What is economics?

[I assign this essay for law students in my law and economics class who might be unfamiliar with economics. This essay fairly basic, and reflects the University of Chicago price theory tradition. I may periodically update it to answer questions students have.]

Economics is a social science that studies how people should and actually do allocate scarce resources amongst people and activities. Let’s unpack this sentence, part by part.1

Scarcity is central to economics. To “economize” is to make the best use of limited resources. If there were bountiful resources, predicting human behavior would be simple: people would do whatever they want. But when humans have limited resources, they have to figure out who gets what at the group level. And, at the individual level, they face trade-offs when deciding when to engage in one activity or another, to consume one good or another.2

Economics asks two types of questions about human behavior when resources are limited. One type is called a “positive” question and asks you to predict what humans will do. It makes no value judgment about the behavior. The second type is called a “normative” question and asks what humans should do. Answering requires some notion of what behavior or outcomes are good, and which are bad. It borders on philosophy in the sense it has to import value judgments to measure how desirable human behavior is.

I say normative economics “imports” values from philosophy because economists do not, in general, debate what humans should aspire to. Instead, they have coalesced around a philosophy called utilitarianism, which says the welfare of a community is equal to the sum of the welfare of each individual, where each individual’s preferences are taken as given. No effort is taken to criticize individual preferences, largely on the grounds of moral humility. Many philosophers object directly to utilitarianism. (Ask your favorite LLM about the “utilitarian monster”.) Moreover, utilitarianism rules out some other philosophies, such as Rawlsianism, which maximizes the utility of the person with the lowest utility and is popular in some, modern Western societies. Nevertheless economists tend to normatively evaluate resource allocations based on utilitarianism on a second-best argument. All philosophies have flaws, but utilitarianism has the least flaws.

While I describe positive and normative economics as asking two different questions, these two branches of the field are connected. In order to do policy analysis, i.e., decide which government or social policy is desirable, one must obviously have a mapping of policies to outcomes and then preferences across those outcomes. The first mapping requires a predictive model of how humans behave under different constraints (policy rules), i.e., positive economics, The second mapping is normative economics.

Finally, what separates economics from other social sciences, like sociology, psychology, and political science, is our basic model and methodology.3 When economics tries to predict what humans will do, it assumes–in the main–that humans have preferences (i.e., draw utility from different products and services), have technological and resource constraints, and will act as if they are maximizing their utility subject to those constraints. It is this maximization problem that helps economics predict how humans allocate scarce resources (a budget) amongst different objects that can be consumed (goods) at the individual level. At a social level, where humans have to allocate scarce resources among a group, economics examines different institutions for resource allocation, like markets, standing in lines, fighting, discrimination, etc.