Download Scientific Method of Economics

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