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Scientific Method of Economics 1.2 Observation of facts Possible explanation of cause/effect (hypothesis) Testing of explanation by comparing outcomes predicted by hypothesis. Accept/reject/modify hypothesis Continual testing of hypothesis against facts. Scientific Method, cont’d 1.2 • Favorable results of testing hypothesis evolves into a theory. • A well tested/widely accepted theory is called a law or principle. • Combinations of laws/principles are incorporated into a model (simple representations of how something works.) Theoretical Economics 1.2 • Example: Economists gather information about problems/issues. • Relevant facts gathered; • Develops cause/effect relationships • Tested against real world observation/data • Theories/principles/laws • Process of deriving theories/principles is called Theoretical Economics. Economic Principles 1.2 • Economic principles: statements about economic behavior or the economy that enable prediction of the probable effects of certain actions. – Ex. Price of a product increases—law of demand says that the demand for that product will decrease. (Explains and predicts.) Terminology 1.2 • Hypothesis: needs initial testing • Theory: has been tested but need more • Law/Principle: a theory that has provided strong predictive accuracy. • Model: Used to illustrate principles into a simplified representation of reality. (Graph, chart, etc.) (Ex: a Roadmap is a model) • Laws, theories, models, principles are sometimes used interchangeably. Terminology, cont’d 1.2 • Generalizations: Imprecise because economic facts are diverse; no two individuals, businesses, act in the same exact way. – Tendencies of the average consumer – Ex. Principle: “Consumer spending rises when personal income rises.” • Some may choose to save all their increase. • Typical consumers will spend more “Other Things Equal" Assumption “Ceteris Parabis” • Assumes all other variables except those under immediate consideration are held constant for a particular analysis. – Ex. Price of Diamondback tickets goes up— what happens to ticket sales? – Other variables may be: • How far out of first place is the team? • What other activities are going on? – All things are NOT equal in the real world. Terminology 1.2 • Abstractions: Economic principles/theories simplify a complex and overwhelming set of data/information by building models and developing principles/laws. • Economic Policies: a course of action based on economic principles that seek to solve an economic problem. – Ex. Inflation: Economic Goals for U.S. 1.2 1. 2. 3. 4. 5. 6. 7. 8. Economic Growth: Full employment: Economic efficiency: Price level stability: Economic freedom: Equitable distribution of income: Economic security: Balance of trade: Note: Disagree on how to achieve these Tradeoffs 1.2 • Economic tradeoff: To achieve one goal may mean that another goal may have to be sacrificed or reduced. • Examples: Efforts to equalize distribution of income: May reduce incentives to work, invest, take risks Tax high income people heavily: May reduce business investments