Economic Law: Nature and Its Limitations

In this article we will discuss about economic law. After reading this article you will also learn about nature and limitations of economic laws.

Meaning of Economic Law:

Every science has its certain laws.

Thus, like other sciences, eco­nomics has its own laws, too.

Such laws describe how a consumer or a producer behaves.

The consumer is assumed to maximise utility or satis­faction subject to the technological constraints under which the firm oper­ates.

The nature and function of the economic system are also the subjects of concern of economic laws.

Three important economic activities are:

i. production,

ii. consumption and

iii. exchange of economic goods and services.

Economic laws have been framed to govern the conduct of these three economic activities. Economic laws are also concerned with the determina­tion of the level of employment and income as also with the distribution of national income or national product among different social classes such as labourers, landlords and capitalists.

Finally, economic laws describe the pattern of growth of the real output of an economy over time. Modern economic growth is characterised by a very high rate of capital formation and extensive use of science-based technology.

It is also characterised by a high rate of growth in productivity, by structural shifts in the economy, most significantly from agriculture to industry and then to services, by social and ideological changes, especially urbanisation and secularisation, and by much increased international economic linkages.

Economic laws also de­scribe the nature and causes of trade among nations. In fact, various eco­nomic laws have been framed encompassing all areas of economic analysis, viz., production, consumption, market price determination, determination of income and employment as also the growth of the economy, international trade and so on.

Some of the most important economic laws are — the Law of Diminishing Returns or the Law of Variable Proportions, the Law of Returns to Scale, the Law of Diminishing Marginal Utility, Keynes’ funda­mental psychological Law of Consumption, the Law of Equi-marginal Util­ity, the Law of Comparative Advantage, Marx’s Laws of the Motions of Capitalism and so on.

However, Robbins broadened the scope of economic laws by suggesting that any activity of man will come under the purview of the la w of econom­ics, provided it is concerned with the allocation of scarce resources among unlimited uses. Whether this activity (i.e., any objective or conduct of man) is connected with money earning and money spending is beside the point.

Thus, economists have to formulate laws which are statements of tendencies governing human behaviour involving choice among alternatives. How­ever, all types of human behaviour are not relevant in this context.

Only those aspects of human behaviour which are concerned with the utilisation of scarce resources for satisfying unlimited wants are taken into considera­tion while formulating economic laws. Robbins, however, was not inter­ested whether the variables and objects involved in the problem of choice could be quantified with the measuring rod of money.

Nature of Economic Laws:

Economic Laws as mere Statements of Tendencies:

Since the days of the classical economists the nature of economic laws has aroused a lot of controversy among the economists. The classical economists discovered the operation of the law of diminishing returns in agriculture which was the most important economic activity on the eve of Industrial Revolution (which started around 1760).

However, the classical economists did not say anything about the nature of economic laws. They believed that these laws were comparable to the laws of nature.

Alfred Marshall first pointed out that economic laws were not definite, precise or exact like the laws of physical sciences. Instead, in his view, such laws are merely statements of tendencies.

In truth, economic laws are highly conditional. Such laws are often stated in an ‘if-then’ form, i.e., in the form: if these assumptions are made then this will happen. Moreover, economic laws are subject to a number of qualifications. All these qualifications are captured under the phrase ‘all other things remaining the same’ or under the broad heading the ‘ceteris paribus’ assump­tion.

In fact, with almost every important law of economics, such as the law of demand, the law of supply, Keynes’ fundamental psychological law of consumption, we attach the ceteris paribus clause. Even the quantity theory of money predicts that, ceteris paribus there is a direct and proportional relationship between the money supply and the general price level. But, in a dynamic world these ‘other things’ hardly remain constant. Thus, we are forced to relax the ceteris paribus assumption in practice.

At times we find the necessity of relaxing this assumption. For example according to the laws of demand and supply, if the market price of a commodity falls people will buy more of it. But, if a fall in price is immedi­ately followed by a fall in the income of the buyers they may continue to buy the same quantity or even less at a lower price. This, however, does not contradict the law of demand.

This simply shows that the ceteris paribus assumption no longer holds, i.e., we cannot always vary only one variable — here price — keeping all other variables, such as income of buyers, their tastes and preferences, price of related goods (substitutes and complements) and so on, unchanged. In this case the assumption has been violated due to an increase in buyers’ income.

Let us consider another example. Suppose, the cost production of com­puters falls due to technological progress. It may apparently seem that as a result of fall in cost per unit the quantity offered for sale will increase. But suppose that the government imposes an additional excise duty on comput­ers.

This, in its turn, will lead to an increase in cost per unit and a consequent fall in the quantity of the commodity supplied in the market. The end result (i.e., whether quantity offered for sale will increase or fall) is not known to us.

Thus, in both the cases the ceteris paribus assumption has been violated. For computers the law of demand has been violated due to income change and the law of supply has been violated due to imposition of a tax on computers.

In a similar manner the law of diminishing returns refers to diminishing marginal product of the variable factor (say, labour).

The law or hypothesis simply states that, as more and more workers are employed in the produc­tion process, keeping all other factors unchanged, every additional worker will gradually make less and less-contribution to the total product In other words, the marginal product of labour will fall beyond a particular point.

There may be an initial stage of increasing returns but the stage of dimin­ishing returns will ultimately be reached. However, technological progress may avert the operation of the law of diminishing returns. India’s Green Revolution has proved this point.

In some parts of India the marginal product of labour, instead of diminishing, has actually increased. However this does not prove that the law of diminishing returns is wrong This is because the law is based on the ceteris paribus assumption, i.e., it assumes that all other things, such as agrarian technology, remain unchanged during the period under consideration.

A related point may also be noted in this context. Economic laws are not at all comparable to legal laws passed by the government or by the parlia­ment. The citizens of a country are under the legal obligation to obey such laws.

Any violation of such laws is punishable. In contrast, an economic law seeks to clearly indicate how a rational individual behaves as a con­sumer, a factor supplier or as a producer. In other words, economic laws tell us how people behave rationally in their economic life.

The Scientific Nature of Economic Laws:

Scientific laws seek to establish cause-and-effect relationships. Economic laws also try to do the same thing. Such laws seek to establish behaviour of man and economic phenomena. Hence, economic laws are scientific in nature. Economists first try to study the behaviour of a rational individual — as a consumer or as a producer.

The objective of such study is to discover a particular type of behaviour, i.e., how scarce resources are used to satisfy wants. Then the behaviour of several individuals is studied to find out whether any particular pattern of behaviour emerges.

By observing the behaviour of several people economists try to establish certain generalisations or general principles of human behaviour, i.e., the behaviour of ra­tional individuals in economic life. Such generalisations or general principles are known as economic laws.

This is why Alfred Marshall commented that, economic laws are nothing other than general tendencies of man’s behaviour in his economic life in which he is primarily concerned with economic activities i.e., money earning and money spending.

Economic laws are of scientific nature, because such laws, like other scientific laws, establish cause-and-effect relationships. To illustrate the point we may refer to a number of laws of economics in this context. Let us first consider the law of demand. According to this law, the quantity demanded of a commodity varies inversely with its price.

A change in market price of a commodity leads to a change in the quantity demanded. Thus, change in price is the cause and the change in quantity demanded is the effect. Likewise, the law of diminishing marginal utility states that as the consumption of a commodity increases every extra unit of it provides less and less additional satisfaction to the consumer.

Thus, marginal utility diminishes. Here, an increase in consumption is the cause and a fall in marginal utility is the effect. Similarly, Keynes’ fundamental psychological law of consumption states that as an individual’s income increases, his consumption expenditure also increases, though not proportionally.

This implies a fall on the marginal propensity to consume (which is the ratio of the change in consumption to the change in income). Here, income change is the cause and consumption change is the effect. Such a cause-and- effect relationship holds for all economic laws.

From our illustrations it is clear that, economic laws like all scientific laws are hypothetical and conditional and are always stated in form, i.e., if this condition holds this result will follow or if this assumption is made, this conclusion will emerge. So, we cannot disprove the scientific nature of economic laws.

In fact, like all scientific laws, economic laws hold good only under certain conditions, i.e., they are hypothetical in nature. So, there is nothing unique or peculiar about economic laws. That economic laws are hypothetical in nature does not deny their scientific character. Thus, eco­nomic laws are no less useful and important than other scientific laws, i.e., the laws of natural science.

Exactness and Definiteness of Economic Laws:

If we make a comparison between economic laws and laws of physical sciences we observe that economic laws are less exact and definite than those of physical sciences. For example, the Law of Diminishing Returns is less exact and definite than the Law of Gravitation.

While we can always accurately calculate and exactly measure the movements of the solar system and predict their exact position at a fixed point of time, we cannot predict the behaviour of different individuals in response to a particular change or the behaviour of the same individual in response to the same stimuli at different time periods.

We can make use of economic laws to say that a man could tend to behave in a particular manner in a certain situation, but such laws cannot tell us how a man would actually behave in response to a particular change. For various reasons — economic and non-economic — people tend to behave differently and quite contrary to what a particular law would suggest.

This explains why Alfred Marshall compared the laws of economics with the laws of tides rather than with the simple and exact law of gravitation. The laws of tides tell us that tides move up and down (i.e., rise and fall) twice a day. These tides are the strongest on full moon nights when they rise to maximum heights.

A scientist would always be interested in ascertaining from these laws what would be the exact height of these tides at a certain place on a particular day.

But, it is not possible for the scientist to state definitely, i.e., with complete certainty, what the heights of these tides would be, because they are affected by external conditions at a particular place, say the Sunderban area (situated on the Bay of Bengal) and time; it is not possible to predict how much tides rise on a particular date or time.

A scientist can only go a step ahead of others and say that if all the external conditions affecting tides remain unchanged during the obser­vation period, the average height of these tides at a particular place (say the Kovalam beach of Kerala) and a particular time can be calculated. Like the laws of the tides, the laws in economics are also inexact and inaccurate.

A question is likely to arise at this stage:

Why are economic laws less definite and exact than those of natural science? The answer is that the object of economic study is such that economic laws are bound to be inexact and indefinite. The basic object of economic study is to discover the behaviour of man faced with the problem of satisfying unlimited wants with limited resources (means).

However, the behaviour of a man depends not only on his tastes (shown by indifference curves) and income (shown by the budget line) but also on various factors which are external to him and hence beyond his control, such as customs and tradition, social environment, family conditions and so on.

All these keep on changing from time to time. Therefore it is quite obvious that economic laws formulated by establishing cause-and-effect relationship regarding human behaviour are bound to be less exact and less definite than laws of physical sciences where external conditions can be controlled.

There are two important ways of establishing economic laws. First, by empirical observations. Since economics is concerned with how we solve society’s economic problems, we have to make a close scrutiny of man’s actions and reactions in the real world.

This will enable us to establish economic laws, i.e., laws relating to national economic behaviour, or, the actual behaviour of man in the economic world. Secondly, economic laws can be formulated by making use of introspective or psychological methods.

Human beings are very different in their nature. So, formulation of economic laws by studying human behaviour alone is not an easy task.

However, economists often proceed on the basis of the assumption that people often behave in a similar fashion in a particular situation or react in the same way to a particular stimulation. Thus, economists often make generalisations about the economic behaviour of man on the basis of their own psychological reactions to a certain phenomenon.

Economists no doubt enjoy an advantage other than social scientists in having a universal yardstick for measuring rod with which they can and always make an overall assessment of human motives or optimisation (maximisation or minimisation) goals as also the results of human actions.

The Transitory Nature of Economic Laws:

Apart from inexactness and lack of definiteness economic laws have other drawbacks as well. Unlike the laws of physical sciences, economic laws are not of a universal nature across time. In other words, such laws do not always hold true. The reason is easy to find out. Economic laws are generally formulated in a particular social-institutional environment.

Therefore, in the event of a change in the environment or social-institutional set up, an established law may lose its relevance. The present economic life of man is the result of a long process of historical evolution. In the process, various changes have taken place in the institutional set up.

Such changes, in their turn, have led to changes in economic laws. For example, various laws of economics which found application in primitive societies gradually lost their relevance in later stages of agricultural and industrial development.

Relative Nature of Economic Laws:

In fact, all economic laws are not alike. They are of two broad categories, (a) universal laws, and (b) relative laws. Economic laws such as the law of demand or the law of diminishing returns (or increasing costs) are univer­sally applicable — applicable in all places and at all times. In contrast, some laws relating to money or economic systems are not applicable everywhere and at all times.

For example, the Gresham’s Law states that bad money will drive good money out of circulation. But, this law does not always hold true. Similarly, Marxian laws of economic development are applicable to capitalist countries and not to socialist countries or even mixed economies. It is so because such laws are related to specific type of economic organisa­tion, viz., and capitalism.

Limitation of Economic Laws:

One major drawback of economic laws is they lack generality. For example, the laws developed to explain the nature and functioning of capitalist economies do not have any relevance for socialist countries. For example, Alfred Marshall developed the laws of demand and supply which apply in a free market in the absence of government intervention.

Such laws do not apply in the erstwhile countries like the former Soviet Union where the price (market) system yielded place to the planning system. In a planned economy, market mechanism is replaced by government allocation or ra­tioning. So, the question of applying the laws of demand and supply does not arise. Thus, economic laws lack generality and are not universally applicable.

Furthermore, some laws of economics which have been developed in the context of advanced industrial countries may not find application in devel­oping countries like India. As V. K. R. V. Rao has pointed out, the multiplier principle, as enuncited by Keynes in the context of the advanced countries of the world, does not work in developing countries like India. This is attributable to the structure of such economies.

Similarly, the Quantity Theory of Money has been developed in the context of industrially advanced countries. It seeks to establish an exact, proportional relationship between money and prices. But, it cannot explain’ the present price situation in India.

Here, inflation is not purely monetary phenomenon as predicted by the Quantity Theory. These two examples make one thing clear at least — the laws and theories of economics devel­oped in the context of advanced countries cannot be applied in developing countries like India.

In fact, there is a feeling among some group of economists that, people in developing countries like India behave and respond differently from those of advanced countries. For example, greater self-consumption of farmers in India explain why the supply response of agricultural commodi­ties is not always favourable in the event of a rise in the price of agricultural products.

It is often observed that, if the price of a particular commodity rises, farmers produce less of it so as to maintain the same level of income. Thus,’ they not only produce less at higher price but generate less marketable surplus when price rises.

Thus, the marketable surplus of, say, wheat varies inversely with its price. But, in developed countries it is observed that, as usual, the supply curve of agricultural output slopes upward from left to right and marketable surplus increases when price rises.

All these examples make it abundantly clear that, most of the laws and principles of economics which have been developed in the context of advanced countries cannot be applied in developing countries like India.