THE ROLE OF ASSUMPTIONS
If you ask a physicist how long it would take for a marbie to fall from the top of a ten story building, 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 correctlv point out 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 more 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 beachball 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 beachball than on a marble because a beachball is much lar ger, The assumption that gravity works in a vacuum is reasonable for studying a falling marble but not for studying a falling beachball.
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 assumptions when studying the effects of the policy change over 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 beachballs, economists use different assumptions when studying the short-run and long run effects of a change in the quantity of money.