1. Economics on two tracks

By: Andrea Terzi

Economics belongs to the social sciences

The social sciences aim to study the causes and consequences of human actions within a set of relationships in a social group, and economics is a field of knowledge within this broader endeavor. Although interest in “economic” issues such as rules of trade, price determination, money, debt, and national wealth has existed since the time of ancient civilizations, the specific subject matter of economics has been defined only in the Modern Age. In the 18th century, moral philosopher Adam Smith, author of The Wealth of Nations (1776), considered the study of the source of wealth and its distribution a separate discipline, and in 1805 Thomas Malthus became England’s first professor of “political economy.”

Since then, economics has progressively become a distinct field of study, and those questions that had typically belonged to the realm of “moral philosophy” and then “political economy” came to be considered part of economics. The publication in 1890 of Principles of Economics by Alfred Marshall, who held the first chair in Economics at the University of Cambridge, is widely considered to mark the completion of this transition (at least in Western Civilization).

Two tracks

Since the time of Marshall’s economics, two separate tracks of economic inquiry have attracted new research in the field. Following Lionel Robbins’s 1932 definition, economics has become the science that studies the optimal allocation of existing resources toward unlimited competing wants in an economy of exchange. A milestone in this track is the general equilibrium model formulated by Kenneth Arrow and Gerard Debreu. This logically proves that in an “economy with complete markets” (including all inter-temporal trades), where traders exchange commodities so as to optimize their economic return, there exists one set of prices at which all markets clear.  Optimizing behavior has further inspired a “new political economy,” studying political mechanisms through incentives and constraints, hinting at a return to the merging of economics and political science with new formal tools.

A wholly different direction is the one taken with the 1936 publication of John Maynard Keynes’s The General Theory of Employment, Interest, and Money, that marks a consequential milestone in the formation of modern economics and the comprehension of a society organized as a monetary economy. Keynes’s approach is “general,” as this broadens the scope of economics to the study of a monetary system of production and exchange (as distinct from a system of pure exchange) and the determination of aggregate output and employment.  Keynes’s model logically proves that a monetary economy, where traders pursue their self-interests and attempt to secure their economic futures in a fundamentally uncertain environment, is likely to stabilize at a position where its real resources are underemployed and will change conditions in response to both privately and publicly driven changes in aggregate demand.

The recurrent, cyclical experience with conditions of deficient demand and poor growth in both advanced and developing countries has no doubt forced researchers in the first track to make exceptions to their models in an attempt to broaden their scope. This led to a generation of general-equilibrium models featuring a number of market adjustment rigidities and imperfections that explain why real-world economies do not mirror the results of an Arrow-Debreu model. And yet, the two tracks as described above remain fundamentally distinct in their methods and can hardly merge.

Next module: Giving and receiving value
Back to Table of Contents