What Economics Means to Me

by: Rick Evans

At the heart of economics is the study of outcomes based on tradeoffs between costs and benefits. One of the broadest categorizations of the various fields within economics is between microeconomics (individual or firm-level decisions) and macroeconomics (regional, country-wide, or world outcomes). But one discovers quickly that even these most basic categories are not terribly helpful because some macroeconomic studies begin with the microeconomic decisions of individual agents and other macroeconomic studies treat the outcomes of regions or countries as the decisions of individual agents. In fact, a large degree of overlap exists among the categories of any taxonomical description of the fields of economics. All the fields of economics attempt to increase our understanding of individual decisions and aggregate outcomes in the face of tradeoffs between costs and benefits.

More illustrative of what economics means to me is a diagram that Russell Cooper put on the board on the first day of his Macro 1 graduate course in September 2003. Below is my interpretation of what he wrote.

For me, the key interaction in economics is among theory, data, and policy. I think the process usually starts with data, although I can come up with stories in which the process starts with policy or theory. In the world, we observe data. These may be relationships, facts, statistics, or other phenomena. We propose theory in order to explain or understand these data. The theory can be classified as economic theory when it includes a tradeoff between costs and benefits. The theory is then tested by bringing it back to the data in order to see how well it explains the data and how well it fits with other data that might not have been related to the original question. If the theory does not fit well enough, the process is repeated and the theory is iteratively refined. If the theory fits the data well, then it can be used for the normative purpose of designing policy. New policy creates new data which must then be evaluated and interpreted through the iteratively refined lens of theory, and the circle of economics continues forever.

In my mind, economic research is most useful and exciting when it provides new insights or implications for individual decision making or policy. One of the most successful economists at influencing policy was the late Milton Friedman. His theoretical and empirical work has influenced policy in the United States and throughout the world. Examples include the inflation targeting focus of monetary policy, the ending of the draft in United States military recruiting, and the implementation of the flat tax in Estonia.