All scientific theories are based on certain assumptions and economic theories are no exception. Economics deals with human behaviour which is relatively more uncertain and unpredictable which makes economic theories all the more dependent on several assumptions.
The most important and the basic of all these is the assumption of rationality. A man is a rational being and the ‘economic’ behaviour of an average man is expected to be rational. It is on this assumption of rationality that earlier economists justified the human longing for wealth.
Optimisation behaviour
Economic behaviour is optimisation behaviour which influences all economic activities. In the field of consumption, it stands for maximisation of utility by proper choice-making in the application of scarce resources towards the fulfilment of a number of human needs. In economic parlance it could be expressed as the process of equalising the ratio marginal utility to price for all articles of consumption. In the field of production an optimal level of output could be achieved by making a choice of factors of production in such a manner that marginal revenue is equal to marginal cost. In the field of exchange both parties to a transaction would stand to gain by striking a bargain which ensures greater relative gain in comparison to the sacrifice made in the form of money or commodity for acquiring the other.
Based on such possible behaviour of individuals, whereby they sought to maximise individual gain, the earlier economists advocated free economy in the hope that, when everybody acted in his best interest and tried to maximise his personal gain, the interest of the society would be automatically served. Profit seeking by individuals would automatically lead to maximisation of social good. All this was based on another important assumption of free competition between buyers and sellers for various goods and services. But free competition amongst persons who are not equal in their bargaining capacity often leads to exploitation of the relative less privileged and weak. Thus, many of the earlier assumptios based on deductive reasoning and on an assumption of rationality were challenged in later times to make room for new assumptions and theories. Some of the changes in these assumptions are as follows:
1. Free economy does not always lead to maximum social benefit when the bargaining sides are not equally placed and there is exploitation of the weak.
2. What is rational from the point of view of an individual may not be so from the point of view of the society as a whole.
3. Based on the assumption that supply creates its own demand, it was propounded by earlier economists that full employment is the normal condition of life. If wages are flexible, there cannot be permanent unemployment.
Thus, the basic assumptions of economics, which even now hold good in general have been modified in a number of ways on the basis of practical experience of inductive method of reasoning. New theories and propositios have come up in modern times based on more valid assumptions to make economic theories more realistic and useful for practical application.
Economic Laws
These are general propositions or statements of tendencies. According to Marshall, these are social laws which relate to branches of conduct in which the strength of motives chiefly concerned can be measured by a money price. An economic law is, in essence an embodiment of conclusion drawn from the observation of human conduct. It shows the cause and effect relationship of various economic phenomena which are concerned with the problem of formulation and exercise of human choices. It generalises the reaction of human beings when they are exposed to economic phenomena.
The laws of economics differ from statutory, moral or customary laws. They are not enforceable as the statutory laws are. They are also free from any moral or ethical bindings, rather indifferent as regards the character of the means and ends.
They are essentially hypothetical or conditional. The validity of an economic generalisation depends of the existence of conditions the presence of which must be taken for granted. ‘Other things being equal’is often a necessary adjunct to any economic law. The phrase implies that the expected result would not flow from the given cause in the absence of certain given conditions.
The law of demand states the tendency of demand to change with a change in price but it does not give exact relationship between the two changes. A certain percentage of fall in price may cause the demand to rise, more or less, depending upon market conditions.
Economics laws are inexact becuase the subject matter of economics is human behaviour which is highly variable and uncertain. It is influenced by a number of diverse forces—ethical, political and social, the effect of which cannot be isolated. Again, economic laws are not capable of being experimented in a laboratory under controlled conditions. That is why Marshall has compared economic laws with the law of the tides rather than the law of gravitation.
Model Building in Economics
An economic model is a mathematical or logical statement of economic theory. It is a method of analysis which presents an over-simplification of the real world. The situation in the real world is composed of a bewildering variety of major and minor variables and unless the less important factors are eliminated, and most essential factors are sorted out, a rigorous analysis is either hopelessly complicated or impossible.
In an economic model, when an economist abstracts from the real world complexity, the abstraction has a role to play in the model building exercises. Some students find therefore economics as unduly abstract and ‘unrealistic’. To them the economic theory model seems only a very distant cousin to the world they see around them. But the abstraction makes the model manageable with a few major variables being easily handed. If the model has to contain all the real world complexities, the purpose of model building is lost and there is no model—only real world.
Small Purpose of Models: The main purpose of an economic model is to predict and to explain behaviour. An economic model of demand might be used by the management to predict the effect on demand of a downturn in the per capita income.
Another purpose of model building, often overlooked, is to help generate new ideas. Through the process of constructing a model one frequently obtains new and useful insights into particular facts of the problems being studied.
Small Types of Economics Models: There are three types of model:
(a) Physical models: These are sculptures, photograph or visual representation of certain aspects of a system.
(b) Analog models: Under these models one set of properties represent the other set which the system under study prossesses. These models are in the form of simple graphs, charts or functions to translate a given variable into another.
(c) Symbolic models: In these models the inter-relationships are expressed through mathematical symbols. There are several types of symbolic models. A few of these are listed below.
1. Quantitative models
2. Allocation models
3. Scheduling models
4. Queuing models
5. Simlation models
6. Leveniory models
The advantages of models may be summarised as follows:
1. Models transform verbal expressions into more scientific expressions viz. diagram, graph or mathematical formula. It is true that statements expressed in prose do not have the same rigour and precision.
2. Standardised terminology facilitates communication. There is a consensus on the use of symbols and language.
3. Models are logical and hence have greater objectivity unlike verbal expression. It is difficult to be vague and ambiguous.
4. Models lend themselves to proper analysis, interpretation and manipulation. This is because mathemetical properties are well developed and can be deduced.
5. The assumptions of a model are stated clearly. This enables the calculation of error of estimation and thereby provides a warning to the user. An intelligent reader of findings knows the difference in results if some assumption does not hold true.
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