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 ScarcityCompare 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 informationBut 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.

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?

Methodology

Models are abstract, yield predictions

simplify reality

verbal

mathematical

• geometric

• algebraic

9

Occam’s RazorThe 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.”

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Formulating Theories

Variables noted, assumptions made, hypotheses formulated.

Predictions are deduced from the assumptions and hypotheses.

Predictions are stated.

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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.

12

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.

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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.

14

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!

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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.

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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.