1.6 Thinking Like an Economist: Abstraction

An abstraction is an idea, intended to mirror reality in its simplest form. The world is a very complicated place; there are many variables or inputs, some identifiable, others not, that affect an outcome, and which we endeavor to identify. In order to understand the outcome which is generally true, but not necessarily absolutely or always so, one must engage in a process of simplification that requires removing minor variables from a general idea in order to reduce the notion to its essential characteristics. Indeed, the Latin word, “abstract,” comes from “drawing” or “taking away from.”

In this process, one is able to derive a broad, general conclusion, based on first principles from which is derived a general idea or rule. In economics, this requires a ceteris paribus assumption, that is to say, holding “all else equal.” Initially, it is assumed that no other variables matter and are thus ignored away. It takes some discipline to do this at first, but it quickly becomes easy; you must merely keep it in mind.

In circumstances where little given or known information may be at hand, one must assume reasonable default assumptions, i.e., premises, which make sense in general and in the simplest, most common form possible. While it may be facile to imagine other considerations, or variables, that may come into play, one must avoid doing this, in order to focus on just a few key variables, which affect the outcome. Here is a relevant comment by Dr. Milton Friedman^[1]: 

A hypothesis is important if it “explains” much by little, that is, if it abstracts the common and crucial elements from the mass of complex and detailed circumstances surrounding the phenomena to be explained and permits valid predictions on the basis of them alone.  To be important, therefore, a hypothesis must be descriptively false in its assumptions; it takes account of, and accounts for, none of the many other attendant circumstances, since its very success shows them to be irrelevant for the phenomena to be explained….

To be sure, Dr. Friedman’s comments are not without criticism, but nevertheless are adhered to, by and large, in the social sciences, including, of course, economics. In certain other disciplines, including law, political theory, history, philosophy, and possibly others, we do not engage in this mode of reasoning. In these fields, by contrast, we are often engaged in dialectical reasoning. There, we first state a thesis, then examine its antithesis. We go back and forth numerous times until we can arrive at a synthesis, which is conclusive or dispositive.

Those of you that are accustomed to dialectical reasoning must diligently avoid the natural instinct to quickly imagine the antithesis; rather you must remain steadfast to the line of reasoning demanded by the more linear manner of abstract argumentation, based on first principles and ceteris paribus delimitations. (A “delimitation” is a limitation that one person herself imposes on the scope of her reasoning.)

When, in certain instances, we deviate from abstract reasoning, we assume specific, more descriptive, circumstances in a contextual or “concrete” manner. The result may not be generalizable. If a conclusion is generalizable, we say that it is true in the overwhelming number of instances, although not necessarily all.

For instance, it is known via mathematics and reason, that interest rates and stock prices are inversely related. Rates go up, prices go down. This is true beyond any doubt – if we assume ceteris paribus. At the same time, it is more than just interest rates alone that affect stock prices.

One of the beauties of abstract reasoning is that it enables us to employ other, more reasonable assumptions when we find that a model has poor predictive power.

Happy travels!