THE LOGIC OF ECONOMICS

Economic life is an enormously complicated hive of activity, with people buying, selling, bargaining, in- vesting, persuading, and threatening. The ultimate purpose of economic science and of this text is to understand this complex undertaking. How do economists go about their task?
Economists use the scientific approach to understand economic life. This involves observing economic affairs and drawing upon statistics and the historical record. For complex phenomena like the impacts of gelled deficits or the causes of inflation,
historical research has provided a rich mine of insights.

Often, economics relies upon analyses and theories. Theoretical approaches allow economists to make broad generalizations, such as those. concerning the advantages of international trade and specialization or the disadvantages of tariffs and quotas.

In addition, economists have developed a specialized technique known as econometric, which applies the tools of statistics to economic problems. Using econometric, economists can sift through mountains of data to extract simple relationships.Budding economists must also be alert to common fallacies in economic reasoning. Because economic relationships are often complex, involving many different variables, it is easy to become confused about .the exact reason behind events or the impact of policies on the economy. The following are some of the common fallacies encountered in economic reasoning:

• The post hoc fallacy. The first fallacy involves the inference of causality. The post hoc fallacy occur.s when tilt assume that, because on/’ event occurred before another event, the fir.st event Taurus the second event.2 An example of this syndrome occurred in the Great Depression of the 1930’s in the United States. Some people had observed that periods of business expansion were preceded or accompanied by rising prices. From this, they concluded that the appropriate remedy for depression was to raise wages and prices. This idea led to a host of legislation and regulations to prop lip wages and prices in an inefficient manner. Did these measures promote economic recovery? Almost surely not. Indeed, they probably slowed recovery, which did not occur until total spending

“Post hoc” is shorthand for post hoc. prop'” hoc. Translated from the Latin, the full expression means “after this. therefore
necessarily because of this.”

began to rise as the government increased military spending ill preparation for World War II.• Failure 10 hold other Hings constant, A second pitfall is failure to hold other things constant when thinking about an issue. For example. we might want to know whether raising tax rates will raise or lower tax revenues. Some people have put forth the seductive argument that we can eat our fiscal cake and have it too. They argue that cutting tax rates will at the same time raise government revenues and lower the budget deficit. They point to the Kennedy:Johnson tax cuts of 1964, which lowered tax rates sharply and were followed by an increase in government revenues in 1965, Hence, they argue, lower tax rates produce

higher revenues. ‘

What is wrong with this reasoning? This argument overlooks the fact that the economy grew from 1964 to 1965. Because people’s incomes grew during that period, government revenues also, grew, even though tax rates were lower, Careful studies indicate that revenues would have been even higher, in 1965 had tax rates not been lowered in 1964. hence , this analysis fails to hold other things (namely, total income ) constant.

Remember to hold other things constant when you are analyzing the impact of (variable on the economic system.

• The fallacy of composition. Sometimes, we assume that what holds true for part of a system also holds true for the whole. In economics, however,we often find that the whole is different from the sum of the parts.when you  assume that what is true for the part is also true for whole , you are  for the whole committing the fallacy’)’ of composition.

Here are some true statements that might surprise surprise  you if you ignored the fallacy of composition: (I) If one farmer has a bumper crop. she has a higher income; if all farmers produce it record crop, farm incomes will fall. (2) If one person receives a great d(‘;11 more money, that person will be better off; if everyone receives a great deal more money,. the society is likely 10 be worse off. (3) If a high tartaric is put on the product of a particular industry, the producers in I hat industry are likely to profit: if hi~h tariffs an’ put on all industries, most producers and consumers will be worse off.

I’these examples contain no tricks or magic.Rather, they are the results of systems of interacting individuals. Often the behavior of the aggregate looks very different from the behavior of’ individual people.

We mention these fallacies only briefly in this introduction. Later, as we introduce the tools of economics,we will provide examples of how inattention to the logic of economics can lead you to false and sometimes costly errors. When you reach the end of this book, you can look back to see why each of these paradoxical examples is true.

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