How economists approach the world: IB Economics 1.2 notes

Why economists use models

The real economy has billions of decisions interacting at once, so economists study it with models: deliberate simplifications that strip away detail to expose one relationship clearly. A demand diagram, a PPC and the AD/AS model are all models. None is a photograph of reality; each is a tool for reasoning about a specific question.

A model is judged not by how realistic its assumptions look but by how well it predicts and explains. This is why saying a model is wrong because it is unrealistic misses the point. Every useful model is unrealistic in some way; the skill is knowing which simplifications are safe for the question at hand and which break the analysis.

Assumptions and ceteris paribus

Because everything in an economy moves at once, economists isolate one relationship by holding the other influences constant. The Latin phrase ceteris paribus means all other things equal. When we say a fall in the price of coffee raises the quantity of coffee demanded, ceteris paribus, we are freezing incomes, tastes and the price of substitutes like tea so we can see the price effect on its own.

This assumption is what lets a two-dimensional demand curve exist at all. In the real world the other factors do change, which is why we distinguish a movement along a curve (caused by the variable on the axis) from a shift of the curve (caused by a ceteris paribus factor changing). Assumptions are not errors; they are the scaffolding that makes analysis possible.

Empirical evidence and refutation

Economics is a social science, so its claims are meant to be tested against real-world data. A positive prediction, such as raising interest rates will slow inflation, can be checked against what actually happens. When the evidence repeatedly contradicts a model's prediction, the model is refuted and should be revised or abandoned. This is the same logic of refutation used across the sciences.

Testing in economics is harder than in a laboratory science because economists rarely run controlled experiments; they observe a moving world where many things change together. That is why they lean on statistical methods, natural experiments and careful reasoning about causation versus correlation, and why reasonable economists can still read the same data differently.

Economic thought over time

Classical economists such as Adam Smith and David Ricardo argued that markets are largely self-correcting: flexible wages and prices guide resources to their best use, so governments should mostly stand back. This laissez-faire view dominated until the Great Depression exposed prolonged mass unemployment that markets did not quickly cure.

John Maynard Keynes, in 1936, argued that economies can get stuck below full employment because of deficient aggregate demand, and that government spending can pull them back. Keynesian thinking shaped policy for decades. Then the stagflation of the 1970s, high inflation and high unemployment together, undercut the simple demand-management story.

Monetarists led by Milton Friedman responded that inflation is, in his words, always and everywhere a monetary phenomenon, so the priority is steady control of the money supply rather than fine-tuning demand. Central banks such as the US Federal Reserve under Paul Volcker and policymakers in Thatcher-era Britain tightened money sharply in the early 1980s. Today most economists borrow from several of these traditions rather than any one.

Positive and normative economics in practice

The positive versus normative split is defined in full in the 1.1 notes; here the point is that it does most of its work inside real policy debates rather than as an abstract distinction. Estimating how many jobs a carbon tax would cost is positive; deciding whether that cost is worth the cut in emissions is normative, and the two get tangled the moment the policy is argued over.

The split also sits under the schools of thought above. Economists often agree on the positive analysis, for example that rent controls tend to reduce the supply of rental housing over time, yet disagree on the normative question of whether protecting current tenants justifies that cost. In evaluation you are usually weighing normative trade-offs on top of positive analysis, so keep the two separate on the page.

Common Paper mistakes

Dismissing a model because its assumptions are unrealistic. All models simplify; the question is whether the simplification is appropriate, not whether it is literally true. Show you understand this by stating an assumption and explaining what it lets the model isolate.

Blurring positive and normative language. Slipping a should into a factual answer, or presenting a value judgement as if it were proven by data, weakens evaluation. Also avoid presenting one school of thought as simply correct: examiners reward showing that classical, Keynesian and monetarist views each fit some situations better than others.

How this is examined

• This is background theory that mainly earns marks through good habits across Paper 1 and Paper 2 rather than as a standalone essay: use ceteris paribus correctly whenever you shift or move along a curve.
• In evaluation, flag when a claim is positive versus normative. Examiners credit candidates who separate what the analysis shows from what they think the government ought to do.
• When a question invites debate about the role of government, referencing the classical versus Keynesian divide (self-correcting markets versus demand management) adds depth, provided you tie it to the specific policy.
• Never write that a model is invalid because it is unrealistic; instead identify the key assumption and say what it usefully isolates.

Key terms

ceteris paribuskeynesian economicsmonetary policyfiscal policy