Economic Theory: Essay on Economic Theory

Economic theory enunciates the laws and principles which govern the functioning of an economy and its various parts.

An economy exists because of two basic facts. First, human wants for goods and services are unlimited, and secondly, productive resources with which to produce goods and services are scarce.

With our wants being virtually unlimited and resources scarce, we cannot satisfy all our wants and desires by producing everything we want.

That being the case, a society has to decide how to use its scarce resources to obtain the maximum possible satisfaction of its members. It is this basic problem of scarcity which gives rise to many of the economic problems which have long been the concern of economists. Since it is not possible to satisfy all wants with the limited means of production, every society must decide some way of selecting those wants which are to be satisfied.

The necessity for economizing arises therefore from the fact that we have limited productive resources such as land, raw materials, skilled manpower, capital equipment etc. at our disposal. These resources being found in limited quantity (the quantity may however increase over time), the goods they can produce are also limited.

Goods are thus scarce because the productive resources are scarce. Since the resources are limited in relation to our wants, we should get most out of what we have. Thus a society is faced with the problem of choice—choice among the vast array of wants that are to be satisfied.

If it is decided to use more resources in one line of production, then resources must be withdrawn from the production of some other goods. The scarcity of resources therefore compels us to choose among the different channels of production to which resources are to be devoted. In other words, we have the problem of allocating scarce resources so as to achieve the greatest possible satisfaction of wants of the people. This is the economic problem. It is also called the economizing problem.

The scarcity of resources relative to human wants gives rise to the struggle of man for sustenance and efforts by him to promote his well-being. That the scarcity of resources in relation to human wants is the fundamental economic problem can be easily understood in the context of poor and developing countries like India where quite a large number of population live at a bare subsistence level.

The struggle for existence due to the scarcity of resources is too obvious in them to need any elaborate explanation. However, to say that the developed countries, such as the U.S.A., where affluence and prosperity have been brought about also confront the scarcity problem raises some doubts.

But the fact is, despite their affluence and riches, developed societies too face the problem of scarcity. Of course, their possession of goods and services has enormously increased, but so have their wants. Indeed, their wants for goods and services have been multiplying during the course of economic growth so that their present wants still remain ahead of their resources and capability to produce.

The problem of scarcity of resources is not only the result of availability of limited resources and capability to produce but also of human wants. So long as human wants for goods and services remain ahead of the resources, both natural and acquired, the economic problem of scarcity would exist. If Americans today, for example, were content to live at the level of the Indian middle class people all their wants would probably be fully satisfied with their available resources and capacity to produce.

In that situation they would face little or no scarcity and economic problem for them would disappear. However, it needs to be emphasized again that the affluent and developed countries of the U.S.A. and Western Europe face the problem of scarcity even today as their present wants run ahead of their increased resources and capability to produce.

Since all wants cannot be satisfied due to scarcity of resources we face the problem of choice-choice among multiple wants which are to be satisfied. If it is decided to use more resources in one line of production, some resources must be withdrawn from another commodity. Thus the problem of choice from the viewpoint of the society as a whole refers to which goods and in what quantities are to be produced and productive resources allocated for their production accordingly so as to achieve greatest possible satisfaction of the people.

An eminent English economist Lord Robbins defines economics in terms of this basic economic problem. According to him, “Economics is a science which studies human behaviour as a relationship between ends and scarce resources which have alternative uses.” Here ends refer to wants which are considered to be unlimited. The use and allocation of scarce resources to produce goods and services have to be such as would maximise satisfaction. This applies both to the behaviour of the individual and of the society as a whole.

The scarcity of resources also compels us to decide how the different goods should be produced, that is, what production methods should be chosen for the production of goods so as to make best possible use of the available resources. If the resources were unlimited, the problem of how goods should be produced would not have arisen. This is because with unlimited resources it would not matter whichever method, efficient or inefficient, was employed for production of goods.

Further, due to scarcity of resources goods cannot be produced in abundant quantities to satisfy all wants of all the people of a society. This raises another problem of choice, namely, who should get how much from the national output. This means how the national product is distributed among various members of a society.

Thus, problem of scarcity gives rise to some problems generally known as basic economic problems which a society has to solve so as to promote material well-being of its people. These basic economic problems relate to what commodities are to be produced, how they are to be produced, how the national product is to be distributed among the people, and how much to provide for future growth.

It is with regard to these problems of resource allocation, the choice of production methods, distribution and economic growth, which have their roots in scarcity of resources, that economist have been asking questions from time to time and providing answers for them.

Besides, economists have also been raising questions about the efficiency of the resource allocation for the production of goods and their distribution among them people. This question of economic efficiency is aimed at knowing whether or not a particular allocation of resources to the production of various goods and distribution of income among them ensures maximum social welfare. The knowledge of the scope and purpose of economic theory can be obtained from the type of relevant questions that have been asked by the economists from time to time and their mode of answering them.

The Scope of Economic Theory and Basic Economic Problems:

There has been a lot of controversy among economists about the true scope of economic theory or its subject-matter. The subject-matter of economics or economic theory has been variously defined. According to Adam Smith, economics enquires into the nature and causes of the wealth of nations.

According to Ricardo, economics studies “how the produce of the earth is distributed”, that is, economics deals with the distribution of income and wealth. According to Marshall, economics is a study of mankind in the ordinary business of life and examines that part of individual and social action which is connected with material requisites of well-being. A. C. Pigou says,” economics studies that part of social welfare which can be brought directly or indirectly into relationship with the measuring rod of money’. Gustav Cassel has defined economics as dealing with markets, prices and market exchange. Professor Lionel Robbins defines economics as a study of the allocation of scarce resources among competing ends or uses. Ludwig Von Mises has defined economics as “the logic of rational action”.

Each definition of economics given above is incomplete and inadequate since they do not indicate the true scope and subject-matter of economics. Moreover, some of them are “too wide” and some “too narrow”. Professor Boulding aptly remarks about some of the above definitions: “To define it (economics) as a study of mankind in the ordinary business of life” is surely too broad. To define it as the study of material wealth is too narrow. To define it as the study of human valuation and choice is again probably too wide, and to define it as the “study of that part of human activity subject to the measuring rod of money is again too narrow”.

A great confusion has been created about the true nature and scope of economics because of these numerous and conflicting definitions of economics. J. N. Keynes was right when he said, “Political economy is said to have strangled itself with definitions” In view of the present author, the subject-matter of the science of economics has grown so wide and vast that it is extremely difficult to put it in a “nutshell” of a definition.

It is because of this fact that modern economists have now stopped discussing the proper way of defining economics. In fact, they think any attempt to define economics is a useless and futile exercise. They are of the view that what economics is about can be better explained by pointing out the various issues and questions with which economists are concerned.

It is because of the difficulties in putting the whole subject-matter of economics in a definition of a few words that Jacob Viner has given a pragmatic definition of economics. According to him, “Economics is what economists do.” In other words, what economics is can be better understood from what economists do and what they have been doing. That is to say, what type of questions economists ask and have been asking and what answers they have provided for them. Thus, what economics is about or, in other words, what is the scope.