Macroeconomics

Macroeconomics
A graph depicting "Circulation in Microeconomics"
A depiction of the circular flow of income
Main article: Macroeconomics

Macroeconomics examines the economy as a whole to explain broad aggregates and their interactions "top down," that is, using a simplified form of general-equilibrium theory.[79] Such aggregates include national income and output, the unemployment rate, and price inflation and subaggregates like total consumption and investment spending and their components. It also studies effects of monetary policy and fiscal policy.

Since at least the 1960s, macroeconomics has been characterized by further integration as to micro-based modeling of sectors, including rationality of players, efficient use of market information, and imperfect competition.[80] This has addressed a long-standing concern about inconsistent developments of the same subject.[81]

Macroeconomic analysis also considers factors affecting the long-term level and growth of national income. Such factors include capital accumulation, technological change and labor force growth.[82][83]
Growth
A world map with countries colored in different shades of orange
World map showing GDP real growth rates for 2008
Main articles: Economic growth and General equilibrium

Growth economics studies factors that explain economic growth – the increase in output per capita of a country over a long period of time. The same factors are used to explain differences in the level of output per capita between countries, in particular why some countries grow faster than others, and whether countries converge at the same rates of growth.

Much-studied factors include the rate of investment, population growth, and technological change. These are represented in theoretical and empirical forms (as in the neoclassical and endogenous growth models) and in growth accounting.[84][85]
The Business Cycle
Main article: Business cycle
See also: Circular flow of income, Aggregate supply, Aggregate demand, Unemployment, and Great Depression

The economics of a depression were the spur for the creation of "macroeconomics" as a separate discipline field of study. During the Great Depression of the 1930s, John Maynard Keynes authored a book entitled The General Theory of Employment, Interest and Money outlining the key theories of Keynesian economics. Keynes contended that aggregate demand for goods might be insufficient during economic downturns, leading to unnecessarily high unemployment and losses of potential output.

He therefore advocated active policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle[86] Thus, a central conclusion of Keynesian economics is that, in some situations, no strong automatic mechanism moves output and employment towards full employment levels. John Hicks' IS/LM model has been the most influential interpretation of The General Theory.

Over the years, the understanding of the business cycle has branched into various schools, related to or opposed to Keynesianism. The neoclassical synthesis refers to the reconciliation of Keynesian economics with neoclassical economics, stating that Keynesianism is correct in the short run, with the economy following neoclassical theory in the long run.

The New classical school critiques the Keynesian view of the business cycle. It includes Friedman's permanent income hypothesis view on consumption, the "rational expectations revolution"[87] spearheaded by Robert Lucas, and real business cycle theory.

In contrast, the New Keynesian school retains the rational expectations assumption, however it assumes a variety of market failures. In particular, New Keynesians assume prices and wages are "sticky", which means they do not adjust instantaneously to changes in economic conditions.

Thus, the new classicals assume that prices and wages adjust automatically to attain full employment, whereas the new Keynesians see full employment as being automatically achieved only in the long run, and hence government and central-bank policies are needed because the "long run" may be very long.
Inflation and monetary policy
Main articles: Inflation and Monetary policy
See also: Money, Quantity theory of money, Monetary policy, History of money, and Milton Friedman
The front and back of a coin. A creature's head is on the front.
A 640 BCE one-third stater electrum coin from Lydia, shown larger. One of the first standardized coins.

Money is a means of final payment for goods in most price system economies and the unit of account in which prices are typically stated. It includes currency held by the nonbank public and checkable deposits. It has been described as a social convention, like language, useful to one largely because it is useful to others.

As a medium of exchange, money facilitates trade. Its economic function can be contrasted with barter (non-monetary exchange). Given a diverse array of produced goods and specialized producers, barter may entail a hard-to-locate double coincidence of wants as to what is exchanged, say apples and a book. Money can reduce the transaction cost of exchange because of its ready acceptability. Then it is less costly for the seller to accept money in exchange, rather than what the buyer produces.[88]

At the level of an economy, theory and evidence are consistent with a positive relationship running from the total money supply to the nominal value of total output and to the general price level. For this reason, management of the money supply is a key aspect of monetary policy.[89][90]
Fiscal policy and regulation
The Bank of England is a central bank
Main articles: Fiscal policy, Government spending, Regulation, and National accounts

National accounting is a method for summarizing aggregate economic activity of a nation. The national accounts are double-entry accounting systems that provide detailed underlying measures of such information. These include the national income and product accounts (NIPA), which provide estimates for the money value of output and income per year or quarter.

NIPA allows for tracking the performance of an economy and its components through business cycles or over longer periods. Price data may permit distinguishing nominal from real amounts, that is, correcting money totals for price changes over time.[91][92] The national accounts also include measurement of the capital stock, wealth of a nation, and international capital flows.[93]
International economics
Main articles: International economics and Economic system

International trade studies determinants of goods-and-services flows across international boundaries. It also concerns the size and distribution of gains from trade. Policy applications include estimating the effects of changing tariff rates and trade quotas. International finance is a macroeconomic field which examines the flow of capital across international borders, and the effects of these movements on exchange rates. Increased trade in goods, services and capital between countries is a major effect of contemporary globalization.[94][95][96]
A world map with countries colored in different colors.
World map showing GDP (PPP) per capita.

The distinct field of development economics examines economic aspects of the development process in relatively low-income countries focussing on structural change, poverty, and economic growth. Approaches in development economics frequently incorporate social and political factors.[97][98]

Economic systems is the branch of economics that studies the methods and institutions by which societies determine the ownership, direction, and allocaton of economic resources. An economic system of a society is the unit of analysis.

Among contemporary systems at different ends of the organizational spectrum are socialist systems and capitalist systems, in which most production occurs in respectively state-run and private enterprises. In between are mixed economies. A common element is the interaction of economic and political influences, broadly described as political economy. Comparative economic systems studies the relative performance and behavior of different economies or systems.[99][100]
Economics in practice
Main articles: Mathematical economics, Economic methodology, and Schools of economics

Contemporary mainstream economics, as a formal mathematical modeling field, could also be called mathematical economics.[101] It draws on the tools of calculus, linear algebra, statistics, game theory, and computer science.[102] Professional economists are expected to be familiar with these tools, although all economists specialize, and some specialize in econometrics and mathematical methods while others specialize in less quantitative areas.

Heterodox economists place less emphasis upon mathematics, and several important historical economists, including Adam Smith and Joseph Schumpeter, have not been mathematicians. Economic reasoning involves intuition regarding economic concepts, and economists attempt to analyze to the point of discovering unintended consequences.
Theory

Mainstream economic theory relies upon a priori quantitative economic models, which employ a variety of concepts. Theory typically proceeds with an assumption of ceteris paribus, which means holding constant explanatory variables other than the one under consideration. When creating theories, the objective is to find ones which are at least as simple in information requirements, more precise in predictions, and more fruitful in generating additional research than prior theories.[103]

In microeconomics, principal concepts include supply and demand, marginalism, rational choice theory, opportunity cost, budget constraints, utility, and the theory of the firm.[104][105] Early macroeconomic models focused on modeling the relationships between aggregate variables, but as the relationships appeared to change over time macroeconomists were pressured to base their models in microfoundations.

The aforementioned microeconomic concepts play a major part in macroeconomic models – for instance, in monetary theory, the quantity theory of money predicts that increases in the money supply increase inflation, and inflation is assumed to be influenced by rational expectations. In development economics, slower growth in developed nations has been sometimes predicted because of the declining marginal returns of investment and capital, and this has been observed in the Four Asian Tigers. Sometimes an economic hypothesis is only qualitative, not quantitative.[106]

Expositions of economic reasoning often use two-dimensional graphs to illustrate theoretical relationships. At a higher level of generality, Paul Samuelson's treatise Foundations of Economic Analysis (1947) used mathematical methods to represent the theory, particularly as to maximizing behavioral relations of agents reaching equilibrium. The book focused on examining the class of statements called operationally meaningful theorems in economics, which are theorems that can conceivably be refuted by empirical data.[107]
Empirical investigation
Main articles: Econometrics and Experimental economics

Economic theories are frequently tested empirically, largely through the use of econometrics using economic data.[108] The controlled experiments common to the physical sciences are difficult and uncommon in economics[109] , and instead broad data is observationally studied; this type of testing is typically regarded as less rigorous than controlled experimentation, and the conclusions typically more tentative. The number of laws discovered by the discipline of economics is relatively very low compared to the physical sciences.[citation needed]

Statistical methods such as regression analysis are common. Practitioners use such methods to estimate the size, economic significance, and statistical significance ("signal strength") of the hypothesized relation(s) and to adjust for noise from other variables. By such means, a hypothesis may gain acceptance, although in a probabilistic, rather than certain, sense. Acceptance is dependent upon the falsifiable hypothesis surviving tests. Use of commonly accepted methods need not produce a final conclusion or even a consensus on a particular question, given different tests, data sets, and prior beliefs.

Criticism based on professional standards and non-replicability of results serve as further checks against bias, errors, and over-generalization,[105][110] although much economic research has been accused of being non-replicable, and prestigious journals have been accused of not facilitating replication through the provision of the code and data.[111] Like theories, uses of test statistics are themselves open to critical analysis,[112][113][114] although critical commentary on papers in economics in prestigious journals such as the American Economic Review has declined precipitously in the past 40 years.[115] This has been attributed to journals' incentives to maximize citations in order to rank higher on the Social Science Citation Index (SSCI).[116]

In applied economics, input-output models employing linear programming methods are quite common. Large amounts of data are run through computer programs to analyze the impact of certain policies; IMPLAN is one well-known example.

Experimental economics has promoted the use of scientifically controlled experiments. This has reduced long-noted distinction of economics from natural sciences allowed direct tests of what were previously taken as axioms.[117][118] In some cases these have found that the axioms are not entirely correct; for example, the ultimatum game has revealed that people reject unequal offers.

In behavioral economics, psychologists Daniel Kahneman and Amos Tversky have won Nobel Prizes in economics for their empirical discovery of several cognitive biases and heuristics. Similar empirical testing occurs in neuroeconomics. Another example is the assumption of narrowly selfish preferences versus a model that tests for selfish, altruistic, and cooperative preferences.[119][120] These techniques have led some to argue that economics is a "genuine science."[8]
Game theory
Main article: Game theory

Game theory is a branch of applied mathematics that studies strategic interactions between agents. In strategic games, agents choose strategies that will maximize their payoff, given the strategies the other agents choose. It provides a formal modeling approach to social situations in which decision makers interact with other agents.

Game theory generalizes maximization approaches developed to analyze markets such as the supply and demand model. The field dates from the 1944 classic Theory of Games and Economic Behavior by John von Neumann and Oskar Morgenstern. It has found significant applications in many areas outside economics as usually construed, including formulation of nuclear strategies, ethics, political science, and evolutionary theory.[121]
Profession
Main article: Economist

The professionalization of economics, reflected in the growth of graduate programs on the subject, has been described as "the main change in economics since around 1900".[122] Most major universities and many colleges have a major, school, or department in which academic degrees are awarded in the subject, whether in the liberal arts, business, or for professional study.

The Nobel Memorial Prize in Economic Sciences (commonly known as the Nobel Prize in Economics) is a prize awarded to economists each year for outstanding intellectual contributions in the field. In the private sector, professional economists are employed as consultants and in industry, including banking and finance. Economists also work for various government departments and agencies, for example, the national Treasury, Central Bank or Bureau of Statistics.
Economics and other subjects
Main articles: Philosophy of economics, Law and Economics, Political economy, and Natural resource economics

Economics is one social science among several and has fields bordering on other areas, including economic geography, economic history, public choice, energy economics, cultural economics, and institutional economics.

Law and economics, or economic analysis of law, is an approach to legal theory that applies methods of economics to law. It includes the use of economic concepts to explain the effects of legal rules, to assess which legal rules are economically efficient, and to predict what the legal rules will be.[123][124] A seminal article by Ronald Coase published in 1961 suggested that well-defined property rights could overcome the problems of externalities.[125]

Political economy is the interdisciplinary study that combines economics, law, and political science in explaining how political institutions, the political environment, and the economic system (capitalist, socialist, mixed) influence each other. It studies questions such as how monopoly, rent seeking behavior, and externalities should impact government policy.[126][127] Historians have employed political economy to explore the ways in the past that persons and groups with common economic interests have used politics to effect changes beneficial to their interests.[128]

Energy economics is a broad scientific subject area which includes topics related to energy supply and energy demand. Georgescu-Roegen reintroduced the concept of entropy in relation to economics and energy from thermodynamics, as distinguished from what he viewed as the mechanistic foundation of neoclassical economics drawn from Newtonian physics. His work contributed significantly to thermoeconomics and to ecological economics. He also did foundational work which later developed into evolutionary economics.[129][130][131][132][133]

The sociological subfield of economic sociology arose, primarily through the work of Émile Durkheim, Max Weber and Georg Simmel, as an approach to analysing the effects of economic phenomena in relation to the overarching social paradigm (i.e. modernity).[134] Classic works include Max Weber's The Protestant Ethic and the Spirit of Capitalism (1905) and Georg Simmel's The Philosophy of Money (1900). More recently, the works of Mark Granovetter, Peter Hedstrom and Richard Swedberg have been influential in this field.
Criticisms of economics

"The dismal science" is a derogatory alternative name for economics devised by the Victorian historian Thomas Carlyle in the 19th century. It is often stated that Carlyle gave economics the nickname "the dismal science" as a response to the late 18th century writings of The Reverend Thomas Robert Malthus, who grimly predicted that starvation would result, as projected population growth exceeded the rate of increase in the food supply. The teachings of Malthus eventually became known under the umbrella phrase "Malthus' Dismal Theorem". His predictions were forestalled by unanticipated dramatic improvements in the efficiency of food production in the 20th century; yet the bleak end he proposed remains as a disputed future possibility, assuming human innovation fails to keep up with population growth.[135]

Some economists, like John Stuart Mill or Leon Walras, have maintained that the production of wealth should not be tied to its distribution. The former is in the field of "applied economics" while the latter belongs to "social economics" and is largely a matter of power and politics.[136]

In The Wealth of Nations, Adam Smith addressed many issues that are currently also the subject of debate and dispute. Smith repeatedly attacks groups of politically aligned individuals who attempt to use their collective influence to manipulate a government into doing their bidding. In Smith's day, these were referred to as factions, but are now more commonly called special interests, a term which can comprise international bankers, corporate conglomerations, outright oligopolies, monopolies, trade unions and other groups.[137]

Economics per se, as a social science, is independent of the political acts of any government or other decision-making organization, however, many policymakers or individuals holding highly ranked positions that can influence other people's lives are known for arbitrarily using a plethora of economic concepts and rhetoric as vehicles to legitimize agendas and value systems, and do not limit their remarks to matters relevant to their responsibilities.[citation needed] The close relation of economic theory and practice with politics[138] is a focus of contention that may shade or distort the most unpretentious original tenets of economics, and is often confused with specific social agendas and value systems.[139] Notwithstanding, economics legitimately has a role in informing government policy. It is, indeed, in some ways an outgrowth of the older field of political economy. Some academic economic journals are currently focusing increased efforts on gauging the consensus of economists regarding certain policy issues in hopes of effecting a more informed political environment. Currently, there exists a low approval rate from professional economists regarding many public policies. Policy issues featured in a recent survey of AEA economists include trade restrictions, social insurance for those put out of work by international competition, genetically modified foods, curbside recycling, health insurance (several questions), medical malpractice, barriers to entering the medical profession, organ donations, unhealthy foods, mortgage deductions, taxing internet sales, Wal-Mart, casinos, ethanol subsidies, and inflation targeting.[140]

In Steady State Economics 1977, Herman Daly argues that there exist logical inconsistencies between the emphasis placed on economic growth and the limited availability of natural resources.[141]

Issues like central bank independence, central bank policies and rhetoric in central bank governors discourse or the premises of macroeconomic policies[142] (monetary and fiscal policy) of the States, are focus of contention and criticism.[143][144][145][146]

Deirdre McCloskey has argued that many empirical economic studies are poorly reported, and while her critique has been well-received, she and Stephen Ziliak argue that practice has not improved.[147] This latter contention is controversial.[148]

A 2002 International Monetary Fund study looked at “consensus forecasts” (the forecasts of large groups of economists) that were made in advance of 60 different national recessions in the ’90s: in 97% of the cases the economists did not predict the contraction a year in advance. On those rare occasions when economists did successfully predict recessions, they significantly underestimated their severity.[149]
Criticism of assumptions

Economics has been subject to criticism that it relies on unrealistic, unverifiable, or highly simplified assumptions, in some cases because these assumptions lend themselves to elegant mathematics. Examples include perfect information, profit maximization and rational choices.[150] [151][152] Some contemporary economic theory has focused on addressing these problems through the emerging subdisciplines of information economics, behavioral economics, and complexity economics, with Geoffrey Hodgson forecasting a major shift in the mainstream approach to economics.[153] Nevertheless, prominent mainstream economists such as Keynes[154] and Joskow, along with heterodox economists, have observed that much of economics is conceptual rather than quantitative, and difficult to model and formalize quantitatively. In a discussion on oligopoly research, Paul Joskow pointed out in 1975 that in practice, serious students of actual economies tended to use "informal models" based upon qualitative factors specific to particular industries. Joskow had a strong feeling that the important work in oligopoly was done through informal observations while formal models were "trotted out ex post". He argued that formal models were largely not important in the empirical work, either, and that the fundamental factor behind the theory of the firm, behavior, was neglected.[155]

Despite these concerns, mainstream graduate programs have become increasingly technical and mathematical.[156] Although much of the most groundbreaking economic research in history involved concepts rather than math, today it is nearly impossible to publish a non-mathematical paper in top economic journals.[157] Disillusionment on the part of some students with the abstract and technical focus of economics led to the post-autistic economics movement, which began in France in 2000.

David Colander, an advocate of complexity economics, has also commented critically on the mathematical methods of economics, which he associates with the MIT approach to economics, as opposed to the Chicago approach (although he also states that the Chicago school can no longer be called intuitive). He believes that the policy recommendations following from Chicago's intuitive approach had something to do with the decline of intuitive economics. He notes that he has encountered colleagues who have outright refused to discuss interesting economics without a formal model, and he believes that the models can sometimes restrict intuition.[158] More recently, however, he has written that heterodox economics, which generally takes a more intuitive approach, needs to ally with mathematicians and become more mathematical.[101] "Mainstream economics is a formal modeling field", he writes, and what is needed is not less math but higher levels of math. He notes that some of the topics highlighted by heterodox economists, such as the importance of institutions or uncertainty, are now being studied in the mainstream through mathematical models without mention of the work done by the heterodox economists. New institutional economics, for example, examines institutions mathematically without much relation to the largely heterodox field of institutional economics.

In his 1974 Nobel Prize lecture, Friedrich Hayek, known for his close association to the heterodox school of Austrian economics, attributed policy failures in economic advising to an uncritical and unscientific propensity to imitate mathematical procedures used in the physical sciences. He argued that even much-studied economic phenomena, such as labor-market unemployment, are inherently more complex than their counterparts in the physical sciences where such methods were earlier formed. Similarly, theory and data are often very imprecise and lend themselves only to the direction of a change needed, not its size.[159] In part because of criticism, economics has undergone a thorough cumulative formalization and elaboration of concepts and methods since the 1940s, some of which have been toward application of the hypothetico-deductive method to explain real-world phenomena.[