What is Economics?
Economics is the economic problem or study of economic problems arising from the fact that resources are scarce relative to our needs and that scarce resources have other uses. It focuses on rationally managing scarce resources in ways that maximise economic benefits at both micro and macro levels. One of the major limitations of economics is that it assumes economic agents are rational and that only economic equilibrium exists. Economics is divided into two parts:
Microeconomics
Macroeconomics.
Below is a brief explanation of micro and macro concepts in Economics.
Microeconomics
Microeconomics is the study of economics at the individual, group, or firm level. This is considered to be basic economics. Microeconomics may be defined as that branch of economic analysis which studies the economic behaviour of the individual unit, maybe a person, a particular household, or a particular firm. This is a study of specific entities rather than all entities combined. Microeconomics is also known as the theory of prices and values, the theory of households, firms, and industries. Most production and welfare theories are microeconomics in nature. A key role of microeconomics is to study how firms can maximise their production and capacity so that they can lower prices and compete in their industry.
Microeconomics
Limitations of Microeconomics
The main limitations of microeconomics are as follows:
Microeconomic studies assume that other values are constant, which is not realistic. All factors are subject to change and are not constant.
One of the important limitations of Microeconomics is that it assumes full employment. In other words, all resources are fully used in the production process, but this is only an illusion and not true.
Adopting a laissez-faire policy is unrealistic in the real world, where we see government interference in economic activity.
Knowledge of the economy as a whole is very important for people as it encompasses all economic factors. But microeconomics only focuses on a small part of the economy as a whole.
The scope of microeconomics is limited and narrow. It does not include income theory, inflation, monetary policy, etc., which are very important for economic analysis.
Macroeconomics
Macroeconomics may be defined as that branch of economic analysis which studies the behaviour of not one particular unit but all the units combined. Macroeconomics is a study in aggregates. Macroeconomics studies the links between different countries in terms of how the policies of one country affect others. Within that framework, an analysis of the successes and failures of government strategies is presented.
Limitations of Macroeconomics
The limitations of macroeconomics are as follows:
Macroeconomics deals with aggregates, which refer to individual totals. However, overall results may differ from individual behaviour.
It does not study the different effects of the aggregate on different sectors of the economy.
It ignores the contribution of Individual units.
If each data unit is different, it becomes difficult to judge.
The aggregate tendency may not affect all sectors equally.
Aggregate values cannot be used when individual items need to be considered separately.
Business Economics
Business economics is the application of microeconomics focused on subjects of great importance and interest. Business Economics deals with the organisation and allocation of a company's scarce resources to achieve desired goals. Thus, it combines the fundamentals of economics and business. The primary concern of business economics is with the company, the environment in which the company is located, and the business decision a company must make. Business Economics seeks to examine and analyse how and why a company behaves. It looks at the impact of actions, the policies of the companies that act, and the economy as a whole.
Limitations of Business Economics/Managerial Economics
The limitations of managerial economics are listed below:
Business economics focuses on business analysis based on financial and costing data. The reliability of this data, therefore, depends on the accuracy of the financial accounting information.
This analysis is based on historical information. But things change when new systems are introduced, and conclusions cannot be predicted from this previous information. Management controls are subject to the personal preferences of individual managers, which may influence to some extent, the final decisions of managers.
It is a costly process as the company usually needs a certain number of managers to keep it functioning properly.
The science of business management is relatively new and not fully developed. So, it can be ambiguous in certain scenarios.
Business Economics
Case Study
“Economics is the study of choice under the conditions of scarcity.” Explain the statement concerning scarcity.
Ans: Scarcity is the basis of an essential problem in Economics. Even free natural resources when there is a cost to acquire or consume them, or when consumer demand for previously unnecessary resources increases due to changing tastes or newly discovered uses. Without scarcity, there would have been neither economic problems nor choice problems. Without a shortage of resources, the concept of infinite needs does not exist. If resources are not limited and desires are no longer unlimited, there would no longer be a question of choice. The question of choice ceases to exist. Therefore, there should be no economic problems and no economics.
Summary
Economics is derived from the Greek word ‘oikonomia’, which can be divided into two parts: ‘Oikos’ means house and ‘nomos’ means management, so together, they mean the management of household finances. The subject of Economics revolves around the central question of the rational use of resources. At the micro level, it rationalises limited resources so that individuals can maximise their satisfaction as consumers and profits as producers, and at the macro level, economies can maximise social welfare along with rapid economic growth.
FAQs on Limitations of Economics: Challenges and Criticisms
1. What are the main limitations of economics as a subject of study?
Economics, as a social science, has several key limitations. It primarily deals with complex and often unpredictable human behaviour, making it less precise than natural sciences. Furthermore, it relies heavily on simplifying assumptions, such as 'ceteris paribus' (all other things being equal), which may not hold true in the real world. The inability to conduct controlled laboratory experiments to test theories is another significant challenge.
2. Why is economics not considered an exact or pure science?
Economics is not considered an exact science because its subject matter is human beings, whose behaviour is not constant or uniform. Unlike in physics or chemistry, it's impossible to conduct controlled experiments in a lab to establish universal laws. Economic laws are essentially statements of general tendencies that are subject to many exceptions, depending on the social, political, and psychological context.
3. How does the unpredictability of human behaviour challenge the accuracy of economic models?
Economic models often assume that individuals act as 'rational agents' who consistently make logical decisions to maximize their own self-interest. However, real-world human behaviour is often influenced by emotions, social norms, psychological biases, and irrational impulses. This gap between the assumed rational behaviour and actual unpredictable actions makes it difficult for economic models to forecast outcomes with high accuracy, especially during periods of market panic or euphoria.
4. What is the meaning of the 'ceteris paribus' assumption, and why is it a limitation in economics?
'Ceteris Paribus' is a Latin phrase meaning 'all other things being held constant'. Economists use this assumption to isolate the relationship between two variables by assuming that other influencing factors do not change. This is a major limitation because, in the real world, the economy is dynamic, and multiple factors change simultaneously. What holds true in an isolated model may not be applicable when all variables are interacting freely.
5. Can economic theories accurately predict real-world events like financial crises? Explain the challenges.
While economic theories provide valuable frameworks for understanding risk, they struggle to accurately predict the timing and severity of events like financial crises. The key challenges include:
- Complex Systems: Modern economies are incredibly complex, with countless interconnected variables.
- Data Lags: Economic data is often collected and reported with a time lag, meaning policymakers may not have a real-time picture of the economy.
- Unforeseeable Shocks: Events known as 'black swans', such as a global pandemic or a sudden geopolitical conflict, are inherently unpredictable and can derail any forecast.
- Human Psychology: Mass psychology, such as herd behaviour and market sentiment, can cause rapid shifts that models based on rationality cannot foresee.
6. How does oversimplification in economic models become a major criticism of the subject?
Oversimplification in economic models becomes a major criticism when the model's assumptions are too far removed from reality. To make analysis possible, models often ignore factors like imperfect information, transaction costs, or the influence of government regulations. While this simplifies the theory, it can lead to policy recommendations that are ineffective or have unintended negative consequences when applied to the complex, 'messy' real world where these factors are significant.
7. What is the difference between positive and normative economics, and how can this distinction be a limitation?
Positive economics is objective and fact-based, describing 'what is' in the economy (e.g., 'raising interest rates will reduce inflation'). Normative economics is subjective and based on value judgments, dealing with 'what ought to be' (e.g., 'the government should provide free healthcare'). The limitation arises because it is often difficult to separate the two. An economist's personal values can unconsciously influence their analysis, blurring the line between objective reporting and subjective policy advice, which can lead to biased conclusions.
