Economic Analysis and Economic Policy:
Economics, like other social sciences, has two aspects. One aspect is analytical and the other is practical. Both these aspects are of great importance because economic analysis is the basis for economic policy. These are, in fact, integral parts of each other.
What is economic Theory?
Economic analysis or economic theory is a body of economic principles built up as a result of logical reasoning. We can call it a “base of tools” with which the economists analyze economic problems. Economic theory derives principles from facts which are systematically arranged and interpreted. In the words of Maconnel, “Economic theories are statements about economic behavior of the economy that enables predictions of the probable effects of certain actions”.
The main steps involved in constructing theory of economics are as under:
- Selection the problem. The first step involved in the formulation of a theory is the selection of problem which is related to the real world.
- Specifying the assumptions. The second step is to specify the assumptions under which the theory is to apply. One standard assumption in-all economic models is “Other things being equal”. The idea of making assumptions is to identify the variables of specific interest and then focus exclusively on the relationship defined among those variables assuming that nothing else of importance will change.
- Identifying the key variables. The third step in building economic model is to identify and define the key variables relevant to the economic problem under consideration. The variables of concern become the basic elements of the theory.
- Formulating hypothesis. The fourth step in constructing theory of economics is to frame relationship as to how the key variables relate to each other. For example, if the price of apples increases in the market, other things being constant, the quantity purchased of apples will decrease. Thus the hypothesis becomes a prediction of what will happen to the quantity purchased of apples if its price increases.
- Testing the hypothesis. The final step involved in constructing economic theory is to test the hypothesis by confronting the predictions of the theory with evidence. For testing the Validity of hypothesis, we are to focus attention on the variables in questions, keeping other factors constant. The first test will lead us either to reject the theory as contrary to the evidence or to continue using the theory until another takes its place with better predictions.
Economic Policy:
Economic policy is the course of action based on economic principles. It aims at resolving a specific economic problem or achieving certain economic goals. Economic theories are the foundations of economic policies. The creation of specific policies for achieving economic goals of the society is not simple and easy matter. The main steps in policy formulation are as under:
- Clear statement of goals. There should he clear statement of the economic goals to be achieved.
- Effects of alternative policies. The second step is to examine and consider the possible effects of alternative policies designed to achieve the economic goal. For example, while considering the merits and demerits of fiscal policy in the achievement of desired level of employment, the altering monetary policy must remain under examination.
- Evaluation. The third step is to evaluate the effectiveness of the policies. The process of evaluation should be continuous. If any drawback is found in it at any stage, it should he improved.
Economic Goals:
If economic policies are framed to achieve certain goals, then they should be placed in order of priority. The numbers of goals which are generally accepted include the following.
(i) Economic growth.
(ii) Providing more jobs for persons who are able and willing to work.
(iii) Achieving maximum fulfillment of wants of the citizens by efficiently using the available resources.
(iv) Bringing stability in price level.
(v) Giving high degree of freedom in economic activities.
(vi) Ensuring fair distribution of wealth in the community.
(vii) Provision of economic security to disabled, handicapped and unemployed persons.
(viii) Making efforts to maintain the rate of foreign exchange.
The economic goals to be achieved differ with the level of employment in the country. For example, the developed countries can aim at achieving full employment, proper distribution of income and price stability etc. The developing countries, on the other hand, are mostly faced with the problems of unemployment, unequal distribution of wealth, price instability etc. Each country, therefore, must devise a system of priorities for its objectives. If may, here also be noted that an economic theory formed as a basis for. Policy measure at one time is not applicable for all times to come. An economic theory which is true today may be obsolete tomorrow.
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