What Are Economic Theories: Definition and Types

What is a theory

A theory is a generation of ideas about a phenomenon that is studied, it entails the conceptualization or production of ideas, and their verification by comparing them with the facts.

In economics, theories explain, predict, and sometimes make it possible to influence an observed phenomena.

For example, the law of demand indicates that demand is inversely proportional to price, and when the price increases, less consumers will buy and it allows to make predictions about what will happen if the price goes up or down.

Types of theories

  • Empirical theories that are based on experiences.
  • Quantitative theories that use mathematical symbols.
  • Operational theories.
  • Theories of human behavior that study how the needs, values, attitudes and any individual characteristics.

The most important economic theories

Microeconomic theories:
  1. Theory of consumption.
  2. Theory of production.
  3. Market theory.
  4. Theory of distribution.
Macroeconomic theories:
  1. Theory of the determination of national income.
  2. Theory of money.
  3. International trade theory.
  4. Economic development theory.

Economic models

Economic models are mathematical representations that result from theories. They are simplified representations of an economic process or phenomenon. (1)

By using economic methods and techniques such as statistics and econometrics, the development of certain phenomena can be predicted in order to influence them if desired.

Example of an economic model

If an increase in the price of raw material will cause a decrease in production, the prediction is quantified with the help of the above-mentioned methods and techniques.

However, no theory is completely true, the intent is to achieve the best possible predictions and, if this is the case, then the models and theories will have served their purpose.

Is a theory always true?

It is the consensus that no theory is absolutely correct, whatever the subject, and this includes economics, physics, and other sciences. Theories fulfill their function of helping to understand, predict and even influence the phenomena under study.

Although they are not 100% exact and are subject to indefinite checks and adaptations to new empirical tests, it is considered that, even if they are not totally correct, they are at least a good approximation that make it possible to understand a wide variety of topics.

See also