The study of economics is often confused as being the study of money, banking or stocks however, the field of economics spans far greater than these components of the economy. This page aims to break down some of the biggest myths surrounding the subject and explain the kind of questions economics seeks to answer. We hope this also provides some insight into how studying economics can lead to a fulfilling and exciting career.
What is economics not?
There are many misconceptions surrounding the study of economics. Before we discuss more about what economics is, first it is probably best to tackle some of the biggest myths of what economics is about. Economics is often thought of as:
- The study of money
- Only for people who want to make money
- Studying stocks and bonds
- Doing equations on a blackboard
The study of money:
While economics certainly looks at money, what it is and how we can use it, money is just one aspect of economics that is rarely looked at in isolation. Economists care more about what money represents (usually goods and services), and how it is influenced by things like inflation or exchange rates. A common question people ask, typically in times of economic downturns, is “why can’t we just print more money?”. Of course, this is a question that most economists are equipped to answer however, depending on your workplace you may never have to address this. If you work in the Bank of England, then you will most definitely analyse questions like these at length and regularly but if you work in the field of energy economics then you are far less likely to cover this small part of economics.
Looking at stocks and bonds:
Stocks and bonds are a part of the economy which many consider very important. They play a key role in investment and savings and so have been studied extensively by some economists, but they are also just one cog in the machine of the economy. Some economists dedicate their lives to studying stocks and bonds, others may rarely even consider them in their analysis.
Only for people who want to make money:
While it is true that students who study economics at university tend to have some of the highest incomes of any undergraduate degree, all economists have different motivations for choosing the subject. Many economists go on to work in non-profit organisations, in research or in public service, where wages can be lower than in the private sector.
Due to the valued skillset that economists develop, there are few sectors that an economist cannot work within in some capacity. This skillset includes being able to look at problems objectively, being comfortable with complex systems, being able to describe relationships in the real-world and being able to analyse data with statistics. Economics also teaches you the ability to communicate complex ideas in clear and concise ways.
Doing equations on a blackboard:
Some people are put off by the idea that being an economist is all about manipulating maths equations with little connection to the real word. While much of economics features mathematics, and some economists certainly do spend much of their lives thinking about abstract mathematical ideas, most economists care about how their ideas relate to the real world. This means using data to test the accuracy of theories, and study real world events.
Most economists today do not work in academia working on obscure maths problems, but instead work on current problems which need immediate solutions in businesses, research institutions, think tanks, government and non-profits. We call this “applied economics”, as it involves applying economic theories, statistics and tools to real world issues.
An unfortunate misunderstanding held by many is that economics and capitalism are inseparable. Many young potential economists are likely put off by the idea that economics is all about a free market capitalism that they do not agree with.
While many in the profession may hold capitalism in high esteem, economists can hold a huge range of differing views. The failures of capitalism are widely acknowledged and studied within economics; its merits are fiercely debated. Studying how to reduce inequality, discrimination and the destruction of the environment are all important areas of research in economics today. Economics, as a subject, benefits hugely from having a wide range of perspectives to draw upon.
There are a huge number of different economic schools of thought, it is our responsibility as economists to use data and evidence to try to distinguish which ones best represent reality. It is worth noting that communism and socialism are economic ideologies, concerned with the relationship between humans, technology and our natural resources.
What is economics?
What does the subject study?
You could ask 10 different economists what economics is and get 10 different definitions, but there will certainly be key themes across their answers. Economics is at its core a human science, concerned with human behaviour at the level of the individual to the level of society.
Economists study how economic agents (individuals, households, firms, government and central banks) optimally choose how to use the limited resources of our planet. Along those lines, many economists call the subject “the study of choice” or “the study of decisions”. They study what we choose to create, how we choose to create it and how we choose who gets it. As you might guess, this covers a lot, from prices to business to the role of government to equality to the psychology of decision making.
One way that economists describe how we make decisions is through incentives. Incentives are rewards and punishments for taking certain actions. These incentives influence the decisions you make and could involve almost anything. The wage you are paid, whether something contributes to a goal you have, a price you would have to pay or cultural opposition to certain behaviour are all examples of incentives. These incentives do not guarantee the decision you make, but they might make you more likely to take certain courses of action.
Economists generally try hard to look objectively at the various trade-offs in incentives, which may force you to consider many perspectives. Former president of the United States, Harry Truman, once complained that he wanted a “one hand economist” that did not say “on one hand this but on the other hand…”.
Types of Economics
The two biggest groups in economics are microeconomics and macroeconomics.
Microeconomics studies individual people and companies – how they make decisions and the incentives they are influenced by. These might help you understand how a person decides between work and leisure or how a company sets its prices compared to competitors.
As an example, here is a famous economic problem in Game Theory, a field of economics that tries to find the best strategies for economic agents in well-defined environments like a game.
In the Prisoner’s Dilemma, two criminals are caught by the police and are placed in separate rooms. They both are given the option of confessing to the crime or staying silent.
If both stay silent, they both go to prison for a short amount of time, only 1 year. If either confess while the other stays silent, the police give the confessor a deal – they do not go to jail while their partner in crime goes to jail for 3 years. Finally, if both confess, then they both go to prison for 2 years.
Using Game Theory, we can use a simple model to describe the situation and figure out what both players are likely to do.
Each of the 4 squares shows the payoff of Criminal 1 and 2 under each of the strategies - each criminal shown by either the orange or blue. 1 year of prison gives a payoff of -1.
Since both criminals want to spend as little time in prison as possible, they both want to choose the strategies where they have the highest (least negative) number.
If both players stay silent, then Criminal 1 will know that by confessing, they can reduce the sentence from 1 year to 0 years. Criminal 2 knows the same. So, they are both incentivised to confess.
If one player confesses and the other stays silent, then the silent player will have to go to prison for 3 years. Knowing this, the silent player would be incentivised to confess as well, to reduce the sentence to 2 years.
Finally, if both players think the other will confess, then they know that if they stay silent that they will have to go to prison for 3 years instead of 2 years.
In this way we can see how our decisions are shaped by incentives. In this situation, both players will confess to the crime (shown by the underlined numbers), as they are incentivised to do so. This is despite the fact that staying silent would have been a better option for both of them.
This is just one of the many ways that microeconomists look at decision making. You can imagine how looking at decisions like this can help us design systems that incentivise individuals, business and more to make better choices.
Once we understand how many individuals make decisions, we might think about how all of those decisions result in behaviour at the level of a country. Macroeconomics looks at society as a whole, at a regional, national or international level.
Macroeconomics helps us understand how millions of individuals and businesses making their own small decisions adds up to big changes for the whole country. This includes the numbers you see in the news every day, such as Gross Domestic Product (GDP, the value of all final goods and services produced in an economy), unemployment and economic growth.
One major thing that macroeconomists study are economic crises. These are events that result in GDP falling, often resulting in a rise in unemployment. We have seen two big economic crises in the past 15 years, one back in 2008 to 2009 called the Great Recession. The most recent caused by the Coronavirus pandemic.
Both of these events have massively different causes and effects. The Great Recession of 2008 most economists consider to be the result of the poor regulation of mortgage lending in the USA and Europe.
At its core, banks in the US and Europe were giving out mortgages for new houses to everyone and anyone, causing house prices to rise rapidly. The result was a “housing bubble burst” after many people could not afford to pay their mortgage. House prices fell massively and the value of mortgage-backed investments followed, causing banks and investors to go bust.
Many banks, including Lehman Brothers, Northern Rock, UBS and Lloyds failed or had to be saved by governments. These effects spread around the economy from one industry to another, causing businesses to fail and people to lose their jobs.
The coronavirus economic crisis, on the other hand, was entirely self-imposed by countries trying to keep their citizens safe by forcing them to stay at home. While the causes of this crisis are easier to understand than the causes of the Great Recession, its effects are very uncertain, and many economists disagree about how severe the impact will be.
Macroeconomists study topics like these to understand the causes of these events and help design government policies to make sure they do not happen again.
Use of Mathematics:
One thread that runs through much of economics is the use of mathematics. We use math to describe relationships in an economy. Not all maths used by economists is difficult. Consider the equation for aggregate demand in an economy, or the value of all goods and services that individuals, organisations and government want to buy in a year.
Y = C + I + G + X - M
The equation is simple: C is consumption, how much we spend on goods and services; I is investment; G is government spending on goods and services; X is exports to other countries; and, M is imports. We can add these all up to derive aggregate demand.
Writing out the equation makes it clearer, but also lets us manipulate it to see how the relationships change in certain situations. For instance, we can now write out the equation for consumption as:
C = Y - I - G - X + M
Using this kind of maths manipulation, we can learn new things about the relationship between different parts of an economy.
Statistics, on the other hand, allows you to collect and study information about economic indicators. This can help us understand what is happening in the real world, helping us improve our understanding.
We call statistics applied to economic problems Econometrics. It is one of the major approaches to understanding economic problems.
Studying statistics is needed to make sure that the information we collect about the world is reliable and representative.
A great example of poor statistics comes from the 1936 presidential election. One newspaper, the Literary Digest, predicted a landslide win in the election for Republican Alf Landon. If you have never heard of him, that is because the result was a terrible failure in polling. Democrat, Franklin D. Roosevelt, did not just win the election, but won in every state except 2.
What went wrong with the Literary Digest’s poll? The survey was conducted entirely over postcard or telephone. The only people who owned telephones in 1936 were very wealthy and usually a republican, therefore their sample size was extremely skewed towards Alf Landon.
Good statistics teaches us how to understand information about the world such that we do not make mistakes like that. While many data on economic indicators are collected from business surveys or from direct accounts of use, many have to be estimated and we rely on good statistical practice for the reliability of these estimates.
Economics vs the other social sciences
While maths is very useful in economics, the nature of studying humans means that economics cannot escape the need for more qualitative subjects like psychology, sociology and philosophy. When economists look at a decision, they often have to take culture, ethics and irrational thinking into account.
Many breakthroughs in economics over the years have come from academics with non-mathematical backgrounds. Behavioural economics tries to model decisions using techniques from psychology. Philosophy, on the other hand, has been drawn upon throughout the history of modern economics, especially when thinking about how we think the economy should be.
What can we do with economics?
Armed with the tools provided to study human decision making, there are few things that have not been studied by economists. Fields in economics look at the economics of law, crime, family, inequality, politics and more.
Here are two examples of interesting applications of economics:
- Using economics to catch teachers cheating on student’s exams
- Using economics to study whether referees are biased
In 2003, a scandal rocked state schools in Chicago, Illinois. Reports from students about cheating made its way to the news, but it was not the children who were the offenders, this time it was the teachers!
This prompted renowned economist Steven Levitt to study the exam results and try to see if he could find out which teachers were cheating, and why. In Chicago, schools with the lowest performing students would be placed on probation, and students who did not meet a minimum of scores would have to repeat the year. Levitt hypothesised that this incentivises teachers to raise the test scores, and cheat on the student’s tests. Cheating methods that had been reported included:
- Changing student’s answers
- Filling in the blanks when a student fails to complete a section
- Allowing students extra time to complete tests
- Providing correct answers to students, or;
- Obtaining copies of an exam illegitimately prior to the test date and teaching students using knowledge of the precise exam questions
Using economic statistics (we call econometrics), Levitt studied the multiple-choice question answers of thousands of students and found suspicious patterns in many of the answers. He found that classrooms with very suspicious test answers also had much higher test scores one year, followed by not as good scores the next, indicating a teacher in the first year had cheated.
His results detected cheating of the most obvious kind in around 5% of all classes across Chicago. Additionally, he found that when the incentives changed just a small amount, for instance if a class had fewer students who would have to resist the year, decreasing the incentive to cheat, he saw large decreases in the scale of cheating.
Using these methods, Levitt started a business to help public schools catch cheating teachers, but to his surprise, no schools even wanted to discuss hiring him. Public schools seemed to benefit so much from the cheating that they had nothing to gain from his services. He had made a cheating detector so good that nobody wanted to use it.
You can read the entire article on cheating in teaching here.
One environment that economists sometimes like to study is sport. Sport offers an environment with very simple rules that can be written down, with players and teams that have clear rewards for winning and punishments for failure. This provides us with a relatively “noise-free” environment to look at how humans make choices.
One study, by Garicano, Palacios-Huerta and Prendergast, set out to ask how our behaviour is affected by non-monetary incentives, or motives that do not involve money.
In football, the amount of extra-time provided at the end of each half is decided entirely by the professional referees. This extra-time is supposed to reflect unusual stoppages during the game, but nobody keeps track of this specifically. Looking at how much extra-time is given under different situations, thought the authors, could tell us something about how social pressure causes corruption.
Using quite simple statistics, the authors found very strong evidence that referees were biased, but perhaps not in the expected ways. Instead of being biased towards particular teams, the evidence showed that the referee favoured the home crowd.
If the home team is ahead, the referee allows about 30% less extra time than average; when the home team is ahead, 35% more time is allowed.
When the differences in scores between teams is more than 2 points, the referee typically stops being biased and gives around 3 minutes of extra-time regardless of who is winning. This can be explained since the incentive for corruption is lower. This is supported by favouritism being absent at half-time, when the extra-time is unlikely to be important to the result.
So, while you may always have suspected that referees were biased, economics has here provided us with answers as to how and why.
Read the article here.
Why is Economics Important?
While these examples are fun, it is important to remember that economics also has very powerful implications on the world around us and is used to study many of society’s biggest problems like pension savings and climate change.
Here are some examples of papers which use the same types of tools to answer important questions:
- Using behavioural economics to increase saving for your pension
- Using economic modelling to calculate the cost of climate change to the world
Saving More, Tomorrow
Behavioural economics has become one of the most innovative and revolutionary new fields in economics. Coming from the field of psychology, these economists take people’s complicated and imperfect decision-making as a given and asks how we can best design economic policy to make irrational economic agents do the rational thing.
One of the great contributions from this field has come from Richard Thaler and his “Nudge” theory. Thaler observed that people have tiny barriers in decision making which cause them to make decisions that they would not really want to make if they were to consider all the real costs and benefits.
Richard Thaler believes this, “Libertarian Paternalism”, approach should be used in government policy. Like libertarianism, people are still free to make choices on what they want, however their choices are guided by a “paternal” government who is better informed. This prevents governments forcing decisions on their citizens, while encouraging people to make better choices.
One area where this has had huge effect is in retirement savings. Between 1983 and 2010 the number of people with inadequate retirement savings increased from 31% to 58%, potentially a huge problem for the future. Thaler showed that you could increase the number of people on effective retirement plans through a few psychological tricks, and with near zero cost to companies and government implementing the policies.
In one paper, Richard Thaler and Shlomo Benartzi set out 3 policies for doing this that they termed ‘Save More Tomorrow (SMT)’.
The first policy they call autoenrollment. This is changing from an “opt-in” to an “opt-out” method, where you have to check a box to not join the savings plan. This overcomes employee’s procrastination and forgetting to join the savings plan.
The second is asking employees to commit to a higher savings rate in the future, not today. People find it easier to make decisions that delay costs into the future, for instance in a few months, or next January.
Finally, they advise that savings rate should be linked to pay rises: studies have shown that people do not psychologically notice losses in income as much when it is accompanied by a larger increase in income.
So did this work? Using just these three methods, the saving rate in some companies grew from just 3.6% to 13.6% in under 4 years.
By demonstrating the effectiveness of policies like these, behavioural economics has become very influential in government’s policies.
The UK government now have a Nudge Unit to help people make better decisions and increase the effectiveness of policies. One policy developed by this new unit is in organ donations.
Up until recently, anyone who wanted to donate their organs after death had to “opt-in” to the program. While most people probably would not mind if their organs were donated, lots of people would never, in their complicated lives, get around to actually “opting-in”. This has resulted in shortages of organ donations.
The Nudge Unit proposed that we change the policy to an “opt-out” approach, where you must tick a box, or fill in some paperwork, if you do not want your organs donated. This still gives individuals the choice to donate your organs or not, but subtly pushes you into making the decision that is better for society.
Read the Saving More, Tomorrow paper here.
The Cost of Climate Change
Perhaps the biggest challenge of our generation, and future generations – climate change. The increasing of global temperatures because of greenhouse gas emissions, is one that has been studied extensively in economics. One study on the subject from 2006, commonly called the Stern Review after it’s author Howard Stern, was particularly influential.
The Stern Review was commissioned by the British government under Tony Blair to try to quantify the costs of climate change. The Review took a global and very long-term perspective.
How would you go about putting a number on the cost of such a big problem? This is a very difficult question to answer, and this paper was not without its critics. The Review’s approach was first to take a high estimate for the cost incurred from the effects of climate change for this generation and the costs over all generations into the future.
The results of the study took headlines across the world: the cost of climate change is likely about 5% of global GDP, every year, and forever more, unless we take drastic and immediate action. Under some scenarios, climate change could cost us as much as 20% of GDP.
The effects of this study were enormous. The Stern Review forced politicians to consider the dire consequences of no action on climate change. The idea of taxing carbon, the recommended policy in the Review, was mostly outside of the mainstream political debate before its publication, but afterwards became central to government climate strategies across the world.
While today many would consider the impact of the Review to have been largely positive because of its impact on the public perception of climate change and its policy impact, it was very controversial among economists. Core to the problem was the problem of how to value the decisions of future generations.
The author of the paper, Howard Stern, decided that it would be unethical to value future generations, say people in the year 2200, less than people today. He therefore set the discount rate, or the amount we care about today’s generation over future generations, at almost 0%. Most economists would say a figure more like 4% would be more appropriate, so you would care about the next generation 4% less than your own, and the one after 4% less than that. Would you really care about people in the year 2800 nearly as much as your own children?
The Stern Review is an interesting example for 3 reasons. First of all, it shows the importance of economic analysis in the most important decisions the world faces. Secondly, it is an example of how economics cannot distance itself from the philosophical questions that other social sciences face – that economic analysis requires ethics and a human perspective. Finally, the actual results of the study are of huge importance - while economists debated over Stern’s figures, they almost all agreed on one thing, the carbon tax needs to be much higher, and it needs to happen now.
You can find the complete Stern Review here.
Benefits of Studying Economics
Studying economics can lead to one of the most rewarding and fulfilling careers of any discipline. As an economist, your work has the opportunity of being very relevant and influential to governments, individuals and businesses.
Good economic analysis helps individuals, policymakers and businesses to make better decisions on a day-to-day basis. In applied economics, we care about problems that have real implications, looking objectively and weighing the costs and benefits of a problem or proposed solution.
While some economists work as academics at universities, most economists work at independent researchers, companies, consultancies, non-profits or the government. This research is often more relevant to current issues and intended to provide solutions to immediate problems.
Whether choosing the right amount to save for your pension, designing a better welfare system for the government, or forecasting next year’s sales for a business, you can use applied economics.
This kind of research and analysis by economists is actually used in government and companies, as well as widely discussed in the media. The debate around Brexit, immigration, the Scottish independence, and climate change, to just name a few, is often framed by economic analysis and estimates. This is not to say that economics is the only consideration for these problems, but they are very important and rarely ignored.
Here are some examples of research that economists do every day and its impact.
Gender Pay Gap
Every year many economists have to battle with misinterpretations of the gender pay gap – the difference in average pay between men and women. Questions such as how big the gap is, how it is changing and how much can be explained by discrimination are asked whenever new data becomes available.
The British consultancy company PWC produces a yearly report they call the Women in Work Index. This compares women in the workplace in the UK, and the UK’s regions, to similar countries.
They estimate that the OECD (a group of rich countries including the UK), could increase female earnings by £2 trillion by eliminating the gender pay gap, and that UK GDP would increase by 8.9% if the pay gap closed to the level seen in Sweden.
The results of Women in Work Index 2020 were discussed in the UK parliament when the gender pay gap was debated in April 2020. Research like this is necessary to hold the government’s policies accountable and find new approaches to solving big problems.
Read the Women in Work Index 2020 here.
Universal Basic Income
One policy proposal that has seen a lot of media attention in recent years is on the topic of Universal Basic Income, or UBI. UBI is a proposed welfare benefit that would replace many of the current benefits with a guaranteed payment to everyone in a country. This basic level of income should be enough to live off of, without the need for unemployment benefits.
UBI has become a hot topic recently, with economists from all walks analysing its effects on wellbeing and the economy. In the past 20 years, hundreds of research papers and models have been written on the topic.
In June 2020, the Fraser of Allander Institute carried out some analysis on the results of a UBI policy. They showed that UBI could hugely reduce poverty when compared to current universal credit, but that it could cost over £7.2 to 38 billion depending on the level of the benefit.
While no country yet has put a UBI policy into place, the idea has become more popular. Applied economic research is sure to be the most important consideration as more politicians warm to the idea.
Read the Fraser of Allander article on UBI here.
Get involved with economics
Economics is a diverse subject with many branches studying all aspects of society from many perspectives.
The work of economists is highly valued across sectors. From academia to consultancies to think tanks to charities to governments, your work can bring about big change for the better.
Economic research often frames the conversation around the biggest issues in society, leading to changes in policy, better business and a more informed public.
The study of economics spans far beyond stocks and shares, and has a real impact on the welfare of all of society.