ECONOMIC METHODOLOGY

a)  Thinking like an economist: the process of developing models in economics, including the need to make assumptions
b)  The use of the ceteris paribus assumption in building models
c)  The inability in economics to make scientific experiments


Thinking like an economist

A social science is a study of people in society and how they relate to one another and to the group to which they belong, e.g. sociology, psychology, political science, history, anthropology or economics. A natural science is any science that deals with phenomena observable in nature, e.g. biology, chemistry, and physics.

The exact methodology of science is a matter of some debate, however a generally acceptable explanation is that scientists make observations in the real world and try to come up with a hypothesis that explains the phenomena they are interested in. An example of this might be Copernicus’s heliocentric model of the solar system whereby the sun is at the centre and the planets orbit around it. The next stage is to test the hypothesis using further observations and experiments. For example, Isaac Newton did many experiments with prisms to show that white light is a mixture of different wavelengths. In economics John Maynard Keynes used a model called the ‘circular flow of income’ to show how unemployment could be reduced. Once a hypothesis is formed experiments are designed to try and disprove it. If the experiments fail to disprove the hypothesis then the hypothesis is regarded as true. However, these are merely provisional truths and they may yet be disproved at a later date when new evidence is found. If a hypothesis is so strong and the evidence overwhelming sometimes scientists credit the hypothesis as a law – such as the law of gravity in physics or Boyles law in Chemistry.


The inability in economics to make scientific experiments

A big problem for social scientists, and especially for economists, is that experiments are harder to do than in the natural sciences. Macroeconomics is a branch of economics that studies things such as the level of unemployment for a country, and economists cannot alter the level of unemployment in a country just to see what happens next – there are practical and ethical difficulties. The scale of the experiment would need to be enormous, and to deliberately make people unemployed would be immoral. In a democratic country it is unlikely that voters would agree to social scientists experimenting on them.

Economists can do some small-scale experiments, for example experiments to find out how people perform if you pay them more have been done successfully. Natural scientists cannot always experiment, for example astronomers are limited to making observations with telescopes, but in general and compared to natural science, economics is handicapped by the difficulty in carrying out experiments.

Because of the difficulty of doing experiments, economic models have to be built in the mind and written down on paper or coded into computer language. Economists spend a lot of time “working in the abstract”. This means that assumptions are made. One very famous assumption made in a type of economics known as ‘neo-classical economics’ is that there is ‘perfect information’, this means buyers and sellers have the same knowledge of a product and everything that can be known is known about it. In the real world this is not true, but economists make this assumption and then think about what will happen next if that assumption were true.

Economists spend a considerable amount of time looking at past data trying to identify trends and find evidence to support or refute their hypotheses. However, in the real world a great many things all change at once so it becomes very difficult to find out what causes what. If an economist believes that an economy grows because of increased investment in infrastructure, the evidence is hard to find because economic growth could have been caused by another variable – for example exports might have increased. Sorting out what causes what is a hard problem to solve. Therefore economists use the ceteris paribus assumption.

The use of the ceteris paribus assumption in building models

Because the world is so complex natural scientists often try to reduce the number of variables in an experiment. It is common for chemists to do experiments at standard temperature and pressure (STP). This removes three variables from their experiment and makes it easier to study cause and effect. In economics we do the same. For example, we might try to find out what happens if the price of a product increases but assume that the number of advertisements for the product stays exactly the same – in this way we can find out how price effects what customers will do without the confusion of other things changing at the same time. However, chemists are more likely to do this in their laboratory whilst economists do it in their heads or on paper. To find proof or disproof of theories, economists frequently use historical data. By looking at past data on things like unemployment and economic growth an hypothesis can be tested. However it takes a lot of statistical work to try and find causes and effects because in the real world many other things will be changing too – for example there might be problems in other countries which effect the country being studied – so this leaves a lot of economic theories open to doubt and disagreement. In the economics profession economists frequently disagree. Being able to criticise different arguments and justifying why they prefer one theory to another is an important skill of the economist.

The business of just altering one variable at a time has a Latin name. Ceteris Paribus means ‘other things being equal’. So when economists do thought experiments they often say or write ceteris paribus so that other economists know that only one variable is being changed. Sometimes the lazy economist forgets to write ‘ceteris paribus’ and we are left to infer that they did. Later we will see that we can make thought experiments more complex by relaxing the ceteris paribus assumption and allowing more than one variable to change.

Using observations, historical data, mathematics and mind experiments, economists build models of the economy and try to develop theories of how the social world operates. This helps them to advise others (politicians for example) on how best to organize society.

Economics is all about choices that societies make and in particular any society has to decide what goods and services it will produce – should the UK for example invest more in infrastructure such as roads, schools and hospitals or perhaps spend less on these types of goods and services and make more consumer goods such as ipads and games consuls? How these things should be made is another decision. Production could be organized along communist principles as it was in Russia before 1990 or with a bare minimum of government involvement as it used to be in Hong Kong. Finally economists consider for whom the goods and services should be produced – should everyone get an equal share or will one group in society have more than others? Thus;

Economics is the social science which investigates what, how, and for whom goods and services are produced

One problem with this definition of economics is that it does not allow for a discussion of ethics. By using the term ‘scientific’ in the definition we exclude opinions, but some economists think ethics should be discussed and disagree how resources should be allocated. Some economists think an equal society where everyone earns similar amounts is desirable, whereas others believe there is nothing wrong with a society that has both poor and rich people, this gives rise to two types of economics; positive and normative – the subjects of the next section.