Assumptions as a Crucial Component of Economic Theories - Essay Example

Milton Friedman, in his essay The Methodology of Positive Economics, argues that the seeming lack of objectivity in economics, and its inability to test its hypothesis accurately are not due to any foundational problem at its core, but rather on the methodological measures that economists apply in testing their theory (1966, pp. 15-16 and 39-13). He argues that it is through a reassessment of these elements that economists can produce theories that "yield valid and meaningful predictions," appropriately achieving its goals. In line with Friedman's arguments, this essay argues that assumptions, as a crucial component of economic theories, need not capture reality as it is, but instead must only be sufficiently adequate to encompass the economic phenomenon in question. Citing John Neville Keynes, Friedman identifies two types of science - positive science and normative science - whose relevance in economic theory depends on its practical application in economic policy (cited in Friedman 1966, p. 3). Whereas normative science deals with what ought to be, normative economics assists policy makers in crafting economic policies that ethically just, depending on the values they hold. In this regard, positive economics, through positive science dealing with "what is", guides policymaker's judgments by providing them with accurate predictive tools to ensure that sound economic policies are produced and that these policies yield results that they are expected to. Hence, positive economics would only hold value if their ability to predict economic phenomena accurately. In the words of Friedman, "[t]he ultimate goal of a positive science is the development of a 'theory' or, 'hypothesis' that yields valid and meaningful predictions about phenomena not yet observed" (p. 7). Two implications can be deduced from this statement: first, in order to predict phenomena accordingly, economic theories must hold analytical relevance; and second, the focus on analytical relevance renders the need for descriptive accuracy, insofar as it is defined as the need for an accurate account of reality, secondary, if not insignificant. However, if as identified by its critics, positive economics lacks the ability to conduct controlled experiments to prove its theory, and maintain objectivity given the imminent significance it holds on the public, as well the economist himself, how can economic theory gain the same confidence and respect wielded by its counterpart in the physical sciences To address this question, Friedman refers to the two elements constituting economic theory, and theory in general - its language and its method of reasoning. First, with regard to the language of theory, Friedman argues that "logistical completeness and consistency are relevant but play a subsidiary role to assure that the hypothesis says what it is intended to say" (p. 10). In this respect, empirical evidence that can be gathered through controlled experiments is only valuable insofar as it can assist in the prompt validation of a theory. It does not hinder the testing of a theory's hypothesis (p. 13). And consequently, it does not affect the ability of economic theory to predict phenomena. Second, with regard to a theory's substantive method of reasoning, Friedman calls attention to the manner that a theory's hypothesis is constructed and further tested. In this respect, Friedman critiques the manner that economists construct a hypothesis by making them "realistically accurate" to conform to empirical data. As Friedman notes, this manner of theory construction is not only impractical and inadequate, but insignificant as well. With regard to its impracticality, Friedman points to the logistical impossibility that surrounds the exercise of making sure assumptions are "realistically accurate." Hence, it is impossible to account for all the facts surrounding a phenomenon to be explained because this phenomenon constitutes a wide range of facts that are both relevant and irrelevant to a theory. It is also inadequate because, as Friedman notes, an assumption's realistic validity is only useful if it is supplemented to check if a particular hypothesis yields better predictions for a wide range of phenomena compared to others (p. 31). Hence, given two types of theories with similar predictive abilities attempting to explain a single phenomenon, the one that accounts for a wider range of facts, such that it is more realistic in its assumptions, would yield greater value as a theory. More importantly, however, a hypothesis' whose assumptions conform to reality renders it irrelevant (pp. 14-15). The basis for this argument is in the manner that theoretical development progresses in the social sciences. In this respect, it is imperative to understand that hypotheses are accepted or rejected not by proving its validity, but by proving its invalidity. As a common example initiated, to prove that "all swans are white," one must account for all swans and show that they are white. However, since it is impossible to ensure that all swans have been accounted for because the existence of a million swans does not negate the existence of a single black swan, it will be impossible to identify a valid criterion to accept or reject it. However, one can say that "not all swans are white" and all that is needed to prove or disprove this is to find a single black swan, which despite its logistical impossibility a criterion for rejecting or accepting it can be arrived at. As Friedman notes, "a hypothesis must be descriptively false in the assumptions" to be valid, and making them descriptively realistic will make this impossible (pp. 14-15). Hence, how can economists test assumptions and hypothesis Friedman argues the need to simply test its ability to sufficiently account as "good approximations for the purpose at hand" - the phenomena being studied (p. 15). In particular, the need to create "ideal types" that are not intended to be descriptive, but rather, "to isolate features that are crucial for a particular problem" (p. 36). Thus, as Milton Friedman accurately argues, positive economics must have as its goal analytical relevance and the ability to predict phenomena, rather than descriptive accuracy. Such that in order to achieve such relevance, a hypothesis must be tested through the ability of its assumptions to sufficiently account for the phenomena being studied contrary to the need to account to describe the facts surrounding it realistically. By doing so, economics, as a systematized body of knowledge can attain the same status of physical sciences insofar as the existence of validly accepted theories are concerned. "theory is to be judged by its predictive power for the class of phenomena which it is intended to 'explain'" (p.7) "The denial to economics of the dramatic and direct evidence of the 'crucial' experiment does hinder the adequate testing of hypothesis," but only by virtue of rendering "the weeding-out of unsuccessful hypotheses slow and difficult" (p. 11). Empirical evidence - for construction and further testing "its further testing involves deducing from it new facts capable of being observed but not previously known and checking these deduced facts against empirical evidence" (p. 13). "the conformity of these 'assumptions' to 'reality' is a test of the validity of the hypothesis different from or additional to the test by implications" (p. 14) - WRONG "Truly important and significant hypotheses will be found to have 'assumptions' that are widely inaccurate descriptive representations of reality, and, in general, the more significant the theory, the more unrealistic the assumptions." ; it takes account of, and accounts for, none of the many circumstances, since its very success shows them to be irrelevant for the phenomena to be explained" (pp. 14-15). Tests that check if the Descriptive accuracy vs. analytical relevance "ideal types "A meaningful hypothesis or theory typically asserts that certain forces are, and other forces are not, important in understanding a particular class of phenomena" (p. 40). "The construction of hypothesis is a creative act of inspiration, intuition, invention; its essence is the vision of something new in familiar material" (p.43). 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