Candidate Number: 26570

Word count: 1405

Question 2: Economists sometimes use simple mathematical models. How, if at all, do such
models tell us anything about real-life economic phenomena? Characterise the perspective of at
least one of Gibbard and Varian, Sugden, Cartwright, Woodward, Friedman, or Hausman on this
issue and offer your own argument on the topic.

Within economics, a discipline deeply rooted in mathematical foundations, models are often used
to explain, represent or predict certain phenomena. However, the simplification of assumptions
that underlie such models inevitably depart from the complexities of economic systems. This
raises debates surrounding their value in understanding and accurately depicting real-life
patterns. This essay argues that models prove valuable in explaining and predicting actual
economic phenomena, however, the degree of simplicity and accuracy of the underlying
assumptions determines their function.

The essay focuses on two nuanced positions, beginning by exploring Friedman’s (1953)
instrumentalist perspective whereby he contends that the validity of a model is determined by its
predictive success, regardless of the ‘realism’ of its assumptions. It moves to presenting
Hausman’s (1998) critique which asserts that assumption realism should not be disregarded,
particularly when considering the wider applicability of models. After considering these views, it
is concluded that while realistic hypotheses are required for certain outcomes, they aren’t
relevant for other purposes by considering different types, and consequently uses, of models to
evaluate how they help in discerning economic phenomena.

In ‘The Methodology of Positive Economics,’ Friedman argues that a model can be viewed as,
‘a conceptual world…simpler than the ‘real world,’ rejecting the necessity of achieving realism.
He claims that the validity of a hypothesis is determined purely by its predictive success with
regards to the phenomena it was designed to explain. Friedman insists that the focus of its
assumptions need not be perfect realism, but rather to act as sufficiently valid approximations for
the intended purpose, which can be confirmed only once the theory has been tested and proven to
arrive at true conclusions. It is maintained that even models with wildly unrealistic assumptions
can yield predictions that are accurate and may prove to be more significant than those with
practical premises if they have greater predictive success. He argues against criticisms regarding
unrealistic assumptions stating that they should not be disapproved of solely as they aren’t exact
representations of real economic systems. Rather, these criticisms only have a basis if the
unrealistic assumptions result in inaccurate predictions.

Friedman further claims that descriptive realism of assumptions is largely irrelevant as no model
can include every detail of the real world, and therefore simplifying assumptions are necessary.
He contends that the abstraction of the essential from complex reality can isolate key causal
relationships. While descriptively inaccurate, this allows the model to generate testable
predictions and focus on how changes in certain variables can impact economic phenomena.
Friedman uses the example of perfect competition to illustrate this point, a fundamental
economic theory that is wildly unrealistic. The perfect competition model makes inaccurate
assumptions that don't truly capture the complexities of the real market, including presuming
homogenous products, perfect information and no barriers to enter and exit the market. However,
the simplicity of the model has been helpful in analysing aspects of market behaviour and
focusing on the effects of factors such as changes in demand or costs. The unrealistic
assumptions derive reasonably accurate predictions regarding economic mechanisms, such as the
impact of an industry wide tax increase in a perfectly competitive market would be passed to
consumers through higher prices. By abstracting other specifics, the model captures the key
mechanism of a shift in costs and still predicts the core causal relationship accurately.

Hausman (1998) argues that although models can provide insights into economic systems, the
realism of assumptions cannot be disregarded when analysing their validity, and thereby
disagrees with Friedman’s position. He suggests that from Friedman’s perspective, a good
hypothesis needs to produce correct and valid predictions only for a specific set of phenomena,
and the only test of whether it is a satisfactory hypothesis is whether it does so. Therefore,
whether the assumptions of the hypothesis are realistic or not is deemed irrelevant to its
assessment. However, Hausman asserts that one should be concerned with the realism of
assumptions and look at wide rather than narrow predictive success when evaluating a theory. He
claims that theories are necessary to guide through situations in which the correct predictions are
unknown.When extending models to new circumstances or assessing it’s future predictive
performance whereby there is no current evidence to evaluate whether predictions are true,
Hausman suggests that the underlying assumptions can provide information about the model’s
plausibility in such instances.

To support his stance, he presents the metaphor of evaluating the performance of a used car
through a test drive or looking under the hood to examine its components. Here Hausman states
that a test drive provides evidence about how well a used car performs, however it is limited in
that it cannot guarantee future performances of the car in varying circumstances. However,
additionally by looking ‘under the hood’ of the car into the engine parts, one can better predict
the car’s behaviour. Therefore, with the car being analogous for economic models and its
components representing theoretical assumptions, Hausman argues that assessing a model solely
based on its narrow predictive success is similar to only using a test drive to evaluate the
functioning of a used car. Looking ‘under the hood’ of models, or rather examining if their
assumptions and components are well constructed, can provide insights into the model’s broader
capabilities and weaknesses that may not affect immediate narrow predictions but still matter.

Although I concur with both perspectives that models can be valuable in explaining and
predicting economic phenomena, I believe that the necessary degree of realism of underlying
assumptions depends on the intended purpose of the model. When using models to explain or
understand certain economic mechanisms, I support Friedman’s perspective that the accuracy of
assumptions could be deemed as irrelevant. In fact, this may prove to produce more accurate
predictions and clearer explanations by capturing or focusing on key causal relationships. This is
true for numerous economic theories including, for example, the Solow growth model, which is
used to analyse long-term economic growth resulting from factors such as capital accumulation,
labour force growth and technological progress. Yet, it is based on unrealistic assumptions which
include a closed economy, constant savings rate and constant exogenous technological
advancement. However, these simplifications result in a model that is useful in predicting and
understanding the relationships between key variables such as capital accumulation and their
impact on long-run economic growth. This supports Friedman’s assertion that a good hypothesis
does not require accurate assumptions. Abstracting from the complexities of realistic economic
interactions can allow for a better basic understanding of fundamental mechanisms that do not
depend on the specifics of the underlying assumptions.

However, when focusing on extending models to new circumstances in which the correct
predictions are unknown such as policy-making decisions, I agree with Hausman that realistic
assumptions are, in fact, necessary. Realistic assumptions increase the applicability of a model to
changing economic conditions, without which it may be difficult to determine the underlying
causes of the observed phenomena. When models are based on assumptions that are founded in
real-world interactions, they can yield more accurate predictions when employed in different
situations, making it reliable across scenarios and time. For example, returning to the Solow
growth model example, although the model provides a useful framework used by governments
and policymakers alike in assessing the impact of various policies on economic growth, due to its
limitations, researchers often use other more sophisticated models in conjunction with the Solow
model. This is to ensure precise predictions which are more in line with the real-world,
suggesting that although the model provides useful insights, for wider applicability more realistic
assumptions may be required. Furthermore, realistic assumptions are necessary when evaluating
decisions with ethical implications, such as policy recommendations, as models based on false,
unrealistic assumptions can result in ethical predicaments. Ethical decisions involve multiple
stakeholders and can lead to unintended negative consequences without a comprehensive
understanding of the real-world context. Accurate assumptions are required to help appreciate
the intricacies of ethical dilemmas and accurately evaluate trade-offs between varying interests
and values.

To conclude, while simplifications in assumptions can yield useful in establishing an

understanding of isolated variables on economic phenomena, added complexities may be more
appropriate when looking at issues such as policy-making. This argument proves to be similar to
that presented by Gibbard and Varian (1978) regarding approximation and caricature models.
Although a model can never truly capture the intricacies of the real-world, it is evident that they
can help in explaining and predicting economic interactions and events.
Commentary

This final summative essay is a revised product of the formative, using all the feedback that was
given. To begin, it was highlighted that I didn’t go into sufficient detail about any of the readings
and to be able to do so within the word count constraint I decided to focus on two perspectives,
Friedman and Hausman’s, rather than three. I understood their stances in greater depth and they
supported my argument best. I also revised the summary of both these views so that they are
more comprehensive and accurate in accordance with the feedback.

When presenting Friedman’s argument, I relied too heavily on quotes at certain points so I
revised that to explain his perspective using my own words. Moreover, some of the summary
was inaccurate, particularly when I stated that Friedman argues that a model needs to only
adequately represent the real world, when in fact he rejects the notion that models need to be
realistic. Therefore, I made this change to the commentary along with providing more details,
particularly regarding his belief that descriptive accuracy of assumptions is irrelevant, and how
the simplifications of assumptions can be effective when analysing key causal relationships
within economic systems. I also made a few minor changes with regards to specific words I used
which did not make sense in the context as suggested by the feedback.

With regards to Hausman’s argument, it was stated that the summary I provided was not
adequate. Therefore, I explored the used car analogy to support his position regarding the
importance of realistic assumptions, particularly for the application of models to new situations. I
also clarified that Hausman does not, in fact, agree with Friedman’s view.

I revised the essay to use a more traditional structure whereby I first present the two views and
then separately describe my own arguments. This was in an effort to distinguish between my
own view and those from the readings as it was noted that this was not always clear. I elaborated
on my perspective and highlighted where it overlapped or disagreed with Hausman and
Friedman. Furthermore, I expanded on my point regarding the importance of realistic
assumptions when evaluating decisions with ethical implications. I emphasise their necessity in
effectively evaluating the trade-offs between different stakeholder interests and avoiding
unintended negative consequences. I also re-worked the introduction to remove the sentences
that seemed redundant or out of place as suggested in the feedback.

Overall, the formative essay was heavily altered based on the comments received. The structure
of the essay was improved to clearly differentiate between the different perspectives presented in
the essay, and each part was revised for greater accuracy and depth.

Word count: 444

Bibliography

Friedman, M. (1953) Essays in positive economics. Chicago: The University of Chicago Press.

Gibbard, A. and Varian , H.R. (1978) ‘Economic Models’, The Journal of Philosophy, 75(11),
pp. 6644–677. doi:http://www.jstor.org/stable/2025484.

Hausman, D.M. (1998) ‘Problems with realism in economics’, Economics and Philosophy,
14(2), pp. 185–213. doi:10.1017/s0266267100003837.