What is an economic theory?

An economic theory is a set of ideas and principles that explain economic phenomena, interpret why and how the economy behaves, and what is the best solution to influence or solve the economic phenomena. Different theories are employed for different purposes. Some economic theories describe phenomena like inflation and supply and demand and why they occur. Meanwhile, other economic theories provide a framework of thought that allows economists to analyze, interpret, and predict the behavior of financial markets, industries, and governments.

Five Foundational Theories in Economics

1. Supply and demand
   Supply and demand is a theory in microeconomics that offers an economic model for price determination in a market. The theory states that, caeteris paribus, the unit price for a particular good will vary until it settles at a point where the quantity demanded is equal to the quantity supplied resulting in economic equilibrium.
2. Marxism
   Coined by Karl Marx, marxism is a type of socioeconomic theory that focuses on the struggle between capitalists and the working class in society. The theory argues that a capitalist’s motivation lies in deriving the most work from the working class by paying the least amount possible in wages, which will create an exploitative economic balance. The theory concludes that this inequality may lead to a worker revolution to overturn capitalism in favor of communism.
3. Laissez-faire capitalism

The economic philosophy of Laissez-faire is a theory of free-market capitalism that opposes government intervention such as regulation, subsidies, minimum wages, trade restrictions, and corporate taxes. This theory states that an economy may prosper if the government does not intervene in it to preserve property, life, and individual freedom. However, many argue that laissez-faire actually leads to poverty and economic imbalances due to absent policies endorsed by the government in the public interest.

4. Monetarism
   The macroeconomic theory promotes the idea that governments can achieve economic stability by controlling the amount of money in circulation. It encourages the use of monetary policy over fiscal policy to manage aggregate demand. For example, using the economic tool of Monetary policy, the government can increase the interest rates which in turn will encourage people to save rather than spend. On the contrary, when interest rates are lowered, the cost of borrowing decreases, which means people can borrow more and spend more.
5. Market socialism
   Market socialism is a type of economic system involving the public, cooperative, as well as social ownership of the means of production in the framework of a market economy. Also known as liberal socialism, the theory proposes the creation of an economic system that contains a mix of worker-owned, nationalized, and privately owned enterprises. Depending on the specific model of market socialism, profit generated via socially owned firms can be directed toward varying channels, such as employee remuneration, public financing or a social dividend.

Conclusion

In the end, can we really have effective theories in economics? The answer is no, theory in economics is never exactly true as it is not verifiable and reliable for prediction and control. Instead, economics deals in speculative interpretations and must continue to do so.