Importance of Assumptions, Hypothesis, and Empiricism in Economics

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The article will discuss the meaning and some key importance of assumptions, hypothesis, and empiricism in the study of economics.


Meaning of Assumptions in Economics

Economists apply assumptions to split down composite and complex economic phenomena and processes and advocate different theories to recognize and understand different economic variables.  Assumption can be defined as some elementary norms accepted and adopted for something to be true or to occur. It means it refers to the situation in which we as a rule admit and accept the thing or statement without any question or any proof. Assumptions can simplify the complex world and make it easier to get and understand.

For example, to understand the market supply, we simply can assume there are only two suppliers in the market and each of them is supplying homogenous products. In reality, there are numerous suppliers in a perfectly competitive market and each of them may supply varieties of heterogeneous products. But by assuming two sellers and a single product or homogeneous product, we can concentrate our thinking on the essence of our problem. Once we understand the market supply in such a simplified imaginary situation, we are in a better position to understand market supply in the complex world in which we are living.  Thus, assumptions are made or imposed to develop, explain, and understand the context of theories.

Similarly, in economics, assumptions are employed to build, clarify, explain, and interpret the theories, principles, and models related to the relationship between different economic participants.  Every economic theory is based on certain assumptions. These assumptions may be psychological or behavioral, institutional, and structural. In economics, assumptions are the primary conditions made before the systematic analysis of theory or the system.

While setting assumptions to study and understand different economic theories and principles, the point to be considered is that while concluding economic theories and laws regarding economic policies it should be acknowledged whether the assumptions intake does not make the policy conclusions unacceptable in case of their removal. Some of the policy questions may be linked with assumptions while departing for analyzing the economic doctrine and theory. However, assumptions are indispensable for building clarity and deducing the policy prescriptions and suggestions. On the other side, intellectual ability and clarity are also needed while setting a set of assumptions.

Role or Importance of Assumptions in Economics

There are different views of different economists belonging to a different school of economic thought. Classical and neoclassical economists believed that economic theories to be realistic and must be based on realistic assumptions. But Friedman has a different view regarding the assumption and its role or importance in economics. According to him, a theory cannot be judged on the realism of its assumptions. Rather the validity of the good theory in economics is its power of prediction and its implications for the real world. He said that the realism of assumption is irrelevant as if the conclusion is verified by accurate predictions, then the theory as a whole is valid. For Freidman, lack of realism in assumptions is not a virtue but it is a necessary evil.

Thus the major importance of assumption in economics is listed as below;

  • Assumptions are included in economic models to describe and present the theories and models in the simplest way
  • They help to support to explain the complex theories, models, and process
  • Assumptions are indented to simplify the complex process
  • The inclusion of assumptions guide for rational behavior
  • Assumptions help a researcher to do research based on facts and experiences
  • They facilitate the indirect test of hypothesis by its implication
  • Assumptions are the most convenient means of specifying the condition under which the theory is expected to be valid
  • They contribute to knowledge transferring and encouraging innovations.
  • Assumptions provide a way for economists to simplify the economic process and make it easier to study and understand.

The assumption is the thing or a case or a situation that we believe and accepts as rue without any proof and justification.  It can simplify the composite and complex phenomenon into simple and understanding one. They are also known as premises or prospectus. Assumptions are considered merely to simplify the analysis of the economic process though they are not entirely realistic. From such assumptions, some implications or conclusions are drawn and deducted through the logical process of reasoning. Thus, assumptions can simplify the multifaceted world and make it easier to get and deliver. Economics as social science, the inclusion of realism in all the aspects of the economic life of its participants is almost impossible, so assumptions have a more crucial role in economic theories and models to make them more understanding, simple, clear, and representative.

Hypothesis in Economics

The hypothesis is the most important aspect of the practical study of theories and principles. In economics also it is the most pragmatic character in the development of economic theory or generalization. Assumptions help to make the complex economic system simple, clear, and easier to understand. The hypothesis is simply a conclusion or prediction drawn from the implication of assumptions. It means that the hypothesis refers to the more solid and advanced form of assumption. If we compare these both, the hypothesis is explicit and assumptions are implicit.

A hypothesis is a testable statement of the potential relationship between two or more variables related to the economy or related to the subject matter of economics. It is a prediction made by a theory that can be compared and tested with observation in the real world. Usually, it takes a form, ‘If there A; there is also B’. Hence a hypothesis is an unproven theory. Hypothesis presents itself as the gap between theory and empirical inquiry.

A scientific hypothesis states the assumptions about the relationship between factors or variables in a form that is testable or falsifiable. The predictions based on a hypothesis are refuted by the direct observation of actual data or through the statistical method of interpretation. Thus, the hypothesis is normally tested explicitly by an experiment. Hypothesis if tested and approved will ensure the validity of the theory and the theory will become more general and universal.

The hypothesis must be testable, taking into account current knowledge and techniques and be realistic as far as possible. It must be verified by statistical and analytical means, to allow verification or falsification.

Role or Importance of Hypothesis in Economics

The hypothesis is a specific statement drawn with the help of assumptions set in under the general phenomenon for prediction. It describes in concrete terms regarding what can be expected, what will happen, how it will happen in the study that is in the consideration. Theory and hypothesis are in general responsible for the movement of knowledge. It means the generation of knowledge from unknown to known is possible with the help of hypothesis and theory.  The major role of the hypothesis in the economic study is presented with the help of given points.

  • Hypothesis plays a critical role in the declaration of a specific thing as they can describe certain facts and are also able to explain the various relationships between such factors.
  • Formulation of hypothesis and their testing is the heart of the economic study. It is done for the generation of logical implications and policy prescriptions for the solution of economic problems and issues.
  • A verified hypothesis will make a theory more applied and universal in application. For example, the verification of the hypothesis of there is a negative relationship between price and quantity demand has made the law of demand applicable everywhere.
  • The testing of the hypothesis is one of the important scientific tasks and with its verification; there is a possibility of the generation of new theory and principle in the economic study.
  • A solid hypothesis and its verification with real-life data are always associated with the most scientific and logical positivism. The reality of the economic variable and their relationships is always carried by hypothesizes.

The hypothesis is a tentative supposition or provisional hues which seem to explain the situation under observation. It is used to explain observed facts or conditions and to guide in another investigation. In economics, the hypothesis generally carries a casual relationship between economic variables. Setting hypotheses and verifying it through different tests linking real-life data is the major concern of practical economics.

For example, the quantity demanded of commodity views inversely with the price is a hypothesis. If the government imposes sales tax on a commodity, then the price rises; the prediction will be that the quantity demanded will decline, ceteris paribus. This hypothesis cannot be rejected or falsified as it is supported by the facts of the real-life data. So, the law of demand states that there is an inverse relationship between the price and the quantity demanded of a commodity. It is a scientific economic hypothesis/theory.

Empiricism in Economics

Empiricism is related to opening out with data and creating and developing mathematical models representing these data and using these models to reach conclusions about the present, and predictions. The origin of empiricism dates back to the period of primeval Greeks, dealing with how we acquire our knowledge of the external world.   For Empiricists, such as Aristotle, this is best made through empirical observations and experiments. Specifically, the philosophy of empiricism was developed in the 17th and 18th centuries by John Locke, George Berkeley, and David Hume.

Empiricism is the philosophy of science that stresses on evidence, especially as discovered through experiments. It is an elementary component of the scientific method and it believes that all hypotheses and theories have got to be tested against observations of the real world rather than sleeping only on reasoning and intuition. Therefore, empiricism refers to the method of analysis of economic events using the relevant data or evidence-based information.

If we are as economists, want to look at the shock of any economic event and explain that impact numerically and quantify properly, then we are using empiricism in economics. After stating the hypothesis, if it is tested by using the data then it is an example of empiricism in economic analysis. The process of empiricism in economics is always started from a setting hypothesis based on general circumstances to lead it up to the generalization or making law that is used to make a correct prediction about the results of any changes in circumstances and the predictions are tested in empirical pieces of evidence to justify the generalization. Some of the unrealistic assumptions can be dropped if the conclusion would be invalid.

The pragmatic demand curve, linear expenditure system, etc. are the result of empiricism in economics. It uses statistics, numbers, and equations to evaluate fictitiously constructed and collected models. The development of empiricism in economics is mainly because of following tow basic reasons;

  1. To test existing theories and to examine their falsifiability in terms of factual evidence
  2. To build theories having empirical content and to make an operational and realistic generalization.

Role or Importance of Empiricism in Economics

Strong empiricism requires cent percent factual content of a theory. Thus, it is an idol and never attained in reality. Much valuable theoretical output in economics would be destroyed if we accept the principle of strong empiricism. However, it has the following advantages or importance.

  • Easy to quantify the results and findings from an analysis
  • Helps to prove or test the hypothesis based on theory and model
  • It allows and helps economists to make a convincing conclusion and findings that may have a good policy inference
  • It has added value to the role of econometrics and has made the economic analysis more meaningful and credible.

The scope and area of empiricism in economics is econometrics. Therefore, most of the research works collect the literature based on empirics. The empiricism should base on solid theory to make a quality research; empirical works without the proper base of theory becomes just a mathematical calculation.

Empiricism is the philosophy of science that refers to an empirical aspect of scientific knowledge obtained through observation, experimentation, and empirical investigation of the stated relations against the real-life data and information. Empiricism is not against the methods of deduction but it requires empirical investigation and testing of hypotheses and predictions based on real-life data and information. Economics as social science, a cent percent empiricism is not possible and thus we can neither bury nor praise empiricism in economics. Thus the article has included the matter related to the importance of assumptions, hypothesis, and empiricism in economics.

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