1 Economic Thinking At the start of class, we used the review questions at the end of chapter 1 to review the remaining concepts. I did not emphasize the circular flow model. It is most relevant in Macroeconomics.

2 Learning Objectives §Describe how economists go about their work §Explain the big questions that economists seek to answer §Understand Scarcity §Compare economic systems

3 The Nature and Role of Theory. §The uses of theories (simplified models). §Everyone uses them... §to describe, explain, predict, or understand.

4 Abstraction §Models leave out much specific information §But answer the basic question. §Model builders must make judgments: l What information to include, and l which details may be safely omitted.

5 Judging Theories §Logical soundness of assumptions and hypotheses §How well a theory predicts. §Theories should yield testable predictions.

Methodology §Economists build models l Answer important questions Why does international (int’l) trade occur? What goods will a country import (export)? How much will be traded and at what price? Will trade affect wages, or other factor payments?

Methodology §Models are abstract, yield predictions l simplify reality l verbal l mathematical geometric algebraic

8 Parts of a Theory. §Variables take on different values. §Assumptions give us a starting point for deductive reasoning. §Hypothesis - a statement about how two or more variables are related. §Predictions are deduced from the assumptions and hypotheses of the theory.

9 Occam’s Razor §The simplest workable theories are also the most useful. §a.k.a. “The Principle of Parsimony” §Einstein: “Everything should be made as simple as possible, but not more so.”

10 Formulating Theories §Variables noted, assumptions made, hypotheses formulated. §Predictions are deduced from the assumptions and hypotheses. §Predictions are stated.

11 Testing Theories §Predictions are tested. §Evidence either confirms or rejects theory. §If confirmed, can the results be reproduced? §If rejected, then either a new theory is formed, or the old one is amended.

12 Arguments §Argument -- a sequence of statements together with a claim. §Sequence -- two or more statements. §Claim -- that one of statements, called the conclusion, follows from the others, called the premises. §An argument is sound if it is valid and all its premises are true.

13 Deductive Arguments §In a valid deductive argument it is impossible for the premise to be true and the conclusion false. §Example: Knowledge is power. Power corrupts. Therefore knowledge corrupts. §Another: Economists are scoundrels. Eastwood is an economist. Therefore Eastwood is a scoundrel.

14 Inductive Arguments §In a correct inductive argument it is improbable for the conclusion to be false if the premise is true. §e.g.,: Pieces of foam fall from the shuttle on almost every launch. Therefore, there is no danger. l Reasoning from a small sample can be dangerous!

15 The Fallacy of False Cause §This fallacy occurs when in argument one mistakes what is not the cause of a given effect for its real cause. §When an argument takes the following form, it is often incorrect: l Event A occurs, then Event B occurs l Therefore A causes B.

16 Variants of the False-Cause Fallacy §Post hoc, ergo propter hoc (Latin) translates roughly as “after this, therefore because of this.” §Accidental correlation: A occurs when B occurs. Therefore A causes B (or vice- versa).

17 The Fallacy of Composition §Assuming that what is true for the individual is true for the group. §Frederic Bastiat’s “Petition of the Candle Makers” illustrates this fallacy.

18 The Fallacy of Decomposition §Assuming that what is true for the group is true for the individual. §Example: Gator-Aid tastes sweet. Therefore all the ingredients of Gator-Aid must taste sweet.

19 Errors in Economic Thinking. §Misunderstanding the Ceteris Paribus condition (Latin phrase meaning “all other things remaining the same”).