The role of assumptions by Economists

If you ask a physicist how long it would take for marble to fall from the top of a ten-story buildings, she will answer the question by assuming that the marble falls in a vacuum. Of course this assumption is false. In fact, the building is surrounded by air, which exerts friction on the falling marble and slows it down. Yet the physicist will correctly point that friction on the marble is so small that its effect is negligible. Assuming the marble falls in a vacuum greatly simplifies the problem without substantially affecting the answer.

Economists make assumptions for the same reason: Assumptions can simplify the complex world and make it easier to understand. To study the effects of international trade, for example, we may assume that the world consists of only two countries and that each country produces only two goods. Of course, the real world consists of dozens of countries, each of which produces thousands of different types of goods. But by assuming two countries and two goods, we can focus our thinking on the essence of the problem. Once we understand international trade in an imaginary world with two countries and two goods, we are in a better position to understand international trade in the complex world in which we live.

The art in scientific thinking whether in physics, biology or economics is deciding which assumptions to make. Suppose, for instance that we were dropping a beach ball rather than a marble from the top of the building. Our physicist would realize that the assumption of no friction is far less accurate in this case. Friction exerts a greater force on a beach ball than a marble because a beach ball is much larger. The assumption that gravity works in a vacuum is reasonable for studying a falling marble but not for studying a falling beach ball.

Similarly, economists use different assumptions to answer different questions. Suppose that we want to study what happens to the economy when the government changes the number of dollars in circulation. An important piece of this analysis, it turns out, is how prices respond. Many prices in the economy change infrequently; the newsstand prices of magazines, for instance, change only every few years. Knowing this fact may lead us to make different time horizons. For studying the short run effects of the policy, we may assume that prices do not change much. We may even make the extreme and artificial assumption that all prices are completely fixed. For studying the long run effects of the policy, however, we may assume that all prices are completely flexible. Just as a physicist uses different assumptions when studying falling marbles and falling beach balls economists use different assumptions when studying the short run and long run effects of a change in the quantity of money.

Economic models:

High school biology teachers teach basic anatomy with plastic replicas of the human body. These models have all the major organs: the heart, the liver, the kidneys, and so on. The models allow teachers to show their students in a simple way how the important parts of the body fit together. Of course, no one would mistake these plastic models for a real person. These models are stylized and they omit many details. Yet despite this lack of realism studying these models is useful for learning how the human body works.

Economists also use models to learn about the world, but instead of being made of plastic, they are most often composed of diagrams and equations. Like a biology teacher’s plastic model, economies models omit many details to allow us to see what is truly important. Just as the biology teacher’s model does not include all of the body’s muscles and capabilities, an economist’s model does not include every feature of the economy.

All the models are built with assumptions to examine various economic issues. Just as a physicist begins the analysis of falling marble without the existence of friction, economists assume away many of the details of the economy that are irrelevant for studying the question at hand. All models in physics, biology and economies simplify reality in understanding of it.