In the natural sciences, a laboratory experiment can isolate various elements and their movements. There is no equivalent in the discipline of economics. The employment of econometrics and econometric model building is an attempt to create a laboratory where controlled experiments can be conducted. Building an Economic Model The idea of having such a laboratory is very appealing to economists and politicians. Once the model is built and endorsed as a good replica of the economy, politicians can evaluate the outcomes of various policies. This, it is held, enhances the efficiency of government policies and leads to a better and more prosperous economy. It is also held that the model can serve as a referee in assessing the validity of various economic ideas. The
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Building an Economic ModelThe idea of having such a laboratory is very appealing to economists and politicians. Once the model is built and endorsed as a good replica of the economy, politicians can evaluate the outcomes of various policies. This, it is held, enhances the efficiency of government policies and leads to a better and more prosperous economy. It is also held that the model can serve as a referee in assessing the validity of various economic ideas. The other purpose of a model is to provide an indication of the future. By means of mathematical and statistical methods, an economist establishes functional relationships between various economic variables. For example, personal consumer outlays are related to personal disposable income and interest rates, while fixed capital spending is explained by the past stock of capital, interest rates, and economic activity. A collection of such various estimated relations—i.e., equations—constitutes an econometric model.
Is the Mathematical Method Valid in Economics?By applying mathematics, mainstream economics is attempting to follow in the footsteps of natural sciences. In the natural sciences, the employment of mathematics enables scientists to formulate the essential nature of objects. By means of a mathematical formula, objects' response to a particular stimulus in a given condition is captured. Consequently, within these given conditions, the same response will be obtained repeatedly. The same approach, however, is not valid in economics. For economics deals with human beings and not objects. As Mises put it, "The experience with which the sciences of human action have to deal is always an experience of complex phenomena. No laboratory experiments can be performed with regard to human action" (Human Action, p. 31). The main characteristic or nature of human beings is that they are rational animals. They use their minds to sustain their lives and well-being. The usage of the mind, however, is not set to follow some kind of automatic procedure, but rather every individual employs his mind in accordance with his own circumstances. This makes it impossible to capture human nature by means of mathematical formulae as is done in the natural sciences. People have the freedom of choice to change their minds and pursue actions that are contrary to what was observed in the past. Because of the unique nature of human beings, analyses in economics can only be qualitative. Furthermore, to pursue quantitative analysis implies the possibility of the assignment of numbers, which can be subjected to all of the operations of arithmetic. To accomplish this, it is necessary to define an objective fixed unit. Such an objective unit, however, does not exist in the realm of human valuations. On this Mises wrote, "There are, in the field of economics, no constant relations, and consequently no measurement is possible" (Human Action, p. 55). There are no constant standards for measuring the minds, the values, the ideas of men. Valuation is the means by which a conscious purposeful individual assesses the given facts of reality. Once an individual establishes what the facts are, he then assesses which ones are the most suitable to attain his various ends.
Individuals' Goals Set the Standard for ValuationIndividual goals or ends set the standard for valuing the facts of reality. For instance, if the goal of an individual is to improve his health, then he will establish which goods will benefit his health and which will not. Among those that will benefit him, some will be more effective than others. There is no way, however, to quantify this effectiveness. All that one could do is rank these goods in accordance with perceived effectiveness. The use of mathematics in economics poses another problem. The employment of mathematical functions implies that human actions are set in motion by various factors. For instance, contrary to the mathematical way of thinking, individual outlays on goods are not "caused" by real income as such. In his own context, every individual decides how much of a given amount of income will be used for consumption and how much for savings. While it is true that people respond to changes in their incomes, the response is not automatic, and it cannot be captured by a mathematical formula. An increase in an individual’s income does not automatically imply that his consumption expenditure will follow suit. Every individual assesses the increase in income against the goals he wants to achieve.
The Validity of Probability in Economics
Economics Is Not about GDP but about Purposeful ConductMost econometric models are designed along the lines of Keynesian economic thinking. The main variable in these models is gross domestic product, which is explained within the model framework by the interactions between various lumped data known as aggregates. The interaction between various aggregates in the model framework gives the impression that the economy is about gross domestic product and not about human beings and human life. Given that human beings are governed by the freedom of choice, the various policy analyses by means of models, known as "what if" or multiplier analyses, are of a suspect nature. After all, to assume that a change in government policy would leave the structure of equations intact would mean that individuals in the economy have ceased to be alive and are in fact frozen.