B. Methodology

1. Some Logic Behind Economies

• Q: How will the quantity of a good (say Coke) people plan to buy change when its price increases?
• Q: How will the price of Coke change when people plan to buy less of it?
• Q: What conclusion can you make after combining the answers of the above 2 questions?
• Q: What’s wrong with the above conclusion?

 

2. Theory

• Thing do not often happen randomly; instead, there are regularities of variable in real world.
• For example: interest rate and stock prices
• Number of university places and university students’ academic standard

 

• Q: If you see a long queue outside a post office, what would you predict?

 

• Q: Suggest some factors that may affect the length of the queue outside a post office?

 

• Human behavior is purposeful (i.e. not random)
• Theories are constructed to make predictions of testable implication to find out the regular pattern about human behavior.

3. Constructing Economic Theories

• Consider the following observations:

(1) The English Level of local secondary school students has been declining.

(2) More and more Hong Kong citizens spend their money for consumption in Shenzhen.

(3) More good quality fruit is exported from California whereas most Americans in California eat poor quality fruit

• Economists are interested in the above observations. They try to explain these observations. In this process, they construct different theories.
• Theories are made up of hypothesizes.
• A hypothesis is a conditional statement, based on which prediction is made.
• Example of a hypothesis: If heavy fine is imposed on throwing litter in public area, the places in Hong Kong will be cleaner.
• A hypothesis is composed of two parts:

(1) An antecedent or a test condition: “If heavy fine is imposed on throwing litter in public area”

(2) A consequent event: “the places in Hong Kong will be cleaner.

• Steps in constructing a theory:

(1) Select the postulate

(2) Select relevant constraints (test conditions)

• For example: In analyzing the consumption decision of a person, the relevant constraints may include his/her wealth and price.

(3) Derive testable implications and test them

• A good theory is potentially refutable, but not yet refuted by evidence.
• If the result of the test is refuted, the theory is discarded.

 

• Consider the following observations:

(1) The number of children per family has been dropping over the decade.

(2) Women’s participation in workforce has been increasing over the period.

(3) Due to medical progress, the rate of natural death of babies has been dropping.

(4) The average weight of newly born babies has been increasing.

 

Q: Find out the relevant information from the above observations and construct a hypothesis to explain the change in the number of children per family? (Which one is irrelevant? Which one is contradiction?)

 

Q: Try to construct a simple theory to explain the phenomenon. What assumption have you made?

                       

4. Characteristics of a theory

(1) A theory must be refutable or carries refutable implications.

• Refutable means that a statement can be potentially refuted

 

• Q: Is each of the following statements is refutable, refuted or not refuted?

(1) White people have a higher chance to get skin cancer.

(2) Typhoon signal No.3 is hoisted tomorrow.

(3) If we can run fast enough, we can go to the future.

(4) There are creatures on the moon.

(5) If there are aliens, they are more intelligent than us.

 

• A theory, which is refutable, is subjected to empirical test. When the findings fail to reject the conclusion of the theory, it is said to be confirmed or verified empirically (A theory can never be proved because by nature it can be potentially refuted).

 

• A theory is said to be empirically valid when it passes a large number of empirical tests. However, when the conclusion of a theory is rejected by an empirical test, it is refuted and needs to be revised or abandoned.

(2)    A theory must be testable or carries testable implications. Why?

• As a theory is subject to empirical test, its antecedent and consequent have to be observable and hence testable.
• An unobservable statement can never be testable because no tests can be conducted to confirm or to reject its conclusion. e.g. If you do something good, you will be rewarded.

(3)    A theory has predicting, not forecasting power.

• What is a forecast?
• A forecast is made by observing the trend of similar events.
• The telling of a future outcome. It is often based on historical data, e.g. technical approach in stock market.
• What is a prediction?
• A prediction is derived from a theory which states that if a certain set of conditions is satisfied, a particular set of events will occur.
• A hypothesis which is logically deduced on the basis of postulates.

 

• Q: Identify whether the following statements is/are forecast or predictions.

(1) If the weather is warm on Winter Solstice, it will be cold during Lunar New Year.

(2) If the 3-year-university system is changed to a 4-year one, the academic standard of A Level students will rise.

 

• Economics concerns prediction of human behavior and does not deal with forecast at all.

(4) A theory must be logically valid (logical validity).

• Theoretical conclusions are logical deduced from the postulate; there should be no internal contradiction between ideas used to explain the data.

 

• Q: If we assume that people maximize the value of time and that speed driving will cause more accident. How would you predict the car-accident rate to change if seat belt requirement is enforced?

 

 

• Q: If the assumption is change. More people only consider safety when driving, what is the conclusion logically deduced?

 

 

 

• If one predicts that car accident rate will decrease, then it is said to be logically invalid because when a driver is protected by the seat belt, the harmful effect caused by an accident is reduced and this will lower the cost of speeding driving. We cannot expect that a driver will drive slower when protection is increased.

(5) Assumptions are widely used in constructing theories.

• Three types of assumptions:

[1] Postulates or axioms

• Postulates are assertions (unproved statements) which govern the fundamental behavioral relationship of human beings.
• Postulates serve as the starting point of a theory.
• The postulate of economics is that constraint maximization. Based on this assumption, when a person discovers a $1000 note in a street without other people around, what will he do?

[2] Abstractions or Simplifications

• Assumptions made to reduce the complexity of the problem. Relaxation of these assumptions will not affect the conclusions of the theory.
• Example: The principle of comparative advantages.

[3] Test conditions or Antecedent

• Example: Ceteris Paribus

 

• Q: What is the test condition for the principle of comparative advantages.

 

• Realism of Assumptions and Usefulness of Economic theory

 

• Q: Can we reject the comparative advantage principle by saying that the two-country two-good assumption is unrealistic?

 

• Q: Can we attack an economic theory because the basic axiom “constraint maximization” is proved to be untrue?

 

• Q: Every year, many S6 students are competing for the post of chairperson, wishing to take responsibilities in different clubs and teams. Do they really want to serve the school or do they act for their own seek?

 

• Q: If we cannot attack a theory by attacking its assumptions, based on what we can judge a theory?

(1)    Logical validity

(2)    Empirical validity

(3)    Predicting (explanatory) power

 

• Q: When do assumptions need to be realistic? Use the principle of comparative advantages as an example to explain the answer.

 

       (6) A theory can never be proved to be true.

• Since a truth always work.

(7) A theory is necessary a simplification of facts.

• If the theory established is too complied, it is hard to handle.

(8) An ideal theory embodies only a few axioms and simplification assumptions but is able to generate a large number of testable implications.

5. Tautology

• Tautology is a statement or an idea which are not refutable. This is also known as definitional identity.

 

• Q: Identify the following statements to determine whether it is tautological or not.

(1) A free good is a good of which its quantity is more than what people want.

(2) The sun has the same weight as the earth.

(3) Individual demand curve will change when a person’s preference changes.

(4) The existence of UFO cannot be explained by science nowadays.

 

• Characteristics of tautology

(1) Tautological statements are made for descriptive purpose.

(2) Cannot or need not to be tested empirically to confirm it or reject it.

(3) Definitional

• The truth of the statement relies on the definition of the key words of the statement.

     (3) Empty

• It either explains nothing or everything.
• Example: Tomorrow it will rain or it will not rain.

6. Ad hoc Theory

• An Ad hoc theory contains too many conditions such that it can only explain data in hand, but cannot be generalized to any other situation.
• An Ad hoc theory is one that only holds under a particular set of conditions.
• Example: If I drop a piece of chalk onto the floor, it will break.
• However, it was rejected in an empirical test, so it is revised as follows:
• If I drop a piece of chalk onto the floor from a height of 1m, it will break.
• If I drop a piece of chalk of 6 inches or above onto the floor from a height of 1m, it will break.
• This type of theory lacks generality.
• Tautology is too board.
• Ad hoc theory is too narrow.

7. Some logical fallacies

(1) Fallacy of confirming the consequent

• i.e. If A, then B

   Fallacy: If B, then A

• Example: If a baby is hungry, he will cry.

    Fallacy: If a baby cries, he is hungry.

(2)    Fallacy of denying the antecedent

• i.e. If A, then B

   Fallacy: If -A, then -B

• Example: If his wife dies, he will not be alive.

    Fallacy: If his wife is alive, he will not die.

 

• This fallacy explains why we cannot reject economic theories by attacking their assumptions. Can you see why?

 

(3) The only correct logical deduction:

• i.e. If A, then B

   Correct deduction: If -B, then -A

• Example1: If a baby is hungry, he will cry.

    Deduction: If a baby does not cry, he is not hungry.

• Example 2: If his wife dies, he will not be alive.

    Fallacy: If he is alive, his wife does not die.