Economics as a social science P1Session 3 Economics as a social science

Key concepts Economics as a human and behavioural science Positive and normative economic statements: WHAT IS and WHAT OUGHT TO BE Some common mistakes and pitfalls in reasoning about economic issues The “scientific method” and simple model-building in economic analysis Coping with complex reality: assumptions and ceteris paribus techniques in economic models Testing economic theories: predictive power as the principal goal? Why economists disagree

Economics: a Social Science Positive statements: what is Normative statements: what ought to be Use positive statements to understand economic world by: Observation and measurement Model building Testing models

Economics is a social science Economists distinguish between two types of statement: What is—positive statements What ought to be—normative statements A positive statement can be tested by checking it against facts A normative statement cannot be tested.

Economics is a social science The task of economic science is to discover positive statements that are consistent with what we observe in the world and that enable us to understand how the economic world works. This task is large and breaks into three steps: Observation and measurement Model building Testing models

Observation and Measurement Economists observe and measure economic activity, keeping track of such things as: Quantities of resources Wages and work hours Prices and quantities of goods and services produced Taxes and government spending Quantities of goods and services bought from and sold to other countries.

Model Building An economic model is a description of some aspect of the economic world that includes only those features of the world that are needed for the purpose at hand. Testing Models We test models to reject those that don’t fit the facts and identify the ones that do fit the facts.

Model and Theory An economic theory is a generalization that summarizes what we think we understand about the economic choices that people make and the performance of industries and entire economies. A theory is a bridge between a model and reality. It is a proposition about which model works.

Obstacles and Pitfalls in Economics Economists cannot easily do experiments and economic behaviour has simultaneous causes. To isolate the effect of interest, economists use the logical device called ceteris paribus or “other things being equal”. Economists try to isolate cause-and-effect relationship by changing only one variable at a time, holding all other relevant factors unchanged.

Obstacles and Pitfalls in Economics When a relationship involves more than two variables, we can plot the relationship between two of the variables by holding other variables constant-by using ceteris paribus. The graphs on the next slide show the relationships among variables.

Graphing Relationships Among More Than Two Variables Ceteris Paribus

Obstacles and Pitfalls in Economics Two common fallacies that economists try to avoid are: The fallacy of composition The fallacy of composition, which is the false statement that what is true for the parts is true for the whole or what is true for the whole is true for the parts. E.G. Suppose a firm pays a minimum wage to labour as an incentive to increase output. However, paying a minimum wage raises costs and hence reduces output, ceteris paribus(given that the firm wants to maintain its current profit margin)

Obstacles and Pitfalls in Economics The post hoc fallacy The post hoc fallacy from the Latin term “Post hoc, ergo propter hoc”—means “after this, therefore because of this,” which is the error of reasoning that a first event causes a second event because the first occurs before the second(the classic chicken or egg scenario). E.g. Does increased government spending expand the economy or does the economy expand in anticipation of increased government spending? NB: Unravelling cause-and-effect is difficult in economics.

Agreement and Disagreement Economists sometimes disagree but in contrast to the popular image, economists find much common ground on a wide range of issues. Homework: check in the textbook a list of economic propositions that most economists agreed on.