Economics is the science that concerns itself with economies, from how societies produce goods and services, to how they consume them. It has influenced world finance at many important junctions throughout history and is a vital part of our everyday lives. The assumptions that guide the study of economics, have changed dramatically throughout history. In this article, we'll look at the history of how economic thought has changed over time, and the major participants in its development.
Tutorial: Economics Basics
The Father of Economics
Adam Smith is widely credited for creating the field of economics, however, he was inspired by French writers, who shared his hatred of mercantilism. In fact, the first methodical study of how economies work, was undertaken by these French physiocrats. Smith took many of their ideas and expanded them into a thesis about how economies should work, as opposed to how they do work.
Smith believed that competition was self-regulating and that governments should take no part in business through tariffs, taxes or any other means, unless it was to protect free-market competition. Many economic theories today are, at least in part, a reaction to Smith's pivotal work in the field. (For more on this influential economist, see Adam Smith: The Father Of Economics.)
The Dismal Science of Marx and Malthus
Karl Marx and Thomas Malthus had decidedly poor reactions to Smith's treatise. Malthus predicted that growing populations would outstrip the food supply. He was proven wrong, however, because he didn't foresee technological innovations that would allow production to keep pace with a growing population. Nonetheless, his work shifted the focus of economics to the scarcity of things, versus the demand for them. (For related reading, see Economics Basics: Demand and Supply.)
This increased focus on scarcity led Karl Marx to declare that the means of production were the most important components in any economy. Marx took his ideas further and became convinced that a class war was going to be initiated by the inherent instabilities he saw in capitalism. However, Marx underestimated the flexibility of capitalism. Instead of creating a clear owner and worker class, investing created a mixed class where owners and workers hold the interests of both classes, in balance. Despite his overly rigid theory, Marx did accurately predicted one trend: businesses grew larger and more powerful, in accordance to the degree of free-market capitalism allowed. (For more insight, see History Of Capitalism.)
Speaking in Numbers
Leon Walras, a French economist, gave economics a new language in his book "Elements of Pure Economics." Walras went to the roots of economic theory and made models and theories that reflected what he found there. General equilibrium theory came from his work, as well as the tendency to express economic concepts statistically and mathematically, instead of just in prose. Alfred Marshall took the mathematical modeling of economies to new heights, introducing many concepts that are still not fully understood, such as economies of scale, marginal utility and the real-cost paradigm.
It is nearly impossible to expose an economy to experimental rigor, therefore, economics is on the edge of science. Through mathematical modeling, however, some economic theory has been rendered testable. (For more, read What Are Economies Of Scale? and Economics Basics: Utility.)
John Maynard Keynes' mixed economy was a response to charges levied by Marx, long ago, that capitalist societies aren't self-correcting. Marx saw this as a fatal flaw, whereas Keynes saw this as a chance for government to justify its existence. Keynesian economics is the code of action that the Federal Reserve follows, to keep the economy running smoothly. (To learn about how the Fed does this, see The Federal Reserve.)
Back to the Beginning: Milton Friedman
The economic policies of the last two decades all bear the marks of Milton Friedman's work. As the U.S. economy matured, Friedman argued that the government had to begin removing the redundant controls it had imposed upon the market, such as antitrust legislation. Rather than growing bigger on the increasing gross domestic product (GDP), Friedman thought that governments should focus on consuming less of an economy's capital, so that more remained in the system. With more capital in the system, it would be possible for the economy to operate without any government interference. (For more on Friedman and his work, see Free Market Maven: Milton Friedman.)
The Bottom Line
Economic thought has diverged into two streams: theoretical and practical. Theoretical economics uses the language of mathematics, statistics and computational modeling to test pure concepts that, in turn, help economists understand the truths of practical economics and shape them into governmental policy. The business cycle, boom and bust cycles, and anti-inflation measures, are outgrowths of economics; understanding them helps the market and government adjust for these variables.