Introduction: What Is Economics?

What It Means

Economics is a social science devoted to the study of how people and societies get what they need and want. Or, in more formal language, economics is the study of how societies divide and use their resources to produce goods and services and of how those goods and services are then distributed and consumed.

Resources are the basic ingredients that are needed to produce the goods and services that people buy. These ingredients can be physical things such as land and factory equipment, and they can be intangible things such as the intellectual and emotional capacities of people, whose work is necessary for the production of goods and services. Whether a society is rich or poor, large or small, resources are, from the viewpoint of economics, scarce. This means that almost everyone in every country would like more goods and services than can ever be produced. Given a limited supply of resources and an unlimited desire on the part of individual consumers and nations, choices must be made about what goods and services to produce, how to produce them, and for whom.

Economists study these often-difficult choices and their significance. They come up with theories about how such choices are made on both individual and collective levels, and they try to make predictions and find solutions to a wide range of societal problems.

Although thinkers in earlier societies sometimes addressed topics that today concern economists, economics as a field did not emerge until after the Middle Ages (a period that lasted from about 500 to 1500), when capitalism became a firmly established economic system. (In capitalism the economy is controlled by private individuals rather than the government.) Much of economic theory grew out of the ideas of Scottish philosopher Adam Smith, whose book An Inquiry into the Nature and Causes of the Wealth of Nations (1776) is generally considered the founding text of the field of economics. Later, as a result of the writings of English economist John Maynard Keynes in the 1930s, economics came to be subdivided into two main branches, microeconomics and macroeconomics. These branches focus, respectively, on individual and collective economic behavior. Since Keynes’s time many economists have worked on unifying these two branches of theory.

When Did It Begin

Throughout history many philosophers and religious thinkers have dealt with economic questions. In ancient Greece, for instance, the philosophers Plato and Aristotle addressed the issue of whether private property was a legitimate concept. Likewise, in the thirteenth century the Italian Christian philosopher Thomas Aquinas discussed the moral aspects of buying and selling goods and services. For much of history, religions such as Christianity and Islam opposed, on moral grounds, such economic trends as the charging of interest (fees paid to those who lend money). But the study of economics did not become systematic until after the Middle Ages.

In the sixteenth through eighteenth centuries, the nation-states of Europe (such as England, France, Spain, and Portugal) wanted to build up power partly by amassing wealth. Out of this desire grew economic theories that dictated the development of capitalism during that time. These theories, later grouped together under the label of mercantilism, generally held that a nation’s wealth was equivalent to its store of gold, silver, and other precious metals. This belief led nations to pursue wealth by maintaining an imbalance in foreign trade. If a nation sold more goods abroad than it imported, then that nation would bring in more gold than it would send outside of its borders through trade. In this way, the developing European nations competed with each other by trying to stockpile gold.

In the eighteenth century Adam Smith (1723–90) conceived of his book An Inquiry into the Nature and Causes of the Wealth of Nations as a rebuttal to the mercantilist viewpoint, but it was much more than that. Smith argued that a nation’s wealth should be measured not just by its horde of gold but also by all of the goods and services that it produces. He also examined the nature of that enormously sophisticated production of goods and services. One of his guiding insights was the notion of the “invisible hand.” This was the concept that, in a situation where buyers and sellers compete freely in the marketplace for what is in their own self-interest, the greatest good for all is consistently achieved, as if by the prodding of an invisible hand. The marketplace, in Smith’s view, was a self-regulating system in which market prices were determined by the forces of supply (what the sellers want) and demand (what the buyers want).

This, together with Smith’s many other crucial insights into the ways that societies use their resources, served as the foundation for much of the economic thought of the nineteenth century. Even in the twentieth and twenty-first centuries, economists continued to refine and reconsider Smith’s ideas in new ways.

More Detailed Information

Nineteenth-century thinkers, foremost among them the English economists David Ricardo (1772–1823) and Thomas Malthus (1766–1834), followed Smith’s lead, fleshing out the details of the self-regulating processes he had described and addressing some of the problems or omissions they saw in his analysis. Ricardo argued against barriers to foreign trade, as had Smith, but Ricardo focused on the ways in which the wages of workers, rent levels, and business profits interacted. Because of the complex effects each of these factors had on one another, Ricardo argued, laws that protected British farmers from outside competition were actually harmful to the wider economy. Malthus, meanwhile, examined the questions of overpopulation and the prospect of a general glut, in which an excess of production might lead to economic stagnation.

Karl Marx (1818–83), the German economist and philosopher best known as the author of the highly influential pamphlet The Communist Manifesto (1848), built on the ideas of Smith and Ricardo to critique capitalism in his lengthier work Das Kapital (1867). Among Marx’s wide-ranging conclusions was the influential idea that business owners essentially derived their profits by paying workers less than they deserved (given the value their labor added to the products). The English philosopher and economist John Stuart Mill (1806–73), meanwhile, also saw flaws in capitalism, but he used Ricardo’s ideas to suggest ways of correcting rather than abolishing the system, as Marx wanted to do.

The theories of these and other thinkers are now commonly grouped together under the heading classical economics. Most economists throughout the late nineteenth and early twentieth centuries continued to accept the basic ideas of the classical economists. The leading figures in the field during this time often focused less on wide-ranging theories than on supporting preexisting theories with sophisticated mathematical principles. During this time economics moved away from its origins in pure theory and observation and became dependent on highly sophisticated mathematical analysis.

Ideas such as the invisible hand (which guided the marketplace, ensuring the greatest good for all) continued to dictate the study and implementation of economic theory. The United States, for instance, had no cohesive economic policy prior to the Great Depression (the severe worldwide economic decline that lasted from 1929 to about 1939). Instead it largely trusted the self-regulating market to take care of itself. But the Great Depression presented economists with problems that their existing theories could not answer.

During the Depression roughly one-third of the U.S. labor force was out of work, which meant that people did not have the money to buy many of the basic necessities of life. Thus, it did not matter that new, enlarged factories with the latest technology were capable of producing goods in previously unimaginable quantities; there was no demand for those goods. The marketplace offered no solution to problems such as this.

It was in this climate that the British economist John Maynard Keynes (1883–1946) offered insights that revolutionized the field. His book The General Theory of Employment, Interest, and Money (1936) proposed that the economy, in certain conditions, might not have the capacity to correct itself. In such a situation, he argued, only a national government had the ability to provide solutions. The government could address the lack of demand created by high unemployment (joblessness) by spending money in a variety of ways. He reasoned that when a government spends money, that money goes into the hands of private citizens, who use it to buy what they want and need. This spurs the growth of business.

Keynes’s ideas, which overturned many of the classical economists’ assumptions, provided an intellectual foundation for many government programs aimed at reducing poverty and regulating the economy. His ideas also led to the creation of a new approach to the study of economics.

Before Keynes introduced his ideas, most economic theory concerned the choices of individual consumers and businesses; in other words, such theories built a picture of the larger economy from the bottom up. After Keynes this way of studying the economy came to be known as microeconomics.

Keynes’s arguments showed the necessity of looking at the economy in another way as well: from the top down. He believed that by analyzing trends at the national level (especially factors such as the economy’s growth, employment, prices, and the money supply), economists might be able to make discoveries that they were unable to see at the microeconomic level. This top-down view of the economy came to be known as macroeconomics. The field of economics today remains subdivided into these two basic ways of looking at economic activity.

Recent Trends

Keynesian economics dominated the academic world and government policymaking through the 1960s, but thinkers such as the American economist Milton Friedman (1912–2006) began to point out flaws in the idea that a government could fine-tune a national economy. Friedman and others brought back classical economic notions of the self-regulating market, arguing that an economy worked best in the absence of government interference. One of the only spheres in which Friedman believed a government should have a role in managing the economy was the money supply (the amount of money in circulation). Friedman’s ideas continued to have influence at the close of the twentieth and the beginning of the twenty-first century, but they were never followed to their full extent.

Today many mainstream economists are engaged in uniting macroeconomic and microeconomic concepts. Whereas Keynesian economists had taken a macro view of the economy that was largely independent of the well-established principles of microeconomics, in the 1970s and beyond economists began finding microeconomic explanations for phenomena that are apparent at the macro level. There are also numerous alternative approaches to economics today, many of which are built on the ideas of nineteenth-century thinkers such as Marx, whose ideas other economists have since left behind.