E
very field of study has its own language and way of thinking.
Mathematicians talk about axioms, integrals, and vector spaces.
Psychologists talk about ego, id, and cognitive dissonance. Lawyers
talk about venue, torts, and promissory estoppel.
Economic;s is no different. Supply, demand, elasticity, comparative
advantage, consumer surplus, deadweight loss-these terms are part
of the economist's language. In the coming chapters, you will encoun-
ter many new terms and some familiar words that economists use in
specialized ways. At first, this new language may seem needlessly
arcane. But as you will see, its value lies in its ability to provide you with
Thinking Like
a new and useful way of thinking about the world in which you live.
The purpose of this book is to help you learn the economist's way
ai1 Economist
of thinking. Just as you cannot become a mathematician, psycholo-
gist, or lawyer overnight, learning to think like an economist will
take some time. Yet with a combination of theory, case studies, and
~:<amples of economics in the news, this book will give you ample
J pJ'ortunity to develop and practice tl)is skill.
fore delving into the substance and details of economics, it is
h: · 1to have an overview of how economists approach the wm:~Jd .
This chapter discusses the field's methodology. What is distinctive
about how economists confront a question? What does it mean to
think like an economist?
,18 PART I INTRODUCTION
2-1 The Economist as Scientist
Economists try to address their subject with a scientist's objectivity. They approach
the study of the economy in much the same way a physicist approaches the study
of matter and a biologist approaches the study of life: They devise theories, collect
data, and then analyze these data to verify or refute their theories.
To beginners, the claim that economics is a science can seem odd. After all,
economists do not work with test tubes or telescopes. The essence of science, how-
ever, is the scientific method-the dispassionate development and testing of theories
about how the world works. This method of inquiry is as applicable to studying
a nation's economy as it is to studying the earth's gravity or a species' evolution.
As Albert Einstein once put it, "The whole of science is nothing more than the
refinement of everyday thinking."
Although Einstein's comment is as true for social sciences such as economics as
it is for natural sciences such as physics, most people are not accustomed to look-
ing at society through a scientific lens. Let's discuss some of the ways economists
apply the logic of science to examine how an economy works.
'Tm a social scientist, 2-la The Scientific Method: Observation,
Michael. That means
I can't explain electricity
Theory, and More Observation
or anything like that, Isaac Newton, the famous 17th-century scientist and mathematician, allegedly
but if you ever want became intrigued one day when he saw an apple fall from a tree. This observation
to know about people, motivated Newton to develop a theory of gravity that applies not only to an apple
I'm your man." falling to the earth but to any two objects in the universe. Subsequent testing of
Newton's theory has shown that it works well in many circumstances (but not all,
as Einstein would later show). Because Newton's theory has been so successful at
explaining what we observe around us, it is still taught in undergraduate physics
courses around the world.
This interplay between theory and observation also occurs in economics. An
economist might live in a country experiencing rapidly increasing prices and be
moved by this observation to develop a theory of inflation. The theory might
assert that high inflation arises when the government prints too much money. To
test this theory, the economist could collect and analyze data on prices and money
from many different countries. If growth in the quantity of money were unrelated
to the rate of price increase, the economist would start to doubt the validity of
this theory of inflation. If money growth and inflation were correlated in inter-
national data, as in fact they are, the economist would become more confident
in the theory.
Although economists use theory and observation like other scientists, they face
an obstacle that makes their task especially challenging: In economics, conducting
experiments is often impractical. Physicists studying gravity can drop objects in
their laboratories to generate data to test their theories. By contrast, economists
studying inflation are not allowed to manipulate a nation's monetary policy simply
to generate useful data. Economists, like astronomers and evolutionary biologists,
usually have to make do with whatever data the world gives them.
To find a substitute for laboratory experiments, economists pay close attention
to the natural experiments offered by history. When a war in the Middle East inter-
rupts the supply of crude oil, for instance, oil prices skyrocket around the world.
For consumers of oil and oil products, such an event depresses living standards. For
economic policymakers, it poses a difficult choice about how best to respond. But
for economic scientists, the event provides an opportunity to study the effects of a
key natural resource on the world's economies. Throughout this book, we consider
, CHAPTER 2 THINKING LIKE AN ECONOMIST 19
many historical episodes. Studying these episodes is valuable because they give
us insight into the economy of the past and allow us to illustrate and evaluate eco-
nomic theories of the present.
2-1 b The Role of Assumptions
If you ask a physicist how long it would take a marble to fall from the top of a
ten-story building, he will likely answer the question by assuming that the marble
falls in a vacuum. Of course, this assumption is false. In fact, the building is sur-
rounded by air, which exerts friction on the falling marble and slows it down. Yet
the physicist will point out that the friction on the marble is so small that its effect
is negligible. Assuming the marble falls in a vacuum simplifies the problem without
substantially affecting the answer.
Economists make assumptions for the same reason: Assumptions can simplify
the complex world and make it easier to understand. To study the effects of inter-
national trade, for example, we might assume that the world consists of only two
countries and that each country produces only two goods. In reality, there are many
countries, each of which produces thousands of different types of goods. But by
considering a world with only two countries and two goods, we can focus our
thinking on the essence of the problem. Once we understand international trade
in this simplified imaginary world, we are in a better position to understand inter-
national trade in the more complex world in which we live.
The art in scientific thinking-whether in physics, biology, or economics-is
deciding which assumptions to make. Suppose, for instance, that instead of drop-
ping a marble from the top of the building, we were dropping a beach ball of the
same weight. Our physicist would realize that the assumption of no friction is less
accurate in this case: Friction exerts a greater force on the beach ball because it is
much larger than a marble. The assumption that gravity works in a vacuum is rea-
sonable when studying a falling marble but not when studying a falling beach ball.
Similarly, economists use different assumptions to answer different questions.
Suppose that we want to study what happens to the economy when the govern-
ment changes the number of dollars in circulation. An important piece of this
analysis, it turns out, is how prices respond. Many prices in the economy change
infrequently: The newsstand prices of magazines, for instance, change only once
every few years. Knowing this fact may lead us to make different assumptions
when studying the effects of the policy change over different time horizons. For
studying the short-run effects of the policy, we may assume that prices do not
change much. We may even make the extreme assumption that all prices are com-
pletely fixed . For studying the long-run effects of the policy, however, we may
assume that all prices are completely flexible. Just as a physicist uses different
assumptions when studying falling marbles and falling beach balls, economists
use different assumptions when studying the short-run and long-run effects of a
change in the quantity of money.
2-lc Economic Models
High school biology teachers teach basic anatomy with plastic replicas of the
human body. These models have all the major organs-the heart, liver, kidneys, and
so on-and allow teachers to show their students very simply how the important
parts of the body fit together. Because these plastic models are stylized and omit
many details, no one would mistake one of them for a real person. Despite this lack
of realism-indeed, because of this lack of realism-studying these models is useful
for learning how the human body works.
very field of study has its own language and way of thinking.
Mathematicians talk about axioms, integrals, and vector spaces.
Psychologists talk about ego, id, and cognitive dissonance. Lawyers
talk about venue, torts, and promissory estoppel.
Economic;s is no different. Supply, demand, elasticity, comparative
advantage, consumer surplus, deadweight loss-these terms are part
of the economist's language. In the coming chapters, you will encoun-
ter many new terms and some familiar words that economists use in
specialized ways. At first, this new language may seem needlessly
arcane. But as you will see, its value lies in its ability to provide you with
Thinking Like
a new and useful way of thinking about the world in which you live.
The purpose of this book is to help you learn the economist's way
ai1 Economist
of thinking. Just as you cannot become a mathematician, psycholo-
gist, or lawyer overnight, learning to think like an economist will
take some time. Yet with a combination of theory, case studies, and
~:<amples of economics in the news, this book will give you ample
J pJ'ortunity to develop and practice tl)is skill.
fore delving into the substance and details of economics, it is
h: · 1to have an overview of how economists approach the wm:~Jd .
This chapter discusses the field's methodology. What is distinctive
about how economists confront a question? What does it mean to
think like an economist?
,18 PART I INTRODUCTION
2-1 The Economist as Scientist
Economists try to address their subject with a scientist's objectivity. They approach
the study of the economy in much the same way a physicist approaches the study
of matter and a biologist approaches the study of life: They devise theories, collect
data, and then analyze these data to verify or refute their theories.
To beginners, the claim that economics is a science can seem odd. After all,
economists do not work with test tubes or telescopes. The essence of science, how-
ever, is the scientific method-the dispassionate development and testing of theories
about how the world works. This method of inquiry is as applicable to studying
a nation's economy as it is to studying the earth's gravity or a species' evolution.
As Albert Einstein once put it, "The whole of science is nothing more than the
refinement of everyday thinking."
Although Einstein's comment is as true for social sciences such as economics as
it is for natural sciences such as physics, most people are not accustomed to look-
ing at society through a scientific lens. Let's discuss some of the ways economists
apply the logic of science to examine how an economy works.
'Tm a social scientist, 2-la The Scientific Method: Observation,
Michael. That means
I can't explain electricity
Theory, and More Observation
or anything like that, Isaac Newton, the famous 17th-century scientist and mathematician, allegedly
but if you ever want became intrigued one day when he saw an apple fall from a tree. This observation
to know about people, motivated Newton to develop a theory of gravity that applies not only to an apple
I'm your man." falling to the earth but to any two objects in the universe. Subsequent testing of
Newton's theory has shown that it works well in many circumstances (but not all,
as Einstein would later show). Because Newton's theory has been so successful at
explaining what we observe around us, it is still taught in undergraduate physics
courses around the world.
This interplay between theory and observation also occurs in economics. An
economist might live in a country experiencing rapidly increasing prices and be
moved by this observation to develop a theory of inflation. The theory might
assert that high inflation arises when the government prints too much money. To
test this theory, the economist could collect and analyze data on prices and money
from many different countries. If growth in the quantity of money were unrelated
to the rate of price increase, the economist would start to doubt the validity of
this theory of inflation. If money growth and inflation were correlated in inter-
national data, as in fact they are, the economist would become more confident
in the theory.
Although economists use theory and observation like other scientists, they face
an obstacle that makes their task especially challenging: In economics, conducting
experiments is often impractical. Physicists studying gravity can drop objects in
their laboratories to generate data to test their theories. By contrast, economists
studying inflation are not allowed to manipulate a nation's monetary policy simply
to generate useful data. Economists, like astronomers and evolutionary biologists,
usually have to make do with whatever data the world gives them.
To find a substitute for laboratory experiments, economists pay close attention
to the natural experiments offered by history. When a war in the Middle East inter-
rupts the supply of crude oil, for instance, oil prices skyrocket around the world.
For consumers of oil and oil products, such an event depresses living standards. For
economic policymakers, it poses a difficult choice about how best to respond. But
for economic scientists, the event provides an opportunity to study the effects of a
key natural resource on the world's economies. Throughout this book, we consider
, CHAPTER 2 THINKING LIKE AN ECONOMIST 19
many historical episodes. Studying these episodes is valuable because they give
us insight into the economy of the past and allow us to illustrate and evaluate eco-
nomic theories of the present.
2-1 b The Role of Assumptions
If you ask a physicist how long it would take a marble to fall from the top of a
ten-story building, he will likely answer the question by assuming that the marble
falls in a vacuum. Of course, this assumption is false. In fact, the building is sur-
rounded by air, which exerts friction on the falling marble and slows it down. Yet
the physicist will point out that the friction on the marble is so small that its effect
is negligible. Assuming the marble falls in a vacuum simplifies the problem without
substantially affecting the answer.
Economists make assumptions for the same reason: Assumptions can simplify
the complex world and make it easier to understand. To study the effects of inter-
national trade, for example, we might assume that the world consists of only two
countries and that each country produces only two goods. In reality, there are many
countries, each of which produces thousands of different types of goods. But by
considering a world with only two countries and two goods, we can focus our
thinking on the essence of the problem. Once we understand international trade
in this simplified imaginary world, we are in a better position to understand inter-
national trade in the more complex world in which we live.
The art in scientific thinking-whether in physics, biology, or economics-is
deciding which assumptions to make. Suppose, for instance, that instead of drop-
ping a marble from the top of the building, we were dropping a beach ball of the
same weight. Our physicist would realize that the assumption of no friction is less
accurate in this case: Friction exerts a greater force on the beach ball because it is
much larger than a marble. The assumption that gravity works in a vacuum is rea-
sonable when studying a falling marble but not when studying a falling beach ball.
Similarly, economists use different assumptions to answer different questions.
Suppose that we want to study what happens to the economy when the govern-
ment changes the number of dollars in circulation. An important piece of this
analysis, it turns out, is how prices respond. Many prices in the economy change
infrequently: The newsstand prices of magazines, for instance, change only once
every few years. Knowing this fact may lead us to make different assumptions
when studying the effects of the policy change over different time horizons. For
studying the short-run effects of the policy, we may assume that prices do not
change much. We may even make the extreme assumption that all prices are com-
pletely fixed . For studying the long-run effects of the policy, however, we may
assume that all prices are completely flexible. Just as a physicist uses different
assumptions when studying falling marbles and falling beach balls, economists
use different assumptions when studying the short-run and long-run effects of a
change in the quantity of money.
2-lc Economic Models
High school biology teachers teach basic anatomy with plastic replicas of the
human body. These models have all the major organs-the heart, liver, kidneys, and
so on-and allow teachers to show their students very simply how the important
parts of the body fit together. Because these plastic models are stylized and omit
many details, no one would mistake one of them for a real person. Despite this lack
of realism-indeed, because of this lack of realism-studying these models is useful
for learning how the human body works.
