What Economics Means to Me
by Damien Eldridge
I am an economist by trade, training and choice. Economics is both a career and a hobby to me. In this short essay, I briefly set out some of my thoughts on the nature of economics, where it has come from and where it is going. Economics is a social science. Like other social scientists, economists attempt to understand the forces that shape the behavior of individuals, the formation of institutions and the structure of societies. The factor that differentiates economics from the other social sciences is a focus on scarcity. If scarcity is present, and it almost always is, then economic analysis is likely to shine some light on the phenomenon being considered. Scarcity forces trade-offs. As the saying goes, there is no such thing as a free lunch!
Economics began as a distinct discipline with the publication of Adam Smith's An inquiry into the nature and causes of the wealth of nations in 1776. This publication introduced the concept of the invisible hand, referring to the process by which the interaction of agents in unimpeded markets resulted in an improvement in social welfare. The logic underlying this result is incredibly simple. If two people choose to trade with each other, then both of them must be better off. After all, if this were not the case, then the agents would not agree to trade in the first place. Despite the simplicity of this idea, it took the best part of two centuries for economists to formally establish the conditions under which this result is true. During that time, the primary focus of economics was on the operation of markets in a competitive setting and the properties of the resulting allocation of resources. This work culminated in the establishment of the existence and welfare properties of a general competitive equilibrium. These results are incredibly important because they provide a benchmark model of the operation of an economic system. This benchmark model establishes the conditions under which Adam Smith's invisible hand actually works. It also provides a starting point for the analysis of what happens when these conditions are violated.
While the general competitive equilibrium model of an economy provides an important benchmark, it leaves many of the most interesting questions unanswered. In particular, it does not provide an explanation for the existence of many economic and social institutions. These include families, firms, clubs, retailers, unions, governments, money and even markets themselves. Furthermore, the general competitive equilibrium model of an economic system does not provide an analysis of the nature of competition when economic agents are neither so small that they have no influence on the markets in which they participate nor so big that they completely dominate the markets in which they participate. Nor does it provide an analysis of the process of price formation. An analysis of the existence and operation of institutions, the nature of competition and the process of price formation all require the use of game theoretic techniques. Many of these techniques have only recently been developed to a point at which they can begin to be used in analysing these phenomena. The potential for game theoretic techniques to shed light on some of these important aspects of societies that we do not yet completely understand ensures that it is an exciting time to be an economist.
Damien Eldridge joined La Trobe University as a lecturer in the Department of Economics and Finance in June 2006. He is also a PhD candidate in the Department of Economics at the University of Texas at Austin. In addition to his academic qualifications, Damien has a number of years of practical experience that was gained while working as an applied microeconomist for a variety of Australian Public Service agencies and an economic consulting firm. His research interests include Microeconomic Theory, Game Theory, Industrial Organization and Applied Microeconomics. Damien Eldridge, Melbourne, Victoria, Australia.