Assumptions in Economics and in the Real World

Commentary

“The purpose of this paper is to demonstrate possibilities and clarify thinking, rather than to be realistic …. In this model individuals are identical and live forever, so that there are no realistic complications involving distribution within or between generations; output is simply given.”

“A theory is a set of abstract principles purporting to be either a correct description of reality or a set of guidelines for man’s actions. Correspondence to reality is the standard of value by which one estimates a theory. If a theory is inapplicable to reality, by what standard can it be estimated as ‘good’?”

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“A concept is a mental integration of two or more units which are isolated according to a specific characteristic(s) and united by a specific definition.

“The units involved may be any aspect of reality: …”

“The relevant question to ask about the assumptions of a theory is not whether they are descriptively realistic, for they never are, but whether they are sufficiently good approximation for the purpose in hand. And this question can be answered only by seeing whether the theory works, which means whether it yields sufficiently accurate predictions.”

In Friedman’s thinking, our knowledge of the world of economics is elusive. Since it is not possible to establish “how things really work,” then it does not really matter what the assumptions of a theory are. In fact, anything goes, as long as the theory can generate accurate predictions. But is predictive capability a valid criterion for accepting a theory?

“Economics can predict the effects to be expected from resorting to definite measures of economic policies. It can answer the question whether a definite policy is able to attain the ends aimed at and, if the answer is in the negative, what its real effects will be. But, of course, this prediction can be only ‘qualitative.’”

“What we can ‘observe’ is always only complex phenomena. What economic history, observation, or experience can tell us is facts like these: Over a definite period of the past the miner John in the coal mines of the X company in the village of Y earned p dollars for a working day of n hours. There is no way that would lead from the assemblage of such and similar data to any theory concerning the factors determining the height of wage rates.”

Contrary to popular thinking, economics is not about gross domestic product (GDP), the consumer price index (CPI), or other economic indicators as such, but about human beings that act and interact. It is about purposive activities undertaken to achieve ends. For instance, one can observe that people are engaged in a variety of activities. They may be performing manual work, driving cars, walking on the street, or dining in restaurants. The essence of these activities is that they are purposeful.

Individual goals or ends set the standard for the evaluation of means. For instance, if the goal of an individual is to improve his health, then he would establish which actions and goods will benefit his health and which will not.