However, economics is also an empirical subject, using inductive methods to explain observed facts.
Methods used in Economic Analysis
On the other hand, demand curves can be built up empirically, that is by observing actual customers reaction to actual price changes, and when market researchers, data collectors gather relevant information, the data can be used inductively to make economic predictions.
In practice, it can be very difficult to say where deduction ends and induction begins. The major steps involved in the method or in the process of deriving economic generalisation through deductive logic are described and explained below:.
In any scientific study, the analyst must have a clear idea of the nature of the problem to be investigated or enquired into. It is absolutely essential for the analyst or theorist to acquire knowledge of the relevant variables — variables about whose behaviour and interrelationship he wants to make generalisations.
The perception of the problem is in most cases a complex exercise. Since every subject has its own language, it is necessary to define certain technical terms associated with the analysis as the second step.
It is also necessary to make assumptions.
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The assumptions maybe of different types, viz. The assumptions are not made arbitrarily. There should be a logical basis behind them.
In other words, the most crucial assumptions are on the basis of actual observations of past events or on the basis of introspection. Similarly, it is assumed that investors seek to strike a balance between risk and return from different projects.
Since the most profitable projects are also the most risky ones, investors seek to choose optimum combinations of risks and returns. Economists also make certain assumptions to simplify the analysis. For example, when they discuss the utility approach to demand theory, they assume that a representative consumer may purchase any number of commodities. But, when they discuss the indifference curve approach they assume that a consumer buys only two goods say, food and clothing.
This assumption is made just for the sake of convenience, i.
The real world is no doubt very complex. Numerous factors play their respective roles and interact with one another. So, it is absolutely essential to make simplifying assumptions to bring into focus the relative importance of different factors, which have a direct or indirect bearing on the problem under investigation.
It is not at all necessary for every assumption to be realistic. The most crucial factor in theorising is whether the predictions made by the theory are supported by the facts or observations.
What is most important, from the viewpoint of scientific theory, is whether it enables us to make accurate predictions. The third step in making generalisations through process of logical deduction is to form a hypothesis on the basis of the assumptions made. A hypothesis is a provisional statement the truth of which is not known to us.
A hypothesis just describes the relationship among factors affecting a particular phenomenon. Differently put, it establishes the cause-and-effect relationship among those variables dependent and independent having direct bearing on the phenomenon. A hypothesis is normally deduced from the assumptions, by following a process of logical reasoning verbally or in symbolic terms or by using graphs and diagrams.
Any of these techniques may be used to deduce the hypothesis about the relationship among economic variables.
Currently, the process of logical deduction is carried out using rigorous mathematics. As a result, the process of the derivation of the hypothesis no doubt becomes more formal.
Nature of Study (Inductive & Deductive) - Introduction to Micro Economics - CA CPT - CS & CMA
However, it also becomes more exact. The final step involved in the deductive method is hypothesis testing.
Hypothesis testing refers to the development and use of statistical criteria to aid decision making about the validity of a hypothesis in uncertain conditions. In any decision about the validity of a hypothesis there is always a chance of making a correct choice and a risk of making a wrong choice. Hypothesis testing is concerned with evaluating these chances and suggesting criteria that minimise the likelihood of making wrong decisions.
Therefore, hypotheses deduced through a process of logical reasoning have to be verified. Otherwise, it is not possible to establish them as generalisations or principles of economic science.
For the testing or verifications of hypothesis economists cannot carry out controlled experiments. Two major problems crop up as a result of uncontrolled experiments.
Firstly, they have to make more and more observations to verify the hypothesis or derive the generalisations.
Methods of Economic Analysis: Deductive Method and Inductive Method
Moreover, it becomes absolutely essential to interpret the facts carefully so as to be able to discern the significant relationship among the relevant economic variables. Yet it is encouraging to note that, a number of useful and significant generalisations have been firmly established in the areas of both the branches of economics.
Total Utility and Marginal Utility Commodity.