Friedman and Samuelsonweek 2

Economic Methodology

Methodology of empirical research

Positivism in economics: Laboratory science Econometrics Instrumentalism Descriptivism

Laws in economics

y = F(x1, x2, …)

y = F(x1, x2, …) = F1x1 + F2x2 + …

Ceteris paribus

“all other things being equal”

xn+1 = xn+2 = … = 0

y = F1x1 + … + Fnxn

laboratory research

Econometric Society

Founded in 1931“an international society for the advancement of economic theory in its relation to statistics and mathematics. The Society shall operate as a completely disinterested, scientific organization without political, social, financial, or nationalistic bias. Its main object shall be to promote studies that aim at a unification of the theoretical-quantitative and the empirical-quantitative approach to economic problems and that are penetrated by constructive and rigorous thinking similar to that which has come to dominate in the natural sciences.”

Cowles Foundation

Cowles Commission for Research in Economics (since 1932)

Cowles Foundation (since 1952)

Econometrica (since 1933)

Trygve Haalvelmo (1911–1999)

Nobel Prize 1989

"for his clarification of the probability theory foundations of econometrics and his analyses of simultaneous economic structures“

The Probability Approach in Econometrics (1944)

Passive observation

Empirical research:

y F1x1 + … + Fnxn

Fn+1xn+1 0

Fn+1 0 ? xn+1 0

(potential influence) (variation)

Lawrence Klein (1920–)

Nobel Prize (1980)"for the creation of econometric models and the application to the analysis of economic fluctuations and economic policies“

“the largest possible system that can be managed and that can explain the main economic magnitudes”

Naïve models

yt+1 = yt + t

yt+1 – yt = yt – yt-1 + t

Milton Friedman (1912–2006)

Nobel Prize (1976)

"for his achievements in the fields of consumption analysis, monetary history and theory and for his demonstration of the complexity of stabilization policy"

Critique

The fact that the equations fit the data from which they are derived is a test primarily of the skill and patience of the analyst; it is not a test of the validity of the equations for any broader body of data. Such a test is provided solely by the consistency of the equations with data not used in the derivation, such as data for periods subsequent to the period analyzed.

Marshallian partitioning

Man’s powers are limited: almost every one of nature’s riddles is complex. He breaks it up, studies one bit at a time, and at last combines his partial solutions with a supreme effort of his whole small strength into some sort of an attempt at a solution of the whole riddle.In breaking it up, he uses some adaptation of a primitive but effective prison, or pound, for segregating those disturbing causes, whose wanderings happen to be inconvenient, for the time: the pound is called Cæteris Paribus.

The Methodology of Positive Economics

Truly important and significant hypotheses will be found to have ‘assumptions’ that are wildly inaccurate descriptive representations of reality, and, in general, the more significant the theory, the more unrealistic the assumptions (in this sense).

Musgrave’s assumptions

Negligibility assumption: a factor that could be expected to affect the phenomenon under investigation actually has no detectable effect.

Domain assumption: an expected factor is absent, and so is used to specify the domain of applicability of the theory concerned.

Heuristic assumption: a factor is considered to be negligible, in order to simplify the ‘logical’ development of the theory.

As-if assumption.

Galilean fall experiments

The Law of Falling Bodies:In the absence of air resistance, any two bodies that are dropped from rest at the same moment will reach the ground at the same time regardless of their mass.

s t ²

In and outside the laboratory

y = F(x1, x2, …) = F1x1 + F2x2 + …

x1: gravity x2: air pressure

x3: temperature x4: magnetic forces

laboratory (vacuum): x2 = 0, x3 = x4 = … = 0

open air: take objects such that F2 F3 … 0

Paul Samuelson (1915–)

Nobel Prize (1970)

"for the scientific work through which he has developed static and dynamic economic theory and actively contributed to raising the level of analysis in economic science"

Truth table P Q

P Q P Q

true true true

true false false

false true true

false false true

Truth table P Q

P Q P Q

true true true

true false false

false true false

false false true

Empirical validity of theories

A: minimal set of assumptions (A+ A)

B: theory

C: complete set of consequences (C C-)

A+ B C- C- true A+ true or false

A B C C true A true