Methods of Economic Analysis

METHODS OF ECONOMIC ANALYSIS

An economic theory derives laws or generalizations through two methods (1) Deductive Method and (2) Inductive Method. These two ways of deriving economic generalizations are now explained in brief.

 1. Deductive Method.

The deductive method is also named as analytical, abstract or prior method. The deductive method consists in deriving conclusions from general truths. It takes a few general principles and applies them to draw conclusions. For instance, if we accept the general proposition Law of diminishing marginal utility Rashid is a man. Therefore, the inference will be drawn that Rashid is motivated by self-interest. In applying the deductive method of economic analysis, we proceed from general to particular.

The classical and neo-classical school of economists notably Ricardo. Senior, Cairnes, J.S. Mill, Malthus, Marshall, Pigou, applied the deductive method in their economic investigations.

 

 The main steps involved in deductive logic are as under_

 (1)   Perception of the problem to be inquired into. In the process of deriving economic generalizations, the analyst must have a clear and precise idea of the problem to be inquired into.

(2)   Defining of terms. The next step in this direction is to define clearly the technical terms to be used in economic analysis. Further, the assumptions made for a theory should also be precise.

(3)   Deducing hypothesis from the assumptions. The third step in deriving generalizations is deducing hypothesis from the assumptions taken.

(4)   Testing of hypothesis. Before establishing laws or generalizations, the hypothesis should be verified through direct observations of events in the real world and through statistical methods. (There is an inverse relationship between price and .quantity demanded of a good is a well-established generalization).

Merits of Deductive Method

The main merits of deductive method are as under:

(1)    This method is near to reality. It is less time consuming and 

         less expensive.

(2)    The use of mathematical techniques in deducing theories

         of economics brings exactness and clarity in economic 

         analysis.

(3)   There being limited scope of experimentation in economics,

        the method helps in deriving economic theories.

(4)   The method is simple because it is analytical, Demerits of 

        deductive method. It is true that deductive method is simple and precise, if the underlying assumptions are valid. There is big, IF, in the statement. The shortcomings of the deductive approach are as under:

(1) The deductive method is simple and precise only if the underlying assumptions are valid. More often the assumptions turn out to be based on half truths or have no relation to reality. The conclusions drawn from such assumptions will, therefore, be misleading.

 

(2) Professor Learner describes the deductive method as ‘armchair’ analysis. According to him, the premises from which inferences are drawn may not hold good at all times, and places. As such deductive reasonings are not applicable universally.

 

(3) The deductive method is highly abstract. It require § a great deal of care to avoid bad, logic or faulty economic reasoning. As the deductive method employed by the classical and neo-classical economists led to many facile conclusions due to reliance on imperfect and incorrect assumptions, therefore, under the German Historical School of economists, a sharp reaction began against this method. They advocated a more realistic method for economic analysis known as inductive method.

2. Inductive Method

Inductive method which is also called empirical method was adopted by the istorical “School of economists. It involves-the process of reasoning from articular facts to general principle. This method derives economic generalizations n the basis of (1) Experimentations (2) Observations and (3) Statistical ‘methods.

Systematically arranged and the general conclusions are drawn from them. For example, we observe 200 persons in the market. We find that nearly 195 persons buy from the cheapest shops, Out of the 5 which remains, 4 persons buy local products even at higher rate just to patronise their own products, while the fifth is a fool. From this observation, we can easily draw conclusions that people like to buy from a cheaper shop unless they are guided by patriotism or they are devoid of common sense.

The main steps involved in the application of inductive method are: (i) observation (ii) formation of hypothesis (iii) generalization and (iv) verification. Merits of inductive method.

(1)    It is based on facts as such the method is realistic.

(2)    In order to test the economic principles, the method makes use of statistical techniques. The inductive method is, therefore, more-reliable.

(3)    Inductive method is dynamic. The changing economic

         phenomenon are analysed and on the  basis of collected

         data, conclusions and solutions are drawn from them.

(4)    Induction method also helps in future investigations.

         Demerits of inductive method.

The main weaknesses of this method are as under.‑

(1)          If conclusions are drawn from insufficient data, the

               generalizations obtained may befaulty.

(2)          The collection of data itself is not an easy task.

               The sources and methods employed In the               

               collection of data differ from investigator to investigator.

               The results, therefore,may differ

               even with the same problem.

(3)          The inductive method is time-consuming and expensive.

 

Conclusion

The above analysis reveals that both the methods have weaknesses. We cannot rely exclusively on any one of them. Modern economists are of the view that both these methods are complimentary. They are partners and not rivals. ‘Alfred Marshall has rightly remarked, “Inductive and Deductive methods are both needed for scientific thought, ag the right and left foot are both needed for walking”. We can apply any of them or both as the situation demands.