The following points highlight the four main categories of assumptions in economic theories. The categories are: 1. Psychological or Behavioural Assumptions 2. Institutional Assumptions 3. Structural Assumptions 4. Ceteris Paribus Assumptions.
Category # 1. Psychological or Behavioural Assumptions:
These assumptions are about the individual human behaviour. They refer to rational behaviour of individuals as consumers and producers. As consumers, they include families, households and individuals; and as producers, they include businessmen, entrepreneurs and firms.
A rational consumer aims at the maximisation of his satisfaction from a given money income and its expenditure on goods and services. On the other hand, a rational producer aims at maximising his profits. The rationality assumptions are at the root of microeconomic theories in which rational consumers and producers interact upon one another through the market system.
The first assumption made is that the buyers and sellers in each market are so numerous and independent that each is a price taker and not a price maker. The second assumption is that all markets are in equilibrium, that is, prices are such that no consumer or producer is dissatisfied with the exchanges in the market.
There is an equilibrium price and equilibrium quantity which always settles after demand and supply change. The third assumption is that all buyers and sellers have perfect knowledge about the prices. According to Baumol and Blinder, rational behaviour “is defined in economics as characterizing those decisions that are most effective in helping the decision- maker achieve his own objectives, whatever they may be. The objectives themselves (unless they are self-contradictory) are never considered rational or irrational”.
An individual as consumer or producer functions as an “economic man” on the basis of the rationality assumption. Rational behaviour is systematic and purposive whereas irrational behaviour is unpredictable and erratic. Even if certain individuals behave in an irrational and erratic manner, the majority of individuals taken together demonstrate collective rationality.
Category # 2. Institutional Assumptions:
These assumptions in economic theory relate to social, political and economic institutions. All economic theories have been developed on the assumption of a capitalist economy in which the means of production and distribution are privately owned and used for personal gain.
It assumes stable government and certain socio-economic institutions which include private property, self-interest, economic liberalism or laissez-faire, competition and the price system. The government’s role is to enforce the “rule of the game” in the market. The institutional assumptions are the basis of micro-economic theories.
Category # 3. Structural Assumptions:
These assumptions relate to the nature, physical structure or topography of the economy and the state of technology. In the short run, economic theories are based on the assumptions of given resources and technology.
These assumptions relate to a static economy where there is movement but no change. But in the long run, labour, capital and other resources and technology are assumed to change in certain theories. They relate to a dynamic economy. However, most economic theories are based on the assumption of a static economy. The structural assumptions are used in production functions of various types and in growth theories.
Category # 4. Ceteris Paribus Assumption:
Another important assumption made in economics is the ceteris paribus or other things being equal assumption. This is used to simplify reality. In order to consider the impact of one factor at a time the other factors are held constant.
In the real world, there may be a number of factors operating simultaneously’ If all of them are included in the analysis, it would become complex. For instance, the law of demand states that the amount demanded increases with a fall in price and diminishes with a rise in price, other things being equal.
The “other things” are such assumptions as no change in income, tastes, habits, prices of related goods etc. If all these factors are included, the Law of Demand would become complex. Thus the assumption of “other things being equal” is used to understand and predict the world’s events in a better way.