Economist» try to address their subject witha scientist'sobjectivity.Theyappniach the study of the economy in much the same way a physicist approaches the study of matter and a biologist approaches the study of life: They devise theories, collect data, and then analyze these data in an attempt to verify or refute their theories.
To beginners, it can seem odd to claim that economics is a science. After all, economists do not work with test tubes or telescopes. The essence of science, however, is the scientific method—the dispassionate development and testing of theories about how the world works. This method of inquiry is as applicable to studying a nation's economy as it is to studying the earth's gravity or a species' evolution. As Albert Einstein once put it, "The whole of science is nothing more lhan Ihe refinement of everyday thinking."
Although Einstein's comment is as true for .vx-ial sciences such as economics as it is for natural sciences such as physics, most people are not accustomed to looking at society through the eyes of a scientist. Let's discuss some of the ways in which economists applv lite logic of science lo examine how an economy works.
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The Scientific Method: Observation, Theory, and More Observation
Isiac Nov ton, the famous 17th-century scientist and mathematician, allegedly became intrigued one day when he saw an apple fall from a tree. This observation motivated Newton to develop a theory of gravity that applies not only to an apple falling to Ihe earth but to any two objects in Ihe universe. Subsequent testing of Newton's theory has shown that it works well in many circumstances (although, as Einstein would later emphasize, not in all circumstances). Because Newton's theory has been so successful at explaining observation, it is still (aught in undergraduate physics courses around the world.
This interplay between theory and observation also occurs in the ficW of economics. An economist might live in a country experiencing rapidly increasing prices and be moved by this observation to develop a theory of inflation. The Ihe-ory might assert that high inflation arises when the government prints too much money. To test this theory, the economist could eolket and analyze data on prices and money from many different countries. If growth in the quantity of money were not al all related lo the rale at which prices are rising, the economist would start to doubt the validity of this theory of inflation. If money growth and inflation were strongly correlated in international data, as in fact they are, the economist would become more confident in the theory.
Although economists use theory and observation like other scientists, they face an obstacle that makes their task especially challenging: In economics, conducting experiments is often difficult and sometimes impossible. Physicists studying gravity can drop many objects in their laboratories to generate data to lest their theories. By contrast, economists studying inflation are not allowed lo manipulate a nation's monetary policy simply to generate useful data. Economists, like astronomers and evolutionary biologists, usually have to make do with whatever data the world happens to give them.
To find a substitute for laboratory experiments, economists pay dose attention to the natural experiments offered by history. When a war in the Middle East interrupts the flow of crude oil, for instance, oil prices skyrocket amund the world.
For consumers of oU and oil products, such an event depresses living standards. For economic policymakers, it poses a difficult choice about how best to respond. But for economic scientists, the event provides an opportunity to study the effects of a key natural resource on the world's economics. Throughout this book, there* fore, we consider many historical episodes. These episodes are valuable to study because they give us insight into the economy of the past and, more important, because they allow us to illustrate and evaluate economic theories of the present.
If you ask a physicist how long it would take a marble to fall from the top of a ten-story building, she will likely answer Ihe question by assuming that the marble falls in a vacuum. Of course, this assumption is false. In fact, the building is surrounded by air, which exerts friction on the falling marble and slow» it down. Yet the physicist will point out that friction on the marble is so small that its effect is negligible. Assuming the marble falls in a vacuum simplifies Ihe problem without substantially affecting the answer.
Economists make assumptions for the »me reason: Assumptions can simplify the complex world and make it easier to understand. To study the effects of international trade, for example, we might assume that the world consists of only two countries and that each country produces only two goods. In reality, there arc numerous countries, cach of which produces thousands of different types of goods. But by assuming two countries and two goods, we can focus our thinking on the essence of the problem. Once we understand internatkinal trade in litis simplified imaginary world, we are in a better position to understand international trade in the more complex world in which we live.
The art in scientific thinking—whether in physics, biology, or economics—is deciding which assumptions to make. Suppose, for instance, that we were dropping a beachball rather than a marble from the top of the building. 0-.ir physicist would realize that the assumption of no friction is less accurate in this case; Friction exerts a greater force on a beachball than on a marble because a beachball is much larger. The assumption that gravity works in a vacuum is reasonable for studying a falling marble but not for studying a falling beachball.
Similarly, economists use different assumptions to answer different questions Suppose that we want to study what happens to the economy when the government changes the number of dollars in circulation. An important piece of this analysis, it turns out, is how prices respond. Many prices in the cconomy change infrequently; the newsstand pries of magazines, for instance, change only every few years. Knowing litis fact may lead us to make different assumptions when studying the effects of the policy change over different time horfeon*. For studying the short-run effects of the policy, we may assume that prices do not change much. We may even make the extreme and artificial assumption that all prices are completely fixed. For studying the long-run effects of lite policy, however, we may assume that all prices are completely flexible, lust as a physicist uses different assumptions when studying falling marbles and falling beachballs. economists use different assumptions when studying the short-run and long-run effects of a cliange in the quantity of money.
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