economic recessions.