How Economists Approach Problems

Economic theory is used for logically analyzing information, studying cause and effect, and solving real problems in economics.

Because economics is a social science, it must often be satisfied with predicting the direction of change instead of the exact amount of change.

In order to keep theories as simple as possible and to isolate extraneous, or less important, variables, economists often use assumptions such as ceteris paribus and economic rationality.

Economically rational behavior is any action that people take to make them better off or to keep them from becoming worse off. Economists predict on the basis that all economic units-consumers; businesses; owners of natural resources, capital, and labor; and government-act in a rational way.

Positive economics deals with what is with facts. Normative economics concerns itself with what ought to be-with opinions. It is important to be aware of this difference. 

Functional relationships between dependent and independent variables may be direct or inverse. Economists find it useful to present these functions by means of graphs or diagrams. On these graphs, direct relationships are shown as a positive slope, and inverse relationships are shown as a negative slope. If the slope of a curve is constant throughout its length, it will be linear (appear as a straight line), and if the slope increases or decreases, the curve will be nonlinear.

Marginal means extra or additional-one more or one less. Marginal analysis recognizes that most economic decisions are made "on the margin" and are not of an all-or-nothing type. 

When the marginal cost of an activity is increasing and marginal benefit from the same activity is decreasing, a person will maximize his or her well-being gained from the activity by equating marginal cost and marginal benefit.

Equilibrium is a state of balance. Though the economy may only rarely be at equilibrium, this is an important concept. It allows economists to focus on the effects of particular disturbances and to predict future events.

It is important to watch out for several problems in the study of economics:

    a. Some familiar terms, such as capital and in vestment, take on quite different meanings in economics from those in common usage.

     b. The fact that one event precedes another does not necessarily indicate a cause-and effect relationship between them.

     c. What is true for a part is not necessarily true for the whole.

     d. It is important to consider time lags-how long it takes for a change in an economic variable to have an effect.

      e. Living in a world of uncertainty, people of ten react to what they expect will happen, rather than to what is actually occurring.