Economic Methodology: Thinking Like an Economist Notes
Thinking Like an Economist
Economics is a specialized field of study that trains individuals to approach the world with a specific analytical mindset. This involves several cognitive practices:
Alternative Thinking: Learning to think in terms of alternatives and the trade-offs they present.
Cost-Benefit Analysis: Evaluating the costs and benefits of both individual choices and broader social choices.
Interconnectivity: Examining and understanding how certain events and issues are related to one another within a complex system.
The Economist as Scientist
Economics is classified as a science. When functioning in the role of a scientist, economists follow a rigorous process to build knowledge:
Theoretical Development: They devise theories to explain economic phenomena.
Data Collection: They gather empirical data to observe real-world behavior.
Data Analysis: They analyze the collected data using statistical and mathematical tools.
Verification and Refutation: They use their analysis to verify or refute their original theories.
Economics as a Social Science
Economists are social scientists rather than physical scientists. While a physical scientist might explain physical phenomena like electricity, a social scientist focuses on understanding human behavior and social organization. Their expertise lies in explaining why people make the choices they do and how societies function.
Models and Variables in Economics
Economists utilize models to simplify a complex reality. The primary goal of a model is to improve understanding of the world by stripping away unnecessary details to focus on core relationships.
Key Variable Types
Endogenous Variables: The values for these variables are determined within the internal logic of the model itself.
Exogenous Variables: These values are determined outside of the model. Identifying whether a variable is endogenous or exogenous is a critical step in separating cause from effect.
Characteristics and Limitations of Models
Stability: High-level models tend to become more unstable the longer the time period being considered or forecast.
Ceteris Paribus: This Latin phrase means "other things equal." It is a fundamental assumption used in economic modeling to signify that all other factors that might affect outcomes are assumed to be constant while one specific variable is changed.
The Role of Assumptions
Assumptions are essential tools for simplifying the real world into manageable concepts.
Simplification Example: To understand the complexities of international trade, economists may start by assuming a world that consists of only two countries producing only two different goods.
The Art of Scientific Thinking: The core challenge of scientific thinking in economics is the art of deciding which assumptions to make. Economists use different sets of assumptions depending on the specific question they are attempting to answer.
Refinement: Once the fundamental model is understood based on simple assumptions, economists can gradually "relax" those assumptions to see how the model changes when more reality is reintroduced.
The Economist as Policy Advisor
Economists often perform two distinct roles based on their current goal:
As Scientists: Economists act as scientists when they are attempting to explain how the world works.
As Policy Advisors: Economists act as policy advisors when they are attempting to change the world.
Positive Versus Normative Analysis
Economists distinguish between two types of statements to maintain clarity in analysis.
Positive Statements (Descriptive Analysis)
Definition: These are statements that attempt to describe the world as it actually is.
Testing: Positive statements can be tested and either confirmed or refuted using evidence and data.
Example 1: Higher federal budget deficits will cause interest rates to increase.
Example 2: An increase in the minimum wage will cause a decrease in employment among the least-skilled workers.
Normative Statements (Prescriptive Analysis)
Definition: These are statements regarding how the world should be.
Testing: It is not possible to test, confirm, or reject normative statements because they are based on personal values and opinions rather than raw data.
Example 1: The income gains from a higher minimum wage are worth more than any slight reductions in employment.
Example 2: Governments should collect from tobacco companies the costs of treating smoking-related illnesses among the poor.
Scientific Judgments and Disagreements
Economics is not considered a "true" science in the same way as physics or chemistry because it deals fundamentally with human behavior. This leads to several reasons why economists may disagree:
Validity of Theories: Economists may disagree about the validity of various alternative positive theories regarding the mechanics of the world.
Difference in Values: Economists often have different values, which leads to conflicting normative views on what policy objectives should be prioritized.
Policy Conflict: Conflicting advice to policymakers can stem from either different scientific judgments or different underlying values.
Political Reality: Even when economists are united in their advice, policymakers may choose to ignore it for various political or social reasons.
Case Study: Unemployment Benefits and Unintended Consequences
A central question in economic policy is whether higher unemployment payments have unintended impacts on the workforce.
Impact Estimates: Recent research indicates that cutting unemployment benefits can hurt millions of families, with approximately million workers potentially losing supplemental funding.
Incentives for Workers: If the available job options pay less than the unemployment compensation, it is rational for workers to delay re-entering the workforce. In many cases, this incentive structure exists.
University of Chicago Findings: An analysis concluded that two-thirds () of workers eligible for unemployment benefits would receive a benefit amount that exceeds their previous pay.
Macroeconomic Impact: These generous checks can contribute to delays in the overall economic rebound as workers wait longer to join the workforce.
Methodologies and Scientific Research
Economics is characterized by a variety of methodological approaches, including:
Neo-classical.
Feminist.
Marxist.
Austrian.
Research Methods
Reasoning: Research is conducted using both inductive and deductive reasoning.
Theory and Observation: Part of the scientific method involves using theory alongside observation, while noting that humans do not always behave in rational or consistent ways.
Experiments: Economists can conduct experiments in controlled laboratory settings or utilize "natural experiments" by observing the outcomes of real-world policy changes or unexpected historical events.
Cause and Effect: A primary goal of economic research is to successfully distinguish between cause and effect within human systems.