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All of a sudden, she asks herself, “If just one roundabout is this complex, how can people manage to configure all of the lights? Beyond traffic lights, if social systems are this complex, how do social scientists manage to understand and analyze the systems as a whole?” This is indeed a great question!
Without hesitation, we can say that Kate is right. Social systems are extremely complex. Understanding them also requires understanding rigorous ways of science and thinking like a social scientist. In this article, we will explain how economists think and how they develop their models. If you want to learn more about the economic way of thinking, please keep reading!
Economic Way of Thinking Definition
Defining the economic way of thinking is crucial for us to understand the methodology of economics. To do this, we will focus on why economics is, by the most, considered a science. Economists don’t wear laboratory coats and we never see them in front of microscopes or laboratory equipment. Nonetheless, the most important thing that science, and maybe humanity, has achieved is the scientific method. Economics uses the scientific method for collecting data and testing theories.
The economic way of thinking can be summed up as using scientific methodology while solving complex social problems, especially related to economics.
Nonetheless, from the philosophical point of view, scientific methodology is a thing we still argue about. To keep things simple, it is better to focus on the main aspects of the scientific methodology and talk about the details later on. Like any other science, economics starts with an observation or a question. After constructing their research question, economists form hypotheses. We should keep in mind that hypotheses should be falsifiable, and they should be logical statements.
Coined by Sir Karl Popper, falsifiability states that if a theory is scientific, we should be able to test it empirically.
Following this, we should be able to test our hypotheses with experiments. This is where social sciences differ from natural sciences. Unlike natural sciences, conducting experiments in social sciences is generally unethical and, most of the time, nearly impossible. Therefore, like other social sciences, economists depend on data, modeling, and statistical approaches to conduct their experiments.
Let’s assume that a country’s central bank decided to increase the interest rates. As an economist, you say that increased interest rates will increase that country’s national currency demand in international markets, since it is reasonable to think that people are going to invest in the country due to increased interest rates. For investing in the market, they will demand the nation’s own currency. Ultimately, increased demand will be reflected in the prices, and the nation’s currency will gain value internationally.
This is your hypothesis. Since you can’t increase the interest rates by yourself, and in addition to that, it may affect thousands of lives, it is nearly impossible to conduct such an experiment. However, you can analyze the past data as evidence to prove your hypothesis. There are many ways to use the historical data to prove your hypothesis and they are way out of the scope of this section. It is important to notice that the lack of experiments in economics is just a speed bump, and we can overcome it.
After analyzing the data, we can support our hypotheses or falsify them. Indeed this is what economists do while they are offering policy suggestions or trying to create an explanation for the phenomena.
Scientific method is an approach to analyze and establish facts about phenomena with a series of steps. These steps can be generalized as forming a hypothesis, conducting experiments over the collected data, and analyzing the results.
Key Ideas in the Economic Way of Thinking
Key ideas in the economic way of thinking can be summed up in three main points. We explained one of them, the scientific method. On the other hand, we also mentioned that social sciences don’t have the chance to conduct experiments. The remaining two key ideas are related to this lack of experiments. One is creating economic models and the other one is the role of assumptions in the economic way of thinking. So, in the end, we can list them as follows.
- Key ideas in the economic way of thinking:
- Scientific methodology
- Economic models
- Assumptions
Models can be defined as the representation of the phenomena. They help us understand the events happening and forecast future events.
The most well-known example of an economic model is the supply and demand model. Nearly in every economics textbook, the supply and demand curve is the first thing we come across and learn. It represents the supply and demand of a good in a market. In real life, these relations may be more complicated than the model. This model captures the very fundamental rules of a market economy. Below you can see an example of the supply and demand model.
Fig. 1 - The Supply and Demand Model in a Free Market
We have ready articles covering the supply and demand model in detail!
If you want to learn more, don’t hesitate to check them out!
- Supply and Demand;- Shifts in Supply;- Shifts in Demand.
While constructing a model, we have to leave some things outside of the model. This is why we call models 'the representation of reality.' For example, in economic models, we generally assume that agents have perfect information or they will act rationally. We do this since we want to obtain the core rules that govern the economic systems. Economists believe that these abstractions are useful for understanding the occurring phenomena. We name these rules as assumptions.
Assumptions are a necessity to construct models. Since phenomena occurring in social systems are immensely complex, we use assumptions to eliminate the complexity and find the underlying rule that derives them. For example, when we are constructing a supply and demand model, we are assuming that people are rational and they will make rational choices. With this, we assume that they will try to maximize their utility. Nonetheless, this is an assumption. We create our models on assumptions like this. In reality, people can make irrational choices. By stating these types of assumptions, we can clearly eliminate the vast complexity of reality.
For a more detailed explanation of the economic models,
please don’t hesitate to reach out to these articles:
- Economic Modelling;
- Economics as Social Science.
Elements of Economic Way of Thinking
The most prominent element of the economic way of thinking is to make an observation. This can be anything directly related to the economy or we can take an interdisciplinary approach and apply tools of economics to different problems of social systems.
A statement can be an observation. For example, we can say that “there are less developed countries in the world.” Indeed this is an observation and reflects reality.
For the next step, economists ask a question about their observations.
Why are there less developed countries in the world? This is an example of a question related to the previous observation.
Following the question, economists will form a hypothesis.
There are less developed countries in the world because these countries have poorly functioning institutions for a developed economy. This is a testable hypothesis. Although the topic of causality in social sciences is generally a risky approach, we will keep things simple in this example.
Finally, economists will collect data and test their hypotheses.
Let us assume that economists collected data and ranked institutional quality around the globe. They have compared this ranking with countries’ GDP per capita. This is a way of testing a hypothesis.
Finally, according to the results, economists may reach a scientific conclusion.
In a nutshell, we can say that the elements of economic way of thinking is and should be parallel to the elements of the scientific way of thinking regarding the following steps.
- Making an observation;
- Proposing a question;
- Forming a hypothesis;
- Testing the hypothesis;
- Coming up with a conclusion.
Economic Thinking Importance
The importance of economic thinking is correlated with the importance of economics as a science. As humans, we are connected to our communities and societies. Economics stresses the relationship between agents and the needs of agents. Therefore, for a better life, economics as a science is crucial as physics or biology. And as we have noted, the economic way of thinking is the driving force behind economics.
For example, if the members of the society that we are living in are unable to find jobs, economists may analyze the market and they can give reports about the ongoing problem. Here we should introduce another aspect of economics, one is the positive statements that economists make and the other one is the normative statements.
To dive deeper into this topic, why not check out:
- Normative and positive statements.
Positive statements are completely descriptive. They don’t include suggestions or they don’t explain how things should be. They just explain things as they are. On the contrary, normative statements give suggestions and describe how things should be. This difference is vital for grasping the conflicts between different economic theories.
Positive statements describe reality as it is.
Instead of creating policy suggestions, they will offer proof of how things work.
Normative statements offer a point of view of how things should be.
Instead of giving raw proof or data, they focus on the policy-making process.
If we want to elaborate on our point of view about positive and normative statements, we can give an example from the economics literature. Let us continue with our previous scenario, where there is a high unemployment rate in your society. An example of a positive statement in this scenario would be “increased amount of unions are causing increased demand for higher wages.” On the other hand, a normative statement would be “solution to unemployment is to decrease the number of unions that causes higher demands in wages.” Logically, both statements can be true or false. Nonetheless, the positive statement doesn’t suggest any action. It just tries to uncover the phenomena itself.
Economic Way of Thinking Examples
To broaden the idea we can give two examples of the economic way of thinking. Our first example will be related to the scientific methodology in economics. Let us assume that you are interested in the field of labor economics and that you decided to investigate the relationships in factor markets. You believe that due to inefficient matchmaking between workers and job owners, unemployment is increasing.
For healthy research, you start with a hypothesis. Your hypothesis is that unemployment arises due to inefficient matchmaking rates between employers and workers in the labor market of a country. To prove your hypothesis, at first, you glance towards the literature to develop your understanding and organize your research plan. After this, you dive deep into data. Obviously, there are many methods to conduct this research, and after careful consideration, you found a suitable research method. After completing your research, either you can find enough proof to support your hypothesis or you may fail to come up with the necessary proof to support your hypothesis. Nonetheless, we should keep in mind that both results are useful since even your failure is a contribution to the scientific literature.
Now, let us assume that you proved that, in that specific factor market, matchmaking between employers and workers is indeed the problem. Can you think of a normative and positive statement on this matter? A positive statement could be the results of the research directly. You can state that 'in that market, due to inefficient matchmaking, unemployment increases.' As you can see, there are no policy suggestions here. You are just stating the facts. But another economist, using your research, may say that 'we should introduce new technologies to increase the efficiency of matchmaking in this market.' Indeed this is a normative statement because they are taking a position and are offering a policy suggestion. In this statement, their values are intertwined with the facts.
Economic Way of Thinking - Key takeaways
- We can say that the economic way of thinking is to apply scientific methodology to the questions related to the economy.
- Since experiments in social sciences may be unethical and impossible to conduct, social scientists use already existing data, mostly from the past, to elaborate on their points.
- The results of the economic research can be used in positive or normative statements. Positive statements describe the world as it is. On the contrary, normative statements suggest policies for shaping the systems as how they ought to be.
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Frequently Asked Questions about Economic Way of Thinking
What is the economic way of thinking?
The economic way of thinking can be summed up as using scientific methodology while solving complex social problems, especially related to economics.
What is the economic way of thinking examples?
For example, let us assume that you want to investigate the relationship between economic crisis and money hoarding of agents. Your economic way of thinking starts with the hypothesis that in the aftermath of economic crises, people will have a tendency towards hoarding. After structuring your hypothesis, you can start testing your data. There are many ways to do this; they are known as statistical approaches. After testing your hypothesis on your data, you can reach a conclusion. This can be an example of the economic way of thinking. You start with structuring a hypothesis, you collect data and test it.
What is the purpose of knowing the economic way of thinking?
The purpose of knowing the economic way of thinking is to uncover complex social systems and explain the rules working behind them.
Why is economic thinking important?
The importance of economic thinking is correlated with the importance of economics as a science. As humans, we are connected to our communities and societies. Economics stresses the relationship between agents and the needs of agents. Therefore, for a better life, economics as a science is crucial, just as physics or biology. The economic way of thinking is the driving force behind economics.
What are the principles of economic thinking?
We can sum up the principles of economic thinking with three core elements: scientific methodology, economic modeling, and assumptions.
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