Economic Thinking

1. Economic Thinking At the start of class, we used the review questions at the end of chapter 1 to review the remaining concepts. I did not emphasize the circular flow model. It is most relevant in Macroeconomics.

2. Learning Objectives • Describe how economists go about their work • Explain the big questions that economists seek to answer • Understand Scarcity • Compare economic systems

3. The Nature and Role of Theory. • The uses of theories (simplified models). • Everyone uses them. . . • to describe, explain, predict, or understand.

4. Abstraction • Models leave out much specific information • But answer the basic question. • Model builders must make judgments: • What information to include, and • which details may be safely omitted.

5. Judging Theories • Logical soundness of assumptions and hypotheses • How well a theory predicts. • Theories should yield testable predictions.

6. Methodology • Economists build models • Answer important questions • Why does international (int’l) trade occur? • What goods will a country import (export)? • How much will be traded and at what price? • Will trade affect wages, or other factor payments?

7. Methodology • Models are abstract, yield predictions • simplify reality • verbal • mathematical • geometric • algebraic

8. Occam’s Razor • The simplest workable theories are also the most useful. • a.k.a. “The Principle of Parsimony” • Einstein: “Everything should be made as simple as possible, but not more so.”

9. Formulating Theories • Variables noted, assumptions made, hypotheses formulated. • Predictions are deduced from the assumptions and hypotheses. • Predictions are stated.

10. Testing Theories • Predictions are tested. • Evidence either confirms or rejects theory. • If confirmed, can the results be reproduced? • If rejected, then either a new theory is formed, or the old one is amended.

11. Arguments • Argument -- a sequence of statements together with a claim. • Sequence -- two or more statements. • Claim -- that one of statements, called the conclusion, follows from the others, called the premises. • An argument is sound if it is valid and all its premises are true.

12. Deductive Arguments • In a valid deductive argument it is impossible for the premise to be true and the conclusion false. • Example: Knowledge is power. Power corrupts. Therefore knowledge corrupts. • Another: Economists are scoundrels. Eastwood is an economist. Therefore Eastwood is a scoundrel.

13. Inductive Arguments • In a correct inductive argument it is improbable for the conclusion to be false if the premise is true. • e.g.,: Pieces of foam fall from the shuttle on almost every launch. Therefore, there is no danger. • Reasoning from a small sample can be dangerous!

14. The Fallacy of False Cause • This fallacy occurs when in argument one mistakes what is not the cause of a given effect for its real cause. • When an argument takes the following form, it is often incorrect: • Event A occurs, then Event B occurs • Therefore A causes B.

15. The Fallacy of Composition • Assuming that what is true for the individual is true for the group. • Frederic Bastiat’s “Petition of the Candle Makers” illustrates this fallacy.