Economic theory explains the movement of goods in a market and is used by governments to make policies. Classical economics favors a free market, while command economies are led by national governments. Keynesian economics combines the two theories. Economists use data to inform decision-making and typically use the model of homo economicus to predict how individuals will react to economic situations.
Economic theory is a broad concept for explaining and understanding the movement of goods in a market. Theoretical economic concepts typically have scientific backing or studies to prove or disprove a stated hypothesis. National governments also have an interest in economic theories. Politicians rely on studies of government spending, tax collection, money supply, and consumer spending data to make laws or set policies. There are several economic theories that focus on different aspects of government policy regarding the economy.
Classical economic theory tends to favor a free market system. Under this theory, little government intervention is needed to help sustain a society. Classical economists believe that individuals empowered to act in their own self-interest will present a strong consumer group. Terms such as capitalism and supply-side economics also describe this theory. The protection of personal property through the courts is often an important component of free market economics.
Another classic economic theory is the command economy led by national governments. Terms associated with these economies include socialism and communism. The main ideas behind these theories are that governments control most of the economic resources. Governments allocate resources, employ certain classes or people, and regulate the economy through heavy taxation. Wealth redistribution attempts to ensure equal status for all individuals living under the umbrella of government.
A more modern economic concept is Keynesian economics. This theory is a slight combination of the two previous theories. Keynesian theory dictates that targeted government spending and intervention in a national economy help keep goods moving when free markets become inefficient. Government spending controls do not often exist in Keynesian economics as governments may not have spending limits. Another inherent problem is the inability to control employment, as government spending does not always lead to job creation.
While other economic theories exist, these are often the main ones used by a government to guide its fiscal and monetary policy. Economists often spend a lot of time collecting data and reviewing financial information to help inform decision making. These studies and information gathering sessions represent the science that supports economic theory. The economic methodology is also important; the methodology dictates how best to collect data and make it useful for economic decision-making.
Typically, economic theory uses a model individual to describe the actions people take in economic environments. The theory — known as homo economicus — describes humans as rational, selfish people who make judgments about their own lives. Through this theory, economists attempt to determine how individuals will react to certain economic situations. Free market economies often ascribe to this theory.
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