Lecture Notes: Assumptions in Economics

Introduction

• Concept of an assumption in economics is crucial for both micro and macroeconomic analysis.
• Assumptions are often used to simplify complex analyses.
• Changing assumptions can alter economic models.

What is an Assumption?

• Definition: An initial condition set before building economic models.
• Assumptions serve as building blocks for theoretical analysis.
• Example: Assuming the supply curve is perfectly elastic (constant cost for each unit).

Importance of Assumptions

• Assumptions help isolate the effects of changes in variables.
• Real-world scenarios often differ from model predictions due to assumptions.
• Models are sometimes criticized for unrealistic assumptions.

The Ceteris Paribus Assumption

• Definition: An assumption that all other factors are held constant to isolate the relationship between two variables.
• Used in:
  • Demand and supply curves.
  • Basic law of demand.
• Example: Analyzing the effect of price changes on coffee demand, assuming other factors are constant.

Challenges to Assumptions

• Assumptions are meant to be tested and can be criticized.
• Standard Theory Assumptions:
  • Consumers are rational and aim to maximize utility.
  • Choices are made independently.
• Challenges:
  • Bounded rationality (limited information, time, and cognitive capacity).
  • Social contexts influence consumer choices.
  • Behavioral economics suggests interdependent choices influenced by social preferences and norms.

Examples of Economic Assumptions

• Rational Behavior:
  • Assumption: Consumers make rational choices to maximize utility.
  • Challenge: Behavioral economists argue for "bounded rationality."
• Independent Choice:
  • Assumption: Decisions are independent of others’ choices.
  • Challenge: Social influences suggest otherwise.
• Profit Maximization in Firms:
  • Assumption: Monopolies aim to maximize profits (where marginal cost equals marginal revenue).
  • Challenge: Firms have diverse objectives, e.g., revenue growth and market share.

Application in Essays and Analysis

• Highlight assumptions clearly in notes.
• Challenge assumptions to enhance essay evaluation marks.
• Questioning assumptions helps align models closer to real-world scenarios.

Conclusion

• Understanding and challenging economic assumptions is crucial for effective analysis and evaluation.
• Use assumption critique as a key strategy in economic essays and exams.