Economics: Methods, Types and Models!
The usual methods of scientific studies — deduction and induction, are available to the economist.
Both methods come from science, viz., Logic. The deductive method involves reasoning from a few fundamental propositions, the truth of which is assumed. The inductive method involves collection of facts, drawing conclusions from them and testing the conclusions by other facts.
Deduction and Induction:
i. Starts from the general and moves to the particular.
ii. Begins with general assumptions and moves to particular conclusions.
iii. Develops a theory, and then examines the facts to see if they follow the theory.
Let there be 360 degrees in circle – (A general assumption)
There are four right angles in circle – (A logical argument)
Therefore this right angle has 90 degrees – (A particular conclusion)
i. Starts from the particular and moves to the general.
ii. Begins with particular observations and moves to general explanations.
iii. Collects observations, then develops a theory to fit the facts.
This apple falls to the ground. (A particular observation)
All apples fall to the ground. (More observations)
All objects attract each other. (A general explanation)
Economics can be a very deductive subject, and economists are used to constructing complicated ‘models’ of human behaviour which begin with a number of assumptions. However, economics is also an empirical subject, using inductive methods to explain observed facts.
Thus the downward sloping demand curve, for example, can be deduced from general assumptions about how people try to maximise their satisfaction from the purchase of goods and services. On the other hand, demand curves can be built up empirically, that is by observing actual customers reacting to market price changes, and when market researchers, census-takers and opinion pollsters collect necessary information, the data can be used inductively to make economic predictions.
In practice it can be very difficult to say where deduction ends and induction begins. Economists need to use both deduction and induction in their work.
Positive and Normative Economics:
Some economics textbooks begin by distinguishing between positive and normative economics. Positive economics deals with what is i.e., with objective explanations of the working of the economy. Normative economics is about what ought to be i.e., it puts forward views based on personal value judgments. Thus, positive economics deals with questions which, in principle at least, are testable.
Similarly, ‘A tax on a good will raise its price’ and ‘Business people will invest more when interest rates are low’, are positive statements about economics. Normative statements would include ‘the Governments ought to give more pensions to retired people in poor countries’, and ‘Unemployment is a more serious problem than inflation’.
Positive statements and questions
Examples: ‘Amitabh Bachchan is a Hindi actor’;
‘Is this table made of wood?’
i. Deal with objective reality;
ii. Tell us something about the world around us;
iii. Can, in principle, be ‘true’ or ‘false’?
Even if we do not yet have the means to do so (e.g. to prove whether there is intelligent life in space), proof is ultimately possible using methods upon which everyone can agree.
Normative statements and questions:
‘Amitabh Bachchan is the best Hindi actor since ‘Dilip Kumar’. ‘Is this a beautiful table?’
i. Deal with subjective opinions;
ii. Tell us something about people’s view of the world, rather than the world itself; they are about values, attitudes or tastes;
iii. Cannot be proved true or false.
They can never be fully resolved because they often depend on moral attitudes (e.g., while most people would agree that Hitler was evil there are some persons who claim the opposite).
Positive economics is the study of economic propositions which can be verified, at least in principle, by the observation of real-world events, and without using normative propositions or value judgments. Normative propositions tend to be prescriptive, and tell us what the person making the proposition believes ought to be done. In practice, the distinction between positive and normative economics is blurred. It is possible to put forward economic propositions which appear to be positive, but, in fact, rest upon value judgments.
Since Nobel Prize has been awarded to a number of economists doing work in the area of welfare economics, the subject has attracted considerable interest to students of economics in recent years. So, it is necessary to know what is meant by welfare economics.
Economics is often divided into two branches — positive and normative. Normative economics is often called welfare economics. The first book on the subject was written by A.C. Pigou. The name of his book is The Economics of Welfare (1920).
Welfare economics is concerned with comparing one state of the economy with another on the basis of value judgments (or ethical considerations) and suggesting some criteria for improving social welfare. Thus, welfare economics deals mainly with normative and ethical issues relating to social choice and individual values.
The purpose of welfare economics is to explain how a society efficient allocation of resources can be identified and achieved. Pigou assumed measurable and inter-personal comparison of utility. According to him, any transfer of income from a relatively rich man to a poor person of the same nature (and temperament) implies an increase in social welfare (or the aggregate sum of satisfaction). This is because income transfer enables more intense wants to be satisfied at the expense of less intense wants.
Modern welfare economics is based on Vilfredo Pareto’s principles of excluding interpersonal comparison of utility. No doubt, Pareto’s writing appeared earlier than Pigou’s book (which first appeared in 1912 as Wealth and Welfare). But they were popularised in England in 1913.
According to Pareto (an Italian economist), total economic welfare is the sum of individual welfare. But one individual’s welfare cannot be compared with that of another individual. So inter-personal comparisons are ruled out. Thus, only those policies that make at least one person better-off without making anyone else worse-off are considered to increase total welfare. Thus, if a million people are made substantially better-off and one individual make slightly worse-off by a policy, the policy does not increase welfare by Pareto’s definition.
However, the Pareto criterion has been severely criticised over the years. Bergeson, Samuelson, Kaldor, Scitovsky, Arrow and above all, Amartya Sen have suggested alternative criteria of welfare maximisation.
In a broad sense, welfare economics studies both positive and normative questions. The notion of ‘best in economics’ involves considerations of efficiency and equity.
An economic model is a simplification of reality which abstracts from the complexities of the real world in order to explain economic phenomena and to make predictions.
Models can be expressed in various ways. The most obvious is to use words; most of the economic models are verbal models. They can also be expressed diagrammatically. Any model is a considerable simplification of reality.
In order to use models we usually have to be able to quantify the variables involved. In principle this may seem an easy task, is practice it is quite difficult.
Theories can never be proved correct because it is not possible to check a theory against every possible observation.
From this viewpoint, a good theory is one that makes wide ranging claims which can be tested, while leaving itself open to falsification.