PRINCIPLES OF ECONOMICS
Module II
Thinking Like an Economist
The Economist as Scientist
Economists, like scientists in other fields, strive to approach their subject with
objectivity. They apply a systematic method to study the economy, which
involves devising theories, collecting data, and analyzing the data to verify or
refute these theories.
Despite not using physical tools like test tubes or telescopes, economists employ
the scientific method, which involves the dispassionate development and testing
of theories about how the world works.
This approach is as valid in studying economic phenomena as it is in studying
physical phenomena like gravity or biological processes.
Albert Einstein famously said, "The whole of science is nothing more than the
refinement of everyday thinking."
This statement highlights that the scientific method is not limited to natural
sciences but is equally applicable to social sciences like economics. However,
many people are not accustomed to viewing society through a scientific lens,
which can make the application of scientific principles in economics seem
unfamiliar.
Following are some of the prominent aspects justifying how economists embody
the characteristics of scientists:
1. Empirical Research: Economists conduct empirical research to test
hypotheses and theories using real-world data.
2. Hypothesis Testing: Like scientists, economists primarily develop
hypotheses about how economic systems work and use empirical methods
to test these hypotheses.
3. Theory Development: Economists develop theories to explain economic
behaviour and phenomena.
4. Predictive Modeling: Economists use mathematical and statistical models
to make predictions about future economic outcomes.
5. Objective Enquiry: Economists pursue objective inquiry into economic
phenomena, striving to minimise bias and ideological influence in their
research.
, 6. Falsifiability: Economists strive to develop theories and models that are
falsifiable that is, capable of being proven false through empirical
evidence.
7. Openness to Revision: Like scientists, economists are open to revising their
theories and models in the light of new evidences and insights.
8. Replication and Validation: Economists encourage other researchers to
replicate their studies using different data sets or methodologies to verify
the robustness of their findings and enhance the credibility of economic
research.
The Scientific Method: Observation, Theory, and More Observation
The scientific method is a core aspect of economics. It involves several steps, as
illustrated by Isaac Newton's famous observation of an apple falling from a tree,
which led him to develop the theory of gravity. This theory, once formulated, was
tested and refined through further observations, becoming a fundamental
principle in physics.
In economics, a similar process occurs:
• Observation: An economist might observe a situation, such as rapidly
increasing prices (inflation) in a country.
• Theory Development: From this observation, the economist might
develop a theory—e.g., inflation occurs when the government prints too
much money.
• Testing the Theory: To test this theory, the economist would collect data
on prices and money supply from various countries. If the data shows a
strong correlation between money supply growth and inflation, the theory
gains credibility. If there is no correlation, the theory might be discarded or
revised.
However, unlike natural sciences, economics faces unique challenges:
• Experimental Limitations: Economists cannot conduct controlled
experiments as easily as natural scientists. For example, a physicist can
drop objects in a lab to study gravity, but an economist cannot manipulate
a country's monetary policy to study inflation.
• Natural Experiments: Economists often rely on "natural experiments,"
where historical events or policy changes provide data for analysis. For
example, an oil price shock due to a Middle East conflict can be studied to
understand the impact of resource scarcity on the global economy.
, These historical episodes are valuable because they offer insights into economic
behaviors and allow economists to evaluate and refine their theories.
The Role of Assumptions in Economics
In both natural and social sciences, assumptions play a crucial role in simplifying
complex realities to make problems more manageable and understandable.
Economists, like physicists, use assumptions to strip down real-world
complexities and focus on the essential elements of a problem.
• Simplification through Assumptions:
o Economists might assume a world with only two countries and two
goods when studying international trade. This assumption simplifies
the problem and helps focus on the fundamental aspects of trade.
• Art of Scientific Thinking:
o The challenge in scientific thinking lies in deciding which
assumptions to make. Assumptions must balance simplicity with
realism to ensure that the model provides useful insights without
being overly complex or unrealistic.
o In economics, different assumptions are used for different contexts,
such as short-run vs. long-run analysis.
• Contextual Assumptions:
o When studying the short-term effects of a policy, economists might
assume that prices are fixed because many prices change
infrequently. For long-term effects, where prices are more likely to
adjust, economists assume that prices are flexible.
o This flexibility in assumptions allows economists to apply their
models appropriately depending on the context of the analysis.
In summary, assumptions are essential tools in economic analysis. They simplify
the complexities of the real world, making it possible to develop models that can
predict economic behavior and guide policy decisions. However, the key is to
choose assumptions that are appropriate for the specific context being studied.
Economic Models
Economists use models much like biologists or physicists to understand the
world. These models simplify the complexities of the real economy to focus on
core elements that help explain economic behavior. These models are often
Module II
Thinking Like an Economist
The Economist as Scientist
Economists, like scientists in other fields, strive to approach their subject with
objectivity. They apply a systematic method to study the economy, which
involves devising theories, collecting data, and analyzing the data to verify or
refute these theories.
Despite not using physical tools like test tubes or telescopes, economists employ
the scientific method, which involves the dispassionate development and testing
of theories about how the world works.
This approach is as valid in studying economic phenomena as it is in studying
physical phenomena like gravity or biological processes.
Albert Einstein famously said, "The whole of science is nothing more than the
refinement of everyday thinking."
This statement highlights that the scientific method is not limited to natural
sciences but is equally applicable to social sciences like economics. However,
many people are not accustomed to viewing society through a scientific lens,
which can make the application of scientific principles in economics seem
unfamiliar.
Following are some of the prominent aspects justifying how economists embody
the characteristics of scientists:
1. Empirical Research: Economists conduct empirical research to test
hypotheses and theories using real-world data.
2. Hypothesis Testing: Like scientists, economists primarily develop
hypotheses about how economic systems work and use empirical methods
to test these hypotheses.
3. Theory Development: Economists develop theories to explain economic
behaviour and phenomena.
4. Predictive Modeling: Economists use mathematical and statistical models
to make predictions about future economic outcomes.
5. Objective Enquiry: Economists pursue objective inquiry into economic
phenomena, striving to minimise bias and ideological influence in their
research.
, 6. Falsifiability: Economists strive to develop theories and models that are
falsifiable that is, capable of being proven false through empirical
evidence.
7. Openness to Revision: Like scientists, economists are open to revising their
theories and models in the light of new evidences and insights.
8. Replication and Validation: Economists encourage other researchers to
replicate their studies using different data sets or methodologies to verify
the robustness of their findings and enhance the credibility of economic
research.
The Scientific Method: Observation, Theory, and More Observation
The scientific method is a core aspect of economics. It involves several steps, as
illustrated by Isaac Newton's famous observation of an apple falling from a tree,
which led him to develop the theory of gravity. This theory, once formulated, was
tested and refined through further observations, becoming a fundamental
principle in physics.
In economics, a similar process occurs:
• Observation: An economist might observe a situation, such as rapidly
increasing prices (inflation) in a country.
• Theory Development: From this observation, the economist might
develop a theory—e.g., inflation occurs when the government prints too
much money.
• Testing the Theory: To test this theory, the economist would collect data
on prices and money supply from various countries. If the data shows a
strong correlation between money supply growth and inflation, the theory
gains credibility. If there is no correlation, the theory might be discarded or
revised.
However, unlike natural sciences, economics faces unique challenges:
• Experimental Limitations: Economists cannot conduct controlled
experiments as easily as natural scientists. For example, a physicist can
drop objects in a lab to study gravity, but an economist cannot manipulate
a country's monetary policy to study inflation.
• Natural Experiments: Economists often rely on "natural experiments,"
where historical events or policy changes provide data for analysis. For
example, an oil price shock due to a Middle East conflict can be studied to
understand the impact of resource scarcity on the global economy.
, These historical episodes are valuable because they offer insights into economic
behaviors and allow economists to evaluate and refine their theories.
The Role of Assumptions in Economics
In both natural and social sciences, assumptions play a crucial role in simplifying
complex realities to make problems more manageable and understandable.
Economists, like physicists, use assumptions to strip down real-world
complexities and focus on the essential elements of a problem.
• Simplification through Assumptions:
o Economists might assume a world with only two countries and two
goods when studying international trade. This assumption simplifies
the problem and helps focus on the fundamental aspects of trade.
• Art of Scientific Thinking:
o The challenge in scientific thinking lies in deciding which
assumptions to make. Assumptions must balance simplicity with
realism to ensure that the model provides useful insights without
being overly complex or unrealistic.
o In economics, different assumptions are used for different contexts,
such as short-run vs. long-run analysis.
• Contextual Assumptions:
o When studying the short-term effects of a policy, economists might
assume that prices are fixed because many prices change
infrequently. For long-term effects, where prices are more likely to
adjust, economists assume that prices are flexible.
o This flexibility in assumptions allows economists to apply their
models appropriately depending on the context of the analysis.
In summary, assumptions are essential tools in economic analysis. They simplify
the complexities of the real world, making it possible to develop models that can
predict economic behavior and guide policy decisions. However, the key is to
choose assumptions that are appropriate for the specific context being studied.
Economic Models
Economists use models much like biologists or physicists to understand the
world. These models simplify the complexities of the real economy to focus on
core elements that help explain economic behavior. These models are often
