Branches of Economics

The essence of economics Opens in new window is the wellbeing of the people, which is formulated as the maximization of social welfare function.

Interestingly, economic activities lead to transformation of natural resources into consumable/usable goods and services.

In other words, production of goods and services, create income earning job opportunities for achieving best outcomes of social welfare function.

What Are The Main Branches of Economics?

Like most other disciplines, economics is divided into several branches and subbranches; the two major branches, are

  1. Microeconomics, and
  2. Macroeconomics.
  • Microeconomics is the study of the behavior of individuals and well-defined groups of individuals in the society, such as households, firms, and industries.
  • Macroeconomics, on the other hand, is the study of broad aggregates, such as national income, employment, consumption, and investment.

In a sense, the micro-macro distinction is artificial because the actual decisions about production, consumption, employment, investment, etc, are made by the micro-units of the economy.

Therefore, the basic principles of economic theory are those which explain the behavior of these micro-units. However, the distinction is justified by the basic differences in the objectives and methods of the two branches.

  • Microeconomics deals primarily with the analysis of price determination and the allocation of specific resources to particular uses.
  • Macroeconomics, on the other hand, deals with the determination of the levels of national income and aggregate resource employment.
  • While microeconomics deals with individual prices and their relations to one another, macroeconomics deals only with aggregate price indices.

As a result, the relationship between individual units and aggregates is not clear in macroeconomics. Nevertheless, the simplifications introducted by aggregation are quite useful.

Despite the great usefulness of microeconomics (and, in particular, the general-equilibrium theory) to an understanding of the way in which the individual decision-making units of the economy fit together to form a coherent whole, its practical use in explaining aggregate behavior is severely limited by its enormous complexity.

A more practical approach is offered by macroeconomics, which attempts to describe the behavior of the economic system in terms of a few simple aggregates and aims explicitly at influencing public policy.

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When properly understood, microeconomics and macroeconomics become complimentary rather than competitive branches of economic theory. Thus,

Positive Economics versus Welfare Economics

Microeconomics is further subdivided into:

  1. Positive economics, and
  2. Welfare economics.

Positive economics is the study of what actually is. That is,

Positive economics deals with the problem of how the economic system actually functions, why it produces the results it does, and how changes in the fundamental data of the economy (such as factor endowments Opens in new window, factor ownership, tastes, and technology Opens in new window) affect the solution of the economic problem.

It is important to observe that positive economics is, in principle, independent of ethical judgments, and its propositions can be tested against the facts of the real world which they purport to explain.

Welfare economics, on the other hand, is the study of what ought to be. It deals with propositions which are themselves logical deductions from a set of assumptions which may or may not be ethical in nature.

In contrast with positive economics, the proposition of welfare economics cannot be tested against the facts of the real world for the simple reason that welfare is not an observable quantity.

Usually, welfare propositions are tested indirectly by testing the assumptions from which they have been derived—and this is an extremely delicate task. The conclusions of welfare economics depend crucially on ethical judgments.

Perhaps an example might make clearer the distinction between positive and welfare economics.

Consider an economy Opens in new window which is contemplating the removal of a tariff on an imported commodity, M.

  • What effects would the removal of the tariff have on the domestic production, consumption, imports, and price of commodity M and of each and every other commodity?
  • Would the removal of the tariff tend to raise or lower real wages and other factor rewards?

These questions belong to the realm of positive economics.

Notice that the accuracy of the answers given to the above questions (i.e., the conclusions of positive economics) can be tested directly against the actual events which will take place after the removal of the tariff.

Consider the following questions.
  1. Will the removal of the tariff make the workers (of the economy contemplating the removal of the tariff) better off or worse off?
  2. What about the effects of the removal of the tariff on the welfare of the owners of land and capital?
  3. Should the tariff be removed or not?

These questions belong to the realm of welfare economics. They all involve a comparison between two situations:

The situation which actually exists before and that which will exist after the removal of the tariff.

Therefore, any answers that welfare economics has to offer necessarily rest on a prediction about the consequences of doing one thing rather than another, a prediction that must be based on positive economics.

What ethical judgments are involved in answering questions (1) – (3)? Questions (1) and (2) can be handled simultaneously.

Consider the case of a single individual, whether worker, landlord, or capitalist. Positive analysis Opens in new window can show whether, after the removal of the tariff, he moves to a higher or lower indifference curve.

To be specific, assume that he moves to a higher indifference curve. Does this mean that this particular individual is better off after the removal of the tariff?

Not unless we make the ethical judgment that no one else but the individual himself is the best judge of his wellbeing.

Without this ethical judgment, we may say that he moves to a higher indifference curve, but we are then only describing how he acts—we are not judging his welfare.

Consider now question (3):

Should the tariff be removed or not?

If social welfare increases with the removal of the tariff, the tariff should be removed; if social welfare decreases, it should not be removed; and if social welfare remains constant, it makes no difference.

But what is social welfare? And how can we find out whether it increases or decreases with the removal of the tariff?

To answer these questions, additional ethical judgments are required. For instance, we postulate that social welfare depends on the welfare of the individuals comprising the society, and on nothing else.

The mathematical expression of this statement is the Bergson–Samuelson social welfare function Opens in new window in its general form.

This function is usually made a little more specific by attributing to it an ethical property, namely, that social welfare increases when one individual becomes better off, with no one else being worse off.

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Now, if the removal of the tariff were to make everybody better off, we could immediately conclude, on the basis of the ethical judgments made so far, that the tariff should be removed. But this is a big if.

What if the removal of the tariff made some people better off and others worse off?

In this more likely case, several alternatives are open to us, and which of course are beyond the scope of this post.

What is important right now, however, is that the propositions of welfare economics depend on ethical judgments whereas the propositions of positive economics do not.