Economics is the study of human interaction in the production and exchange of goods and services in the context of large-scale societies.
In human interaction, our thoughts affect our behavior. Among all animal species, humans are unique in the extent to which we record information and communicate with one another. Our beliefs, and especially our shared beliefs, vary across cultures and evolve over time. This makes the causal structure in human interaction more complex than that in natural science. We are limited in our ability to predict and control human interaction, including economic behavior.
Economics is focused on human interaction in the production and exchange of goods and services. Political science explores human interaction in the exercise of government power. Sociology explores human interaction in the maintenance of status hierarchies and social norms. Psychology and anthropology explore more fundamental aspects of human interaction, often with a focus on interaction within families or isolated small groups.
Economics is most useful in studying large-scale societies, even though there are some economic concepts that can be applied to just one individual (the so-called “Robinson Crusoe economy”). A large-scale society differs from a family or a small isolated tribe in two important ways. First, it is possible in a large-scale society to have a much higher degree of specialization. Second, in a large-scale society, exchange takes place among people who do not know one another and who do not engage in repeated interactions with one another. To coordinate complex specialization and anonymous exchange, large-scale societies require mechanisms that are not needed in small groups. Economists explore these coordination mechanisms.
Many economists employ a technique in which they set up a simplified version of an economic problem, make some basic assumptions about the goals of individuals, calculate the optimal strategy for each type of individual, and arrive at a mathematical prediction for the outcome. This optimization modeling has come to dominate the research and pedagogy of economics. However, for the purpose of describing human interaction, optimization modeling is rigid, limited, and often misleading. It is best to treat optimization modeling as just one tool of economic analysis, rather than as the essence of economics.
Arnold, could you comment on the ‘economic imperialism’ into areas like the family using rational choice theory. It doesn’t seem to fit your definition of Economics and yet many do include it in the discipline. Perhaps rational choice theory – an overlapping but separate offshoot from economics – should be made distinct from economics.
This is an absolutely fantastic intro into economics. I just spent a few weeks organizing my own thoughts on the nature of economics and markets and all I can say is that I am totally impressed and have no recommended changes. Spot on!
It’s like in Measure For Measure when Isabella tells Angelo to “show some pity” and Angelo says:
“I show it most of all when I show justice,
For then I pity those I do not know.”
Justice is one of those mechanisms that, strictly speaking, isn’t needed in small groups. In a family, a brother and a sister can forgive each other and go back to normal. We know who to say sorry to, and we can promise to do better, and expect to get pulled up on it if we fall short a second time. But in a large-scale society, it couldn’t work like that. We need to be able to make plans, and put our faith in an enormous chain of promises carried out by millions of people who have no way of knowing how they’re contributing to the whole elaborate system, beyond knowing that this needs to be delivered to this spot by this time, and that this has to be paid in exchange for that. All the rest of it is unknowable.
I don’t have any problems with this description of the subject matter of economics, but its method is somewhat lacking. When I first began studying science from the primary literature rather than textbooks, I was impressed by one description that pointed out that the “descriptive adequacy” of a theory should be prior to the “explanatory adequacy” of its successors. The criticism of optimization modeling begins to get at this point.
The canonical description of the scientific method bridges these two stages by a repeated process of “create a hypothesis/theory”, “use the theory to make predictions”, “test predictions against reality”, “revise and improve theory based on test outcomes”. The theory-based economics described here seems to leave out the reality testing stage. That the few words it would have taken to include it were omitted implies that engagement with the real world by economic theorists is unimportant, if not simply unthinkable. That’s too bad.
Bravo! (Long slow clap)