Economics: What Economists Do

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We've said that economics is the study of rational choice in the face of scarcity. Let's talk now about what it means for economics to be a study. Economics is called a social science, or a behavioral science. And, as a science, economics is a disciplined way of thinking through problems. The scientific method is a tried and true way for knowledge to accumulate. To ask questions, to craft explanations, and to come up with ways of testing those explanations against what's going on in the real world.
So economics, as a science, uses the scientific method to understand the way the world works. The scientific method begins with a question. That is, all science begins with curiosity about the world works. If you want to be a scientist you should develop the habit of curiosity. That is, asking the question why at least three times a day. You drive through a little town and you wonder why are all the gas stations clustered on the four corners of the main intersection? Or you go to the grocery store and you wonder why are there 150 different kinds of breakfast cereal, and yet, there are only really three categories - cereal that tastes like fruit, cereal that tastes like chocolate, and cereal that's good for you. Why? Why? Why? Ask the question why and you're training your mind to be scientific and preparing yourself to be sharper and more flexible.
Economics really asks three questions over and over again. The first question is, what should we produce? That is, what are we going to produce of all the possible baskets and bundles and combinations of goods and services that we can create in our economy? What combination of houses and cars and clothes and vacations and medical care are we going to create out of our limited resources? The second question is, how will it be produced? That is, how will we combine labor and capital and raw materials to create the goods and services that satisfy our needs and wants? And the third question is, who is going to get it? That is, how will these goods and services be divided among all of the people in the economy, each of whom wants more?
What will we produce? How will it be produced? And who will get it? These are the questions that economics asks. Economics also asks more specific questions about each of these general categories, such as, what would happen if we imposed a minimum wage law on the labor market? Would it create unemployment? Would it increase the wealth of workers? What would be the consequence? We're asking a question here, and that's the beginning of science.
What would happen if consumer income increases? Would it lead to more spending or more saving or something else? Ask the question, and the next thing you know, you'll find yourself at the second step of the scientific method, that is, you'll be building a model.
What is an economic model? What is a scientific model? A model really is nothing more than a map. Think for a moment about the way a map works. You begin with a question. How do I get from the theatre district to the Metropolitan Museum if I'm in New York City? Well, that answer is going to depend on the method of transportation that you choose. If you want to know how I would find the best walking route; that is, which streets should I take and can I cut through Central Park, you're going to want to use this map. It's a street map of New York City that has the parks and restaurants and theatres and museums right here in different colors.
On the other hand, if you're planning to take the subway from the theatre district and find out how close you can get to the Metropolitan Museum, you'll want to use this inset map, which instead of the streets, focuses on the subway routes, each of them being color-coded. The map that you want to choose depends on the question that you originally asked. If you're going to be riding the subway and your question is, which subway should I take, you don't need a map that has a lot of streets on it. You want all that detail cut away so that you can clearly see the subway routes.
On the other hand, if you're going to be above ground, walking on the streets, you don't care what's underneath you. The subway routes are irrelevant and would only add clutter to this picture. So a good map is one that includes enough information to help you answer your question without irrelevant information that would only distract you and clutter the picture.
The same is true with a model. If we want to ask ourselves what is it that determines the amount of money that households spend on consumer goods and services each year, what determines consumer spending, and when does it rise, and when does it fall, we're going to want to build a relationship between consumer spending and other variables that influence it. We're going to be looking for those variables that probably have the most direct impact on the consumer's choice to spend or save money, and to ignore the rest.
So as we're building this model, we're going to want to include things, like consumer income, taxes, the stock market, and other factors that influence how much money people choose to spend. We can probably ignore other things that bear less on the consumer spending decision, such as the gender of the children or the color of the breadwinner's hair. I mean, these are real facts from the real world, but they probably aren't very important in determining how much money people spend.
Margaret Mead once said that a model that is completely realistic is no more useful than a map with a scale of one-to-one. The only reason the map helps you is that it's simple enough and simplified enough to help you see the big picture and the details that are necessary in helping you guide your way through the city. On a typical map you won't see trees and dogs and cars, because they're not necessary. And by eliminating them, and showing you the grid of the streets, you are helped in navigating your way around New York.
So we build a model, and perhaps that model is a story whereby people make spending decisions based on their income, their taxes, and their age. People who are younger tend to spend more and save more in their middle years and spend it in retirement. We build a relationship among these variables and that becomes our model of how consumers make their spending decisions.
Now, once we've got a model the relationships that we imagine hold among the variables allow us to derive certain hypotheses. Hypotheses are predictions about how the world works. One hypothesis might be than increase in consumer income leads to an increase in consumer spending. Now, that hypothesis is something we can test. We can go out and get data from the real world and compare the relationship between observed consumer income changes and changes in consumer spending. And if our data matches the predictions of our model, then we believe that we've explained something about the real world. We believe that since our story matches the facts, we've come to understand more thoroughly the way the world works. This is the scientific method. Ask a question, isolate the variables that are related and important and build a model, and then come up with some predictions or hypotheses that you can test against the data in the real world, and when that happens, you're doing science.
Now, one of the things that helps you be a careful and disciplined scientist is looking at these changes in a careful way; that is, trying to isolate the variables from one another and looking at the effect of one variable while holding the other variables constant. For instance, we want to know what happens to consumer spending when consumer income changes, and we're trying to predict a relationship between income and consumption that will explain something about the way the world works. Well, if we want to do that, we need to hold constant the other factors that influence consumer spending decisions. So if we hold taxes constant - my pink bar here over the t means that I'm holding taxes constant - and we look at consumers of a particular age so that we hold age and demographic factors constant, then what's the relationship between income and consumer spending? And perhaps we predict in our model that if you increase income and hold everything else constant, consumer spending will also increase. This assumption that we're holding everything else constant has a name. That assumption is called "ceteris paribus," and the question that we ask is, what will happen to consumer spending if we increase consumer income ceteris paribus; that is, holding constant all of the other variables that also influence consumption decisions? So whenever you hear me use the term "ceteris paribus," what I'm doing is I'm isolating a variable. I'm saying, "What will happen to consumption when income increases? Let's focus on income and hold everything else constant." That's what ceteris paribus means.
So you're training now to be an economist. You're training to use the scientific method in order to answer questions about the way the world works. So what are you going to do with this training once you've sharpened these skills? Well, you can find economists in all walks of life. Economists show up in business, they show up in government, and they show up in academics. In business, economists make forecasts about what's going to happen to interest rates and consumer spending and housing starts. They look at the big picture and help to advise the people who are making decisions in corporations about when to launch a new product, and when to expand their operations, and into which countries.
In government you find economists doing research, collecting data, figuring out how to finance the government debt, when to impose new taxes, and looking at broadly what's happening in the economy to consumer spending, business spending, and imports and exports.
And finally, in academics, not only do you find people who are teaching your economics classes, you also find high caliber researchers who hold academic positions in research universities. They are supported to do research and answer questions, like what will happen when a minimum wage is imposed, or what's the relationship between income and consumption, or what's the effect of tariffs and quotas on the flow of international trade. Economists show up in business, government, and academics, and, as you train to be an economist you'll find that you can use these tools even if your title isn't economist, because these logical, scientific ways of thinking pay off in all kinds of lines of business.
There's one more thing to say about economics as a study, and that is that we want to make a careful distinction between positive economics, on one hand, and normative economics, on the other. Positive economics is economics as a predictive, descriptive social science. Positive economics seeks to answer the question, how does the world work? What is going on? Whenever we do positive economics we're making observations. We're asking questions like, what will happen when a minimum wage law is imposed on the labor market? Will we see unemployment? Will we see an increase in wealth? Positive economics answers the question, what will happen in the bread market if we impose a tax on the sales of bread? Positive economics answers questions about the way the world works, what is, predictions and descriptions.
On the other hand, normative economics is about making judgments or evaluations. Normative economics answers the question, how should the world work? What is a good outcome? Normative economics answers the question, should we have a minimum wage law at all, or is there a better way to provide for low-income workers, perhaps an earned income tax credit or some other policy? Normative economics is about norms, and norms are standards of judgment - what is good, what is better, and what is bad. Whenever we're doing normative economics we're seeking to come up with the best policy for a particular situation. Should the government pay off the national debt? Should we have a tax on gasoline or cigarettes? Normative economics answers the questions, what is good?
Now, of course, if you're going to want to make judgments about the way the world should work, you'd probably better have a pretty good understanding about the way the world actually does work. That is, if you want to build a garden that you think is beautiful, you need to know a lot about the way plants grow and which ones respond to sunlight and which ones respond to fertilizer. You need to understand the structure of the economy before you start saying what it is that the government ought to do, or what it is that corporations should be allowed or prohibited from doing. To make judgments, you should have an understanding of the structure of the relationships and the economy. So positive economics and normative economics are very closely related.
So if you want to be an economist you'll be using a scientific method to describe and make predictions, and eventually make recommendations about what kind of policies help lead to good outcomes.
Introduction to Economics
The Basics of Economics
What Economists Do Page [3 of 3]