Nature and Structure of the Economy

NATURE OF THE ECONOMY

The nature of economics is related to the study of wealth or human behaviour or of scarce resources. The scope is very wide and includes the subject matter of economics whether economics is a science or an art or whether it is positive or normative science.

Wealth and Welfare Connotations

Wealth and Welfare connotations are segregated into the classical view of Adam Smith and Neo Classical View of Marshall. First, Let us discuss Classical view and the relating contemporaries.

The Classical View and Contemporaries

The Classical Economist Adam Smith defines Economics as the science of Wealth. He defines as “nature and cause of wealth of nations” whereby it”proposes to enrich people and sovereign”. The classical view is misleading and has serious defects. This view of conception of economics as a science of wealth which laid exclusive stress on material wealth. Material wealth is the object of desires of man. Wealth was considered to be the stop in itself. By stressing on the word”Material Wealth” Economist Adam Smith narrowed the scope of Economics by excluding all material activities which are related to the production of non-material goods and services such as Engineers, Accountants etc.

Now, after bearing in mind the classical view of Adam Smith, we are going to see the Neo Classical View by Economist Marshall and its Contemporaries.

Neo-Classical View and Contemporaries

Alfred Marshall led neo-classical school which placed all the economists a reputable position among social science. He emphasised on a man’s welfare. Wealth was observed as the basis of human welfare, not stop in itself but a means to a stop. According to Marshall”Political Economy or Economics is a study of mankind in the ordinary business of life. It inspects that part of individual and social accomplishment which is most intimately associated with the achievement and with the use of the material conditions of well being. It is on the one side a study of riches and on the other and more significant side a part of study of man. The contemporaries are it excludes activities of socially disagreeable and non-standard persons like thieves, misers etc, non-economic activities and activities having dishonorable ends are excluded from the study of economics.

Scarcity Definition of Robbins

According to Robbins, “Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.” It was Lord Robbins, who exposed the rational discrepancy and insufficiencies of other economists’ definitions.

Growth Oriented Definition

Modern Age is the age of economic development. Its key purpose is to enhance social wellbeing and progress the standard of living of the people by getting rid of poverty, redundancy, disparity of income and wealth, malnutrition etc. of the realm. Hence the financial development is the essential point of all economic policies.

Subject Matter of Economics

The subject matter of economics is the study of grounds of material interests or as the science of wealth. Men who are sensible beings and take action under the active social, legal and institutional group. It eliminates the performance, manners of socially objectionable and uncharacteristic persons like misers, thieves etc. It consists of the study of the exertion of consumption, production, exchange and distribution of wealth, as well as the fortitude of the values of goods and services the amount of employment and the determinants of fiscal development. Further it comprises the study of grounds of poverty, unemployment, under employment, inflation etc. and actions for their elimination.

Economics as a Science

Economics is a science since its laws have widespread soundness such as the law of diminishing returns, the law of diminishing marginal utility, the law of demand etc. It is called as a science since its self-remedial nature. It goes on amendments in the dawn of new specifics based on interpretations. Hence Economics is a science like any other science that has its own generalizations, theories or laws of economics which traces out a casual relationship between two or more phenomena.

Economics as an Art

The practical application of scientific techniques is the Art of Economics. Some economists consider economics as a science and art while few others as science and applied science. It is considered as newest of science and oldest of arts and the queen of all the social sciences.

Economics as a Positive Science

As per the nineteenth century experts, economics is a positive science. Since it seeks to explain what has actually happened but not what is ought to happen. According to J.N.Keynes, Positive science is defined as “A body of systematized knowledge concerning what ought to be and concerned with the ideal as distinguished from the actual.”

Normative Economics

With contrast to the Positive Science, Normative Science deals with the”what is ought to happen” cases. That is predictions of future economic development with regards to the present conditions are discussed in this. The postulations on which economic laws, theories or principles are based relate to man and his problems. If we attempt to test and forecast fiscal actions on their basis the subjectivity elements always penetrates. Therefore, the laws of economics are at best propensities.

STRUCTURE OF THE ECONOMY

Understanding the economy requires a basic knowledge of the key flows that influence economic activity. How do interest rates affect households and businesses? How does government policy influence GDP? Forming a view on these and many other policy questions requires some knowledge of the economy’s structure.

The two institutions that have the greatest effect on the economy are the Reserve Bank (RBNZ) and the government. The RBNZ has the most influence on economic activity. By raising or lowering interest rates the RBNZ can control economic activity. The government sets the agenda for medium to long-term economic growth by putting in place the necessary economic institutions and frameworks. The Governor of the Reserve Bank, will influence how the economy performs within the context of the economic infrastructure, but the government has the ability to alter that infrastructure.

A basic model of the economy

Those influences are easier to understand if we have a simple model of how the economy works in mind.

Imagine a bathtub full of water, where the water level represents the level of employment or economic activity.

There are two drains on the bathtub: taxes and savings. The government collects taxes and then uses it to fund a lot of other activities like health, education, justice, social welfare, etc. The government can control how much it spends through its annual Budget.

Savings are invested either by households or by businesses. So we could put our savings towards a house, or we could it put in the bank. The bank would then lend it to businesses to invest. That comes back to the economy.

Now comes the trade-off: if the economy falls below the ‘full employment’ level there is unemployment. If it rises above that level then there is inflation. Both of these are undesirable; we don’t want mass unemployment, nor do we want very high inflation.

How much of the taxes and savings coming back into the economy depends on two key agencies: the government and the RBNZ. By controlling fiscal and monetary policy respectively they control the ‘taps’ that fill the bathtub back up. The government decides, for example, how much to tax and how much to spend. On the savings and investment side the RBNZ’s key instrument is the interest rate.

The key thing to realise is that the government and RBNZ cannot simultaneously reduce inflation and increase employment, so they face a trade-off between the two. If they were to try, then the two ‘drain’ and ‘tap’ mechanisms would be fighting each other and get us nowhere.