Methods of Economic Analysis – StudiousGuy

Any economic analysis involves the formulation of laws and generalizations through two methods- deductive and inductive.

This is also called a priori reasoning. We start from unchallenged elementary or rudimentary assumptions/ facts and then arrive at conclusions(build a hypothesis or theory) using logical analysis or our own analytical abilities. In this kind of reasoning, we go from general to specific. The stages in deductive reasoning are:

• Testing the hypothesis using more observations, etc.

This reasoning gives us a hypothesis and if this hypothesis gets verified we get general economic principles or laws.

• It is a simple method, doesn’t involve the use of any complex software analysis, etc. only simple deductive logic is required.

• This method is important for economists as it focuses upon economic reasoning which is of paramount importance.

In this method of reasoning we start from assumptions, thus, if the assumptions happen to be logically flawed the whole process becomes faulty and would give wrong conclusions. Thus, the logical fallacy is a disadvantage of this method.

This type of reasoning flows from facts to theory. First, we collect information and facts and then move towards providing evidence using economic theory and facts. This method formulates principles using the sub-methods- Observations, Experimentations, Statistical methods.

Data is collected about a particular economic theory and then conclusions are drawn. The stages in this method are:

• Since it is based on facts it is more realistic and reliable.

• Using statistical methods and experimentations makes the process more scientific, thus, more acceptable universally rather than just depending on your own reasoning and logic.

• Since the economic environment is dynamic and always changing, relying upon a more scientific method always helps reach logical conclusions.

• If the data used is insufficient and faulty it would lead to faulty conclusions, making the hypothesis less reliable.

• It is a time-consuming process and thus expensive as well.

• The collection of all the data is not an easy job and varies from person to person. As to how they collect data.

3 Economics: Methods, approaches, fields and relevant questions

“Causal” vs. “Descriptive”

“Causal” papers try to get at whether one factor or event “A” can be seen to directly “cause” an outcome “B”. For example, “does an individual getting more years of schooling lead him or her to have higher income, on average?” A good way to think about this conception of causality is to consider the counterfactual: if a typical person who received a university degree had been randomly selected to not get this education, would her income have been lower than it now is? Similarly (but not identically) if the typical person without his education had been randomly input into a university program, would her income now be greater?

Since the real world does not usually present such clean experiments, “causal” empirical researchers rely on various techniques which usually themselves depend on" identification assumptions." See, for example, control strategies, difference in difference, and instrumental variables techniques.

“Descriptive” papers essentially aim to present a picture of “what the data looks like” in an informative way. Causal relationships may be suggested but the authors are not making a strong claim that they can identify these. They may present a data-driven portrait of an industry, of wealth and inequality in a country or globally over time, of particular patterns and trends in consumption, of a panel of governments’ monetary and fiscal policy, etc. They may focus on the ‘functional form’ of relationships in the data and the ‘residual’ or ‘error structure. They may hint at causal relationships or propose a governing model. They may identify a ’puzzle’ in the data (e.g., the ‘equity premium puzzle’) and propose potential explanations. They may use the data to ‘provide support’ for these explanations. They may devote much of the paper to providing a theoretical explanation (remember, in Economics these are usually mathematical models) for the pattern. They may also run statistical tests and report confidence intervals; one can establish a ‘statistically significant’ relationship between two variables even if the relationship is not (necessarily) causal. This is particular important when one sees the data as subject to measurement error and/or as a sample from a larger population. E.g., just because age and wealth (or height and head-size, or political affiliation and food-preference) are strongly related to one another in a random representative sample of 10 people does not mean they are strongly related to one another in the entire population.

Methods of Economic Analysis

Analysis refers to studying a given topic in detail. Economic analysis refers to the investigation of a particular topic from the perspective of an economist. It includes conducting an in-depth study of various processes such as production, consumption, consumer behaviour, national income, employment and others. It evaluates the given industry in detail with all the aspects associated with that particular industry.

Moreover, the primary aim of economic analysis is to determine the effectiveness of operations within an economy. There are two types of economic study or economic analysis: Deductive Method and Inductive Method. Here, we take a look at these methods and also present an overview of the process of making the hypothesis.

Deductive method

It is a method of economic investigation or economic analysis. It is also known as the analytical abstract priori method or the hypothetical method. In this method, a person is required to assume the factual information and then follow the phase of logical reasoning to arrive at a concrete result or conclusion. By including some assumptions and experiments, a theory is built in this method.

For instance, it is a common fact that businessmen strive for maximum profits. Therefore, assumptions such as businessmen buying materials at a cheaper cost and cutting labour costs are added to build an economic theory that offers solutions to qualitative and labour-related issues. Hence, the common rule to remember in the case of deductive methods is to move from general facts to particular assumptions and, eventually, constructive theories.

Moreover, in the deductive method, simple facts help in creating complex hypotheses. Therefore, three stages or phases are recognised in the deductive method:

Observation Logical reasoning Experimentation, instance and testing through observation.

Making the hypothesis is an important component of the deductive method of economic analysis.

Merits of the deductive method

Following are the merits of the deductive method:

Simple and convenient: This method is observation based and is fairly easy to practice. For example, in the Law of Diminishing Marginal Utility, after the increase in consumption, the consumer reaches the point of satiety, and the utility of the good begins to diminish. Removes the need for experimentation: Experiments are vital in subjects like chemistry and physics but not mandatory in the case of economics. Deductive method is an alternative to experiments as far as economics as a subject is concerned. Accurate results: Deductive method includes logical reasoning on the part of the economist or the analyst. Hence, logical thinking increases the chances of precision and sets high standards.

Demerits of deductive reasoning

The disadvantages of the deductive method are as follows:

Assumption based: Assumptions have a higher chance of going wrong and result in invalid solutions. This can lead to a serious economic crisis if done inappropriately. Imaginative: There is a greater chance of the deductive method being far from reality since it works on the basis of imagination. Real-life problems cannot be solved by imaginative or utopic solutions.

Inductive method

In the inductive method, analysts or theorists progress from a practical outlook to a scientific problem in order to shorten the gap between theoretical knowledge and practical applications. The induction method is carried out in two forms, via statistics and experimentation. This method is classically associated with statistical forms of investigations. It involves a lot of numbers, quantities and formal terms.

Merits of inductive method

It is a very practical and applicable method, and it is simply descriptive. It is totally verifiable since it deals with quantities. Laws and theories under the inductive method may not be universal but are condition specific.

Demerits of inductive method

If in case the analysts or theorists do not possess a balanced and stable judgement, then this method is unhelpful as they will be extracting insufficient data. Inductive method works on the basis of experiments, and experiments require materials and resources. It is often difficult to gather and access the facts required for experiments. The Inductive method is an incomplete method alone. It can be used if combined with deductive methods or deductive reasoning.

Deductive method vs inductive method

BASIS DEDUCTIVE METHOD INDUCTIVE METHOD ORIGIN Used by those believing in classical theories. Used by those who believe in Neo-classical theories. TECHNIQUE Abstract Practical OTHER NAMES Analytical, priori or abstract method Historical, empirical or posterior method PROCEDURE Facts are followed by logical reasoning Practical scenario to scientific techniques SCOPE Works under the social science model. Works under the science model. APPLICATION Universal Situation specific RESULTS Confirmation of the making the hypothesis Generalised results STRUCTURE Highly structured method Less structured

Hence, there are some differences between the deductive method and the inductive method of economic analysis.

Making the hypothesis

Before dwelling on the process of making the hypothesis, one must understand the meaning of the hypothesis. Hypothesis refers to any idea or assumption based on proving an argument or answering any question. It consists of several components, such as background research, which includes in-depth knowledge of facts. This is followed by a literature review, which refers to the part where the analyst evaluates the searched facts.

After all these steps are performed, then comes the part where the analyst must think about potential questions that can be asked or should be asked to reach a conclusion.

The following steps must be followed for making the hypothesis:

Gathering observational data regarding the topic. The gathered data or information must be evaluated to look for the causes of the problem. Next, analysts should create a list of problems concerning the topic. After making the hypothesis, analysts must begin to confirm or disprove the matters of the hypothesis to reach a conclusion.

Conclusion

Deductive method and inductive method are, hence, complementary methods of economic analysis. The two methods work the best when used together. They are co-relative and help in establishing concrete theories and producing novice solutions to economic and social problems. Great economists such as Alfred Marshall also supported the complementary relationship between the two methods.