Economic theories give the model of comprehending the operation of the economies, the market and the economic decisions that people and governments of these economies make every day, which in turn have a control over the economy. These theories are not mere hypothetical study; they form actual policy and give an influence over the global financial systems and economy. This paper shall penetrate deep into the contemporary economic theories, its functions and impacts on the current global economy.
What Are the Economic Theories?
Economic theories are the efforts on describing actions of people, businesses and governments, on different parts of economical behavior. These theories are used in the effort to explain the manner in which resources are distributed, the manner in which the market balances demand and supply along with the manner in which the government can affect the stability of the economy as well as its growth. Economic theories are vital to everyone who wants to join or comprehend economic systems and to policy makers and economists as well as individuals in charge of businesses.
Economic theories in the current world have changed with the modern economic theories taking into consideration newer factors such as behavioral economics and modern technology among interconnectedness in the world today. The economic theories can assist in determining the economic issues, creating possible solutions, and telling what may happen in various circumstances.
Important Economic Principles
Modern economics is very interested in a number of major economic theories. Part of the theories have played a key role in defining the economic policies and practices in the world. The most considerable ones are:
- Keynesian Economics
- Monetarism
- Supply-Side Economics
- Behavioral Economics
- Neoclassical Economics
Keynesian Economics: Government Action to Stir-up Demand
Keynesian economics Keynesian economics as developed by John Maynard Keynes in the wake of the Great Depression holds that the amount of demand in the economy is the most significant determinant to the entire economic activity. The chief notion of that theory by Keynes is that demand creates its own supply and it is the fundamental idea brought forward by him. Keynes argued that the lack of demand in the economy but especially during the recessions creates unemployment and a lack of utilization of resources caused by the inability of the private sector to create sufficient demand in order to revive the economy. Government should come in such times to increase demand and thereby spur economic growth.
Keynes urged the government to spend more during recessions even when this could result in deficit spends. He claimed that, because of injecting money into the economy by ways and means of public works and social programs, the government could bring about a demand, make jobs and generate economic growth. Moreover, Keynes was of the opinion that monetary policy (risking interest rates) to stimulate investments and consumption through fiscal policy should be employed by governments.
The Keynesian Economics uses include:
- Great Depression: The New Deal programs offered by Franklin D. Roosevelt made use of Keynesian policies, whose key aspect involved massive government spending as a means to get the economy moving again.
- World economic crisis in 2008: The number of governments applied to Keynesian stimulus packages, which led to the reduction of the economic harm produced by the financial collapse.
Monetarism: The Functions of Money Supply
Monetarism is another concept of economics that gained popularity thanks to economist Milton Friedman whose reasoning switched to the involvement of the money supply in predicting economic stability and inflation. Monetarists are of the opinion that the supply of money impacts directly to the activity level and inflation of the economy. Monetarism suggests the question of reigning the monetary amount whereby the secret of control of economic issues is trickling down.
According to monetarists, the government can still, though to a smaller extent, determine the demand through the fiscal (state spending and taxation) policy but the government should use monetary policy (regulation of the money supply) to manage the economy. They would say that excess money in circulation may inflict an inflation and back too little may result in stagnation. Monetarists also stress on the relevancy of substantiating stable and predictable monetary policies.
Uses of the Monetarism:
- Stagflation in 1970s: Monetarist ideas were actually implemented in the 1980s by central banks including The U.S Federal Reserve lead by Paul Volcker to offer to curb inflation by non-inflating the money supply.
- Present Monetary Policies: The central banks of various countries in the world especially the Federal Reserve and the European Central Bank still emphasize using of interest rates and money supply to regulate inflation.
Supply-Side Economics: Accentuating Production as well as Investment
Supply-side economics is the theory which is focused on the role of the people (businesses and individuals) who can activate the economic progress. It suggests that it is necessary to cut taxes and policies that govern businesses and those with high income level to promote investment, lead to an upsurge in production and employment and eventually be able to create a stronger economy.
The argument of supply-side economics is that, with reduced taxation of businesses and entrepreneurs, they will be able to increase revenues to be used in further growth, technology, job creation, etc. Reduced tax on individual especially high earners is also thought to stimulate expenditure and investment which leads to economic growth. Critics of this theory are saying that it favors the rich too much and is contributing to an income gap whereas proponents explain that all persons are getting their advantage through a stronger economy.
Examples of the use of Supply-Side Economics:
- Reaganomics: Also famously known supply side economy was the economic policies put in place during the presidency of Ronald Reagan in the U.S and these policies included major cuts on business and individual taxes.
- Global Tax Reforms: Supply side policies have also been embraced by many nations by reducing the level of taxes charged at the corporate level with a view to luring investors and stimulate their growth.
Behavioral Economics: The Rationality of Human Choice
Behavioral economics is the combination of information gathered by psychology with the knowledge of the classic economic theory in order to comprehend the way real people make the decisions. On the one hand, classical economics bears in mind that people are rational beings who will always take the necessary steps to maximize their utility. Behavioral economics acknowledges that individuals make decisions that are based on their emotions, biases, and other psychological events.
Behavioral economists have cited an enormous number of biases that may guide individuals to make irrational choices, which may include loss aversion, individuals fear losses more than they appreciate gains, framing effects, whereby the presentation of choices can affect the decision. The economics discipline has resulted in the introduction of novel policies, marketing and business tactics.
Behavioral Economics applications:
- Nudging: Behavioral economics helps government and company to put a vein on people so that they can make better decisions and are not bound. There is an illustration, such as automatic participation in retirement savings plans raising up the rate of savings.
- Consumer Behavior: Marketers can utilize some of the behavioral economics principles into consumer behavior like using the limited time offers to sell the products via the discounts.
Neoclassical Economics: The Market as the System of Self-Regulations
Neoclassical economics is based on classical economics but adds in marginalism, which helps incorporate the concepts in classical economics but also adds a sense of economic decisions being made at the margin, i.e. the costs and benefits of additional economic actions are considered by individuals and businesses. According to neoclassical economists, markets tend to be efficient and it is the law of nature that the supply and demand settle into a balance without the intervention of the government.
According to this paradigm, people are guided by rationality in order to maximize their utility and companies try to achieve profits. Neoclassical economics focuses on the role of the free market, competition and constrained government intervention. According to the critics, this alternative does not take into account market failures, inequality or environmental issues.
Usages of Neoclassical Economics:
- Market Liberalization: Neoclassical economic thinking remained prominent in such areas as the movement toward deregulation and market liberalization in most countries, especially during the late 20th century.
- Globalization: The neoclassical economics has also guided the policies which facilitate free trade, liberalization of markets across the world.
The Economic Theories in Development of Policy
Economic theories can not be just academic ones as they take the central stage in government policy-making. These theories are applied in taxation design of policymakers who determine the amount to be spent on social programs, the extent government interferes with markets, and set monetary policies.
An example would be Keynesian economics playing a key role in the financial crisis in 2008 whereby governments in most countries of the world implemented stimulus packages by increasing demand. Conversely, the tightening of inflation is still done according to principles of monetarism by central bank policies.
Criticisms and Imperfection of Economic Theories
With all their power to influence, economic theories are not devoid of criticisms. Keynesianism has also drawn criticisms with an expectation that it encourages unmanageable debt as a result of too much government spending. Monetarism has, in as much as it was able to curb inflation, been accused of being uncaring in issues of social wellbeing and distribution of income. The Little economic model has its opponents, as they found that supply-side economics can only benefit the rich, and behavioral economics can succeed in effective policy translation.
Conclusion
The complexities of the global economy are based on modern economic theories that give clarity on numerous aspects of the global economy. Keynesian policies on handling recessions and the monetarist policies on handling inflation the theories have distinct ideas and models on how the economic activities behave. These economic theories are likely to keep shifting as today a global economy is struggling with new challenges, including technological shifts and climate crises but not only them, and policymakers help the world become an ever-shifting world.