This article will help you to learn about the difference between economic laws and economic theories.
Difference between Economic Laws and Economic Theories
Every important law and generalisation of economics is based upon some assumption(s).
There is a feeling among some group of people that, if unrealistic assumptions are made the laws originating there-from will be invalidated or falsified.
However, another group of economists, led by the 1976 Nobel Laureate economist Milton Friedman, hold an exactly opposite viewpoint.
In Friedman’s opinion, positive economics explains “a system of generalisations that can be used to make correct predictions about the consequences of any change in circumstances.” Positive economies is very much a science in the sense that its predictions have to be tested in the light of empirical evidence (i.e. on the basis of facts and figures).
Even if the assumptions of positive economics is unrealistic, it is as much a science as any other physical science like biology or chemistry. The crucial issue is whether the predictions based on economic laws are verified by facts and figures.
Friedman and his followers correctly believe that, since assumptions are made to simplify our analysis they cannot be realistic. We have only to know whether any policy conclusion drawn from any economic theory or law is invalidated if any of the assumptions is relaxed.
Economic Laws vs. Economic Theories:
Economic laws seek to establish cause-and-effect relationships among variables. But, the laws of economics fail to provide any acceptable explanation of the relations stated by them. So, we have to develop relevant theories with a twofold purpose.
Our primary purpose is to explain the relevant economic laws through deductive logic. Our second objective is to provide the validity of the law through the logical process of reasoning.
A simple example will help us to clarify the point. One of the fundamental laws of microeconomics is the law of demand. It seeks to establish an inverse relation between the market price of a commodity and the quantity demanded of it. Since more is demanded when price is low, the demand curve for a commodity usually slopes downward from left to right.
However, we account for the downward slope of the demand curve by the marginal utility theory, developed by Carl Menger, Alfred Marshall and W. S. Jevons. This theory states that, the demand curve of a normal good slopes downward from left to right due to the operation of a fundamental psychological law, viz., the Law of Diminishing Marginal Utility.
Alternatively, one can explain the downward slope of the demand curve with the help of the indifference curve approach, developed originally by F. Y. Edgeworth and Vilfredo Pareto and refined and modified later by J. R. Hicks and R G. D. Allen.