Methods of Analysis

Economic laws or generalization states the relationship between economic variables. Economic theory provides an explanation of the stated relation between the variables. It means economic theory brings out the logical reasoning and logical basis of generalization. An economic theory deduces generalization through the procedure of logical reasoning and explains the condition under which the stated generalization will hold true.

In the latter half of the 19^th century, there was a bitter controversy between the Classical School of Britain and the Historical School of Germany on the relative merits and demerits of induction and deduction. The Classical School stood solidly for the deduction, while the Historical School, which reacted against the Classical School, stood firm for induction. Deduction and induction are the two methods of logic or rationing that help to set up the truth.

The Deductive Method

Deduction refers to the procedure of reasoning or inference from general to particular or from universal to individual. The deductive method is also called abstract, analytical, and a prior method and represents an abstract approach to the derivation of economic generalization and theories. It involves the process of reasoning from certain laws or principles which are assumed to be true, to the analysis of facts. The inferences are drawn which are verified against observed facts.   

Bacon described dedication as, a “descending process” in which we proceed from a general principle to its consequences.

It means that deduction suggests collecting the information from the large or wider groups and then applying them to small and narrow groups or even individual levels.  

Several classical economists including Thomas Robert Malthus, J.S. Mill, and Nassau Senior, etc. supported the deductive method and did not hesitate to resort to empirical analysis. In fact, some of them did a lot of factual research to test or verify their theoretical conclusions.

Steps Involved in Deductive Method

Identification and perception of the problem

To enter into an inquiry or to do research or analysis there must be a clear idea of the problem. He must know the significant variables regarding whose behavior and interrelationship he wants to derive generalizations. The problem must be stated clearly. It may be very wide like poverty, unemployment, inflation, etc., or narrow relating to the industry. The narrower the problem the better it would be to conduct the inquiry.

Definition of technical terms and making assumptions

The next step in the process of deduction is to define the various terms to be used in the analysis in a precise and clear way as well as to state assumptions that are the basis of the hypothesis. The mentioned assumptions may be behaviorally pertaining to the behavior of the economic variables or they may be technological relating to the state of technology and the endowed factors. To be fruitful for the inquiry the assumptions must be general.

According to Prof. Boulding, economic theory represents just a map of the real-world phenomenon and not a perfect picture of it. Thus with the map, we cannot expect everything, and the same case is applied in the case of economic theory that we should not expect the economic analysis to take into account every detail and quirk of real economic behavior. Therefore, in any economic inquiry, more than one set of assumptions should be made in terms of which a hypothesis may be formulated.

Formulating hypothesis

The next step is to formulate a hypothesis on the basis of assumptions. A hypothesis describes the relationship between factors affecting a phenomenon. It establishes a causal relationship between variables having a bearing on the phenomenon. It is a suggestion based on facts that are used as a basis for logical deduction.

The hypothesis can be set in two ways. The initial is through logical deduction. In logical deduction, symbolic terms are used to set the hypothesis. The geometric or graphical technique is also used to deduce the hypothesis in logical deduction. Ricardo, Senior, Robbins, etc. used the logical method.  Besides the logical process, the hypothesis about the relationship between factors can be deduced with the help of more formal mathematics. Cournot, Pareto, and Edgeworth used mathematical methods. Modern economists are making increasing use of both econometrics and mathematics in deducing reasoning analyzing and testing hypotheses.  

Testing and verification of the hypothesis

Hypothesis deduced on the basis of assumptions have to be verified before they are established as generalizations or principles of economics. Verification is related to confirming whether the hypothesis is in agreement with facts. Whether a hypothesis is true or not can be verified by observation and experiment. For such verification economists cannot make controlled experiments, because they have to determine uniformities in behavior patterns of man. As we cannot make experiments with a man under controlled conditions such as in pure science or in lab tests and experiments.

So there is always a problem with verification and experiment in social-economic relationships.  For example, the hypothesis that firms always attempt to maximize profits is based upon the observation that some firms do behave in this way. This premise is based on prior knowledge which will continue to be accepted so long as conclusions deduced from it are consistent with the fact. So the hypothesis stands verified. If the hypothesis is not established, it can be explained that the hypothesis was right but the results are conflicting due to special conditions. In economics, most hypotheses stay unproven due to the complexity of factors concerned with human behavior which in turn depends upon social, political, and economic factors.

The dependence by economists on uncontrolled experiences however does increase the number of observations required to verify the hypothesis or to establish the generalizations.

Therefore various statistical and econometric methods are used to verify the hypothesis. Economists need to confirm whether the null hypothesis is accepted or rejected, and based on that result, a conclusion is to be made. Economics as asocial science is different than pure science, so it may have more than one answer to each question. Therefore, the results may be contradictory or different from the general perception.

Merits of Deductive method

The deductive method has the following advantages;

• It is a method of intellectual experiment.   
• Captures the reality. It works from wider to narrow or closer to the real situation.
• Simple: It is a simple analytic method of research. The hypothesis makes it easy to explain the situation and information with more clarity and helps in making abstraction and simplification.
• Powerful and exact: This method allows us to use mathematical and statistical techniques and tools so the findings are more accurate and powerful. Exactness and clarity are more associated with mathematics.
• Indispensable and universal: In the case of a direct experiment is not possible, this method is indispensable. As the findings are based on general principles, they are said to be universal too.

 Demerits of Deduction Method

• Unrealistic assumption: If the chosen assumption is unrealistic then the whole research would be misguided. It means deduction depends on the nature of assumptions and if they are unrealistic the theory breaks down.
• Not-universally applicable: There may be some exceptional cases in which this method cannot provide credible results. Therefore, as a response to this limitation, the inductive method was developed.
• Abstract and static method: Deduction as an abstract method, needs skills to apply and conduct the research. Also, it depends on the assumption of old economic theories so it may not capture the condition impacted by continuously changing scenarios.
• Possibility of incorrect verification: The verification of the hypothesis or the generalization is the outcome of verification against the real-world data. If the data is wrong or inadequate then the theory will not correspond with facts and will be refuted.
• Ignorance of the real world in the name of mathematics and econometrics.

Conclusion

The deductive method also known as the analytical, abstract, and prior method was strongly advocated and also made use by economists belonging to the Classical School. It may be described as the technique of an abstract approach to the problems of economic science. In this method, we start from a few indisputable facts about human life, and human nature, or draw inferences from them about concrete individual cases. The deduction approach enjoys several advantages that cannot be ignored in any evaluation of economic methodology. In deduction, the important assumption of Ceteris paribus is assumed throughout the process of reasoning.

References

Ahuja, H.L. (2017). Advanced Economic Theory. New Delhi: S Chand And Company Limited.

Jhingan, M.L (2012). Advanced Economic Theory. New Delhi: Vrinda Publications (P) LTD.