Economics is a social science that studies the economic relationships and behavior of individuals, organizations, societies, and nations. The theories studied in economics are based on the facts relating to the behavior of human beings and other economic participants. Any fact-based on established and verified hypothesis got the status of theory. The theory that is not based on fact is unproductive and meaningless.
A theory expresses a cause and effect relationship between different variables in consideration. It attempts to describe the answer to issues like why. Definitions of different terms set of assumptions about the behavior of the subject matters etc. are major content of the theory. After setting assumptions theory is to follow logical deduction to discover the implied mean of assumptions. These issues and implications are the predictions of the theory and that are to be tested by the procedure of observation, statistical tools, and data analysis. If the theory passes the test no simultaneous works are to be performed. However, if the theory is refused by the test then either it is amended or discarded.
Thus in real-world theory means to explain, understand, and predict phenomena in the real world, and the theory must be related to, tested by empirical observations of the real-life of people.
Ernest Nagel defines economic theory, “as a set of statements, organized in a characteristic way, and designed to serve as partial premises for explaining as well as predicting an indeterminately large class of economic phenomenon.”
The theory is always different from the hypothesis. A hypothesis is a postulation and an idea that is anticipated for investigation and observation so that it can be tested to look if it may or not be true.
In scientific mode, the hypothesis is formed before any appropriate and valid research has been made. A hypothesis is usually uncertain and tentative as it is an assumption or suggestion made strictly for the objective to be tested.
A theory is a doctrine that is produced as an effort to clarify things that have already been substantiated by data. The theory is assumed more scientific, and true than the hypothesis as it is deduced with the series of rigors of experimentation and control in the scientific methods.
The economic theory includes generalizations. It means economic theory concerns statements of general uniform tendencies of relationships among various economic phenomena. For example, the generalization that demand is a negative function of price expresses a relationship between price and demand, ceteris paribus. The law of demand holds only when other things remaining the same.
Steps Involved in Developing a Scientific Theory
If the theory is verified and proved true, it provides possible solutions or suggestions to the problems or issues identified and defined under the consideration or investigation. It is necessary in the case of social sciences like economics because economists always tend to provide solutions and issued that emerged in societies. The final stage in economics is related to the application of theory (applied economics) involving the value judgment.
Importance of Theoretical Economics
Economic theories provide different economic frameworks and tools of economic analysis that are used and essential in the explanation of economic variables and their relationships. They provide different mechanisms for the evaluation of the performance of the economic variables and finally in policy formulation with their value judgment. The major uses are explained briefly below;
It provides economic tools
Economic theories provide tools to economists. So Mrs. Joan Robinson considered economic theory as a “box of tools”. Economic theories provide numerous tools and ideas by using them economist’s analysis of economic issues. Economic tools apply to all types of economies.
Helps in explaining the economic phenomenon
The economic phenomenon’s and relationship existed in the real world can be easily explained with the help of economic theories. Based on previously established knowledge and frameworks economic theories choose relevant economic variables, facts, classify, and interpret them and establish causal relationships among these variables to solve existing economic problems.
For instance, to find the causes of poverty in underdeveloped countries data are collected, enumerated analyzed, and classified. Based on established methods and frameworks policymakers or economists’ study the nature of poverty to conclude its causes and establish a causal relationship between different causes of poverty in such countries.
Helps in the prediction of economic activity
The study of economic theories helps in the prediction of the solution to economic problems. The economic theory includes predictive accuracy in exploring economic issues of the real world. It helps to find the real causes and consequences of different economic activities that emerged in real life.
Judges the performance of the economy
Different concepts and aspects of theoretical economics are needed to evaluate the performance of different sectors of the economy as well as the entire economy.
Formulation and understanding economic policies
Theoretical economics and its principles help to understand and formulating different economic policies. If we have to understand the formulated policies we need to know about theoretical economics. Similarly, policymakers can formulate sound policies with the help of theoretical economics.
Thus theoretical economics can be used for understanding and formulation of different economic policies and decisions. It provides the bank of economic tools that are needed to understand economic variables, predict their values, and evaluate their impact and formulation of policies to influence and guide the economy to move in a positive direction.
Limitations of Theoretical Economics
Theoretical economics has the following limitations
- It is hard to find realistic data on human life.
- The probability of accurate prediction in economic theories is less.
- Almost all economic theories assume that economic agents are rational. But in reality, all the economic entities may not be rational. It means all the behavior of a human being is not rational. Sometimes their economic decisions may be influenced by different social and legal institutions and frameworks rather than their self-interest.
- Economic theories are based on different unrealistic assumptions relating to human behavior. According to Boulding, “Economic analysis is not a perfect picture of economic life; it is a map of it. Just we do not expect a map to always to take into account every detail and quirk of real economic behaviors.”
- The concepts and frameworks designed by economic theories are not fully applied in policy formulation to predict and solve real-life problems. It may be influenced by time factors as well as assumptions set by the theory.
Theoretical economics presents the behavioral aspects of social entities. It expresses and studies the relationship between different economic variables. It is a rigorous and sophisticated process representing the behavior of humans, societies, and nations relating to real life.
Economic theories provide the box of several economic tools that are used in the economic analysis of the behavior of human beings. It is used for the formulation and understanding of different economic policies and solving different real-life economic problems. Economic theories are formed with a set of assumptions relating to human undertakings so their reliability and applicability may not be permanent.
Jhingan, M.L (2012). Advanced Economic Theory. New Delhi: Vrinda Publications (P) LTD.
Maddala, G.S., & Miller, Ellen. (2004). Microeconomics Theory and Applications. Chennai: McGraw Hill Education (India) Private Limited.