Understanding Economics: Theories, Models, and Research
Economics is the science that studies the most convenient satisfaction of society’s scarce resources to obtain an ordered set of objectives.
Positive vs. Normative Economics
- Positive economics is defined as the science that seeks objective explanations of the functioning of economic phenomena; it deals with what is or could be.
- Normative economics, by contrast, offers prescriptions for action based on personal value judgments and subjective concerns about what should be.
Economics as a Science
The main purpose of economic science is to understand how the economies of individual countries function. This comprehension requires adequate theories to explain the functioning of economic phenomena, and for this, we must resort to abstraction.
- Theories attempt to explain why certain events occur or document the relationship between two or more things.
- Models are a simplification and abstraction of reality that, through arguments and conclusions, explain a particular proposition or an aspect of a broader phenomenon.
- The Law of Large Numbers argues that, on average, random movements of a large number of individuals tend to cancel each other out.
Economic Research
In economics, both inductive and deductive methods are used. Thus, from the observation of natural phenomena using inductive procedures and then drawing hypotheses by deduction, we formulate theories and laws.
- Acceptance and Refutation of a Theory: The criterion for determining whether a theory or model is valid is not whether it performs a completely realistic description of the phenomenon it purports to explain because none do, but whether the predictions derived from the model are consistent with the existing evidence.
- Methodology in Economics: The procedure usually followed in the development of research in economics has three phases:
- In the first, we observe the phenomena, and we wonder why there may be a certain relationship.
- In the second, we formulate a series of hypotheses and develop a theory that attempts to explain the observed phenomenon.
- The third tests or verifies the predictions of the theory, contrasting them with the data.
Realism of Assumptions in Economic Models
The assumptions that make up the various theories are propositions whose validity is taken as given. They are introduced to materialize the modes of behavior of economic agents.
Difficulties in Conducting Controlled Experiments
Since these variables do not remain constant, individuals change their behavior and habits of conduct with advancing economic knowledge of phenomena in order to take advantage of them.
Value Judgments in Economic Analysis
These influence the issues that the scientist studies, the type of questions that are asked, the concepts used, and the assumptions made, and can bias the analysis of economic phenomena.
Tools of Economic Analysis
- An economic variable is something that influences decisions about fundamental economic problems or something that describes the results of those decisions.
- Economic data are facts, usually expressed in figures, that provide information on economic variables.
- An index number expresses the value of each period in relation to a given base year.
Types of Economic Variables
- Endogenous variables: Those whose values are determined by the system of functional relationships between the variables involved in the model.
- Exogenous variables: Those whose values are not determined within the model in which they are inserted.
- Stock variables: Those that are referred to a moment in time.
- Flow variables: Those that only make sense when related to a period of time.
- Nominal variables: Those that are expressed in current monetary units, i.e., in units of the applicable year.
- Real variables: Those that take into account changes in the general price level.