2.2 Building and Testing Economic
Theories LO 2, 3
Theories (sometimes called models) are designed to explain and
predict what we see. A theory consists of a set of definitions of the
variables to be discussed, a set of assumptions about how the
variables behave, and the conditions under which the theory is meant
to apply.
A theory provides predictions of the type “If one event occurs, then
another event will also occur.”
Theories are tested by checking their predictions against evidence. In
economics, testing is almost always done using the data produced by
the world of ordinary events.
Economists make use of statistical analysis when testing their
theories. They must take care to make the distinction between
correlation and causation.
The progress of any science lies in finding better explanations of
events than are now available. Thus, in any developing science, one
must expect to discard some existing theories and replace them with
demonstrably superior alternatives.