Figure 2-1 The Interaction Between Theory and Empirical
Observation
Testing Theories
A theory is tested by confronting its predictions with empirical evidence.
For example, is an improvement in the weather actually followed by an
increase in wheat production? Or, is an increase in the world price of oil
actually followed by an increase in oil production by Canadian producers?
A theory ceases to be useful when it cannot predict better than an
alternative theory. When a theory consistently fails to predict better than
an available alternative, it is either modified or replaced. Figure 2-1
illustrates the interaction between theory and empirical observation that
occurs in economics.