THE METHODOLOGY OF ECONOMICS

Section Objectives

Understand how economists use economic models

Evaluate the economic activity using graphs

Explain why economists can disagree

Methodology

Three tools of analysis Model building Graphs Positive versus normative analysis

Model-Building

Step 1 Identify the problem

Step 2 Develop a model by selecting the variables

based on an assumption Step 3

Collect data and test the model

Model-Building

Step 1: Identify the Problem Define the problem What is the question you want to answer

“Why were 100 million fewer gallons of gasoline purchased in December than in May?”

Model-Building

Step 2: Develop a Model Model: a simplification of reality used to

understand the relationship between variables. (aka: theory)

Emphasizes those variables that are most important by assuming that all other variables remain unchanged.

http://goo.gl/maps/Cpr9s

Model-Building

Step 2: Develop a Model Ex. The gasoline model consists of two

variables Price of gas Quantity of gas consumed

All other possible causes for the decline are ignored

Assumption: something that is accepted as being true. Consumer incomes and other variables do not

change when gasoline prices rise.

Model-Building

Step 2: Develop a Model Useful only if it yields accurate predictions. If evidence confirms a model, it is accepted If evidence does not support a model, the

model is rejected

Model-Building

Step 3: Test the Model Gather data to test the model “If the price of gasoline rises, gasoline

purchases fall.” Investigation reveals that the price of gasoline

rose sharply between May and Dec. The data supports the model, thus the model is valid.

Applying Graphs to Economics Economists use graphs to present

economic models. Graphs are the simplest way to present

and understand the relationship between economic variables

Basic economic analysis concerns the relationship between two variables

Applying Graphs to Economics Direct Relationship

A positive relationship between two variables When one variable increases the other variable

increases When one variable decreases the other variable

decreases Both variables change in the same direction

Also assumes that all other variables not shown remain unchanged

Applying Graphs to Economics

30 60 90 1200

0.51

1.52

2.53

3.54

4.5

PC Expenditure and Income

Annual Income(thousands of dollars)

PC

Exp

en

dit

ure

(t

hou

san

ds o

f d

ollars

per

year)

Applying Graphs to Economics

Another tool used is to arrange in rows and columns

This table shows the same info in a different formatPoint PC Expenditure

(thousands of dollars per year)

Annual Income(thousands of

dollars)

A $1 $30

B $2 $60

C $3 $90

D $4 $120

Applying Graphs to Economics Inverse relationship

A negative relationship between two variables When one variable decreases the other variable

increases When one variable increases the other variable

decreases The variables move in opposite directions

Applying Graphs to Economics

25 50 75 1000

10

20

30

40

50

60

70

80

90

Quantity of Super Hero Games Purchased(millions per year)

Pri

ce p

er

Su

per

Hero

Gam

e(d

ollars

)

Applying Graphs to Economics Law of demand

Inverse relationship between a product’s price and quantity demanded

Law of supply Direct relationship between a product’s

price and the quantity demanded

Why Do Economists Disagree? Positive Economics

Analysis based on facts Uses statements that can be proven either true

or false Often a positive statement is expressed using

the words “if” and “then” A positive statement does NOT have to be

true, it has to be testable

Why Do Economists Disagree? Normative Economics

Analysis based on value judgments Express an opinion on a subject Key words or phrases are normative

Good Bad Need Should Ought to be