Thursday, January 18, 2007

The Nature of Economics (Tutorial 1 2007)

1. Why is economics not a laboratory science?

Step 1: Define: Laboratory science - sciences in which research can be done in a laboratory setting.
Step 2: Key Command Word: Why is ____ not _____? (Show Comprehension skills by giving examples/ illustrating)

Economics CANNOT be a laboratory science because variables affecting a particular economic phenomenon cannot be separated or isolated for study, unlike that for physical sciences.

For example, there are many factors determining the demand for a particular good, such as cars. When the economist observes the effect of changes in the price of a good on the purchase of that good by households, he has no control over the other factors (e.g. income), which may also change, unlike for a laboratory science, where factors can be isolated.

Also, the human element is present in economics. Human behaviour is never fully unpredictable, unlike that for inanimate things and natural forces. Hence, the study of economics is never precise and can only be based on the "Law of Large Numbers" (i.e. looking at human economic behaviour in a group and not an individual specimen in a laboratory)

2. What is the scientific method and how does it relate to theoretical economics?

Step 1: Defining Key Terms: The scientific method, as used by economists, is an approach whereby the economist observes the behaviour of man, followed by a process of reasoning and formulation of economic theories and finally testing them for their validity.

Step 2: Key Command Word: "How does it relate…?": The scientific method is used by economists to firstly formulate economic theories before determining if they can be accepted as laws or principles. These economic laws or principles are formulated to explain and/or predict behavior of individuals or institutions.

What is the difference between a hypothesis and an economic law or principle?

Step 1: Defining Key Terms: A hypothesis is a “guessimate” as to the possible cause-and effect relationships between and among facts given. An economic law or principle is a theory that is found to be sufficiently profound and universal after testing it against empirical evidence. In other words, it can be found to have "strong empirical regularity".

Step 2: Key Command Word: "What is the difference …..?": An economic law or principle is formulated only after the hypothesis has been tested for validity.

3. Explain the following statement:

a. “Good economic policy requires good economic theory.”


Step 1: Define key terms (i.e. show knowledge of key terms):

• Economic policy: A course of action intended to help a government resolve a specific economic problem or to further a country’s economic goals. E.g. to maintain full employment, achieve a higher rate of economic growth, reduce income inequalities, maintain price stability etc.

• Economic theory: A coherent and plausible explanation of how two or more economic variables are related. For example, the theory of demand shows a (simplified) relationship between the price of any good and its quantity demanded.

Step 2: Explain statement (i.e. give the meaning of, show your comprehension of):

• A good economic theory is one that is able to (fairly) accurately explain and yield predictions about real-life economic phenomenon that occurs. A good economic policy, on the other hand, refers to one that is effective. Economic policies are developed and assessed based on economic theories. In other words, economic theories are the foundation of economic policies. Therefore, an economic policy (action taken) can only be effective (i.e. good) if the underlying economic theory is correct (i.e. good).

b. “Facts serve to sort out good and bad hypotheses.”


Step 1: Define key terms (i.e. show knowledge of key terms):

• Facts: Real-world (observable) empirical evidence/data.

• Hypotheses: A proposed (tentative) explanation for an observed phenomenon, which is yet to be tested. A hypothesis is usually made up of a prediction about the relationship between two or more economic variables. E.g. greater consumer spendings are the result of higher consumer incomes.

Step 2: Explain statement (i.e. give the meaning of, show your comprehension of):

• A good hypothesis refers to one that is found to “work”, i.e. to be consistent with what is happening in the real world. When economists want to sort out (separate) good and bad hypotheses, they must subject them to systematic and repeated comparisons with relevant real-world data (i.e. facts). Good hypotheses will be confirmed by these data while bad hypotheses will be found to be invalid and must be discarded. Hence, it can be said that facts are useful in sorting out good and bad hypotheses.

c. “The ceteris paribus assumption helps isolate key economic relationships.”

Step 1: Define key terms (i.e. show knowledge of key terms):

• Facts: “Other things being equal” assumption = ceteris paribus assumption. The ceteris paribus assumption means that “all other relevant factors do not change” when we are looking at the relationship between two particular factors. E.g. when we say the rise in price of hamburgers results in people buying fewer hamburgers, ceteris paribus, we mean that all other things that may affect hamburger purchases (e.g. income, tastes, price of noodles) are assumed to remain unchanged.

• Key economic relationships: Relationships between factors that are most important in explaining a particular economic phenomenon/behaviour.

Step 2: Explain statement (i.e. give the meaning of, show your comprehension of):

• Unlike natural scientists that are able to carry out controlled experiments to ascertain relationships between two variables, e.g. plant growth and sunlight in a laboratory, economists must test their theories using real-world data, generated by the actual operation of the economy. Under these conditions, it is difficult to ascertain economic relationships between two variables as “other things” do change and may impact and influence the data collected. In other words, if more than one explanatory factor is involved, it can be difficult to sort out what has caused what.
The “other things being equal” assumption is hence extremely important as it allows economists to zero in and to isolate the effects of factors in an economic phenomenon. In this way, key economic relationships can be ascertained or established.

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