“A good theory is one that explains much by little” (Milton Friedman). Discuss whether this is true of economic theories. [35]

H3 Economics Cambridge N2007 Q2 Economics Essay response

“A good theory is one that explains much by little” (Milton Friedman). Discuss whether this is true of economic theories. [35]

Milton Friedman once famously argued that “a good theory is one that explains much by little”, which suggests that a good economic theory should be able to offer an universal account for economic events using simple modelling. The more parsimonious the explanation, the better the economic model, ceteris paribus. This paper argues that such a statement is true as it is in line with the objective in constructing economic theories that are useful in terms of predictive power. However, this criteria does not apply in every situation as sometimes we must rely on economic theories which are more complicated or perhaps on the other hand limited in the range of application.

George Stigler suggested three criteria for us to evaluate all economic theories. These criteria are: tractability, generality, and correspondence with reality. Tractability refers to the easy manipulation of the model and the convenience of fitting the theory into other models. Generality refers to the extent in which the theory can be applied to a large population. The greater the extent, the better the theory is. Correspondence with reality refers to the capacity of the theories in producing explanations and predictions that cohere with the real world. Going with these criteria, we can see that what Milton Friedman suggests can be true. “Explains much by little” means that the theory can be used to account for many economic events or for events in many different situations and contexts. It also means that the theory is not complicated and should be easy to understand. Thus, it can be argued that any theory which fulfills the requirement of “a good theory” by Milton Friedman will be able to meet the “Tractability” and “Generality” requirements by Stigler. Friedman’s statement also seems to suggest that the theory should have an acceptable degree of correspondence with reality, otherwise it cannot be claimed to be able to “explain” the world. Therefore, Friedman’s statement is likely to be true for economic theories. One example to illustrate its validity is the "law" of demand and supply, which is a simple model but one which is able to capture the universal relationship of demand and supply and prices and quantity demanded.

We should further question and closely examine the validity of these three criteria. It is virtually no debate that a simpler model is preferred to a complex model, assuming that they can both produce the same results. Friedman once argued that the process of constructing economic models is to abstract the rich complexity of the reality to relationships of quantifiable variables. The criterion of tractability is thus acceptable. He gives the example of maximization of profits by firms. In firm analysis, economists usually go by the assumption that firms seek to maximize profits. Friedman argues that this assumption allows us to analyze the market easily because all the firms are likely to behave in the same way as they are maximizing their profit since they will lose out due to natural selection if they behave in different ways. Thus, even if the reality is more complex than the theory, this single assumption allows us to abstract the key element of the market and analyze firm decisions with more convenience. Therefore, the criterion of using a simple model to explain economic phenomena is justified. 

Secondly, the criterion of generality is also an important requirement for any economic theory. It is noted that economic aims to capture universal economic behaviors, and therefore is more interested in how does a population behaves in aggregate level. Ultimately, economists aim to develop theories that can explain and predict economic behaviors, especially when it is related to policy making. Firstly, a theory that can account for a larger population is usually preferred to one that can account for a small population. Secondly, a large population enables economists to observe patterns in behaviors which may not be readily obvious in a small population. Therefore, the criterion of generality is also justified. 

In this case, Friedman’s claim that a good economic theory should be able to explain much by little is supported since the statement is in line with the objective in constructing economic knowledge. However, Friedman seems to assume that these two criteria should be placed in priority before the third criterion: correspondence with reality. He could be suggesting that we should not accept theories that can provide accurate predictions but are intractable or limited in the range of applications. 

Correspondence with reality is an important assumption because it is the ultimate test of the theories. Even though Friedman’s statement is true, it should be recognized that these three criteria are difficult to achieve simultaneously, and usually we should compromise one to improve another. For example, theories may predict very accurately but its range of applications is likely to be limited. On the other hand, when the theory is developed to account for a larger population, its accuracy is likely to be compromised. According to Daniel Hausman's reading of J. S. Mill, economics is an inexact science which can offer theories which have loose fit with reality. It seems difficult to achieve the same degree of accuracy in knowledge claims like in natural sciences while ensuring that the law is universal. 

It is sometimes difficult to judge which criterion should be placed in priority. Some argues that providing understanding is also an important requirement for economic theories. Ultimately, economics is the study of human behavior, and people are intuitively interested in understanding the mechanism of an economy. From this perspective, accuracy of economic theory should be placed as the priority and Friedman’s statement does not continue to serve as a yardstick to evaluate a theory. 

In conclusion, Friedman’s statement is in line with the objective of constructing economic claims that are universal, accurate and tractable. However, we may need different economic theories in different situations, and the requirement may not usually serve as a good indicator of good theory, especially in cases where accuracy of claims are taken as a more important quality than tractability and generality. Ultimately, a good theory is one that can serve our interests and is able to assist us in achieving our objectives. Thus Friedman’s claim is only true when we assume that the purpose of constructing economic theories is to provide an account for economic behaviours in the aggregate level. 

JC Economics Essays: As this is the A level examination season, and there is also the upcoming H3 Economics examination, I decided to include a few H3 economics essays in addition to the wide variety of economics papers (H1, H2, A levels, GCE/GCSE/AS) here on my economics site. This H3 economics essay was contributed by WXN and written under examination conditions of around 1 hour. Thank you WXN for your kind contribution. 

Some areas of improvement for this essay could be: a wider scope of exploration could have been conducted. He could have delved into Ockham's razor, the philosophy of positivism and empiricism, or launched into a small case study of theories of the firm where profit maximisation has been roundly criticised by Herbert Simon, Olivier Williamson, and other such famous economists, and the varied empirical studies that flatly contradicted theories. More recent economic theories and studies could also be utilised, such as Schelling's checkerboard model and the famous George Akerlof's lemons model. All of these could have added further depth and rigour to his paper, and made it even better. 

However, WXN did also do many things right, making all the right moves that make an economics essay strong. What do you think were the strong points in his essay? What did he do that you could learn from? For instance, WXN cited famous economists (and used their quotes to further his case, while signalling that he put in effort to study hard) and used a yardstick to evaluate the sentence. Given the time constraints and examination pressure, this H3 economics essay is actually quite strong. How would you have approached this essay, and what would you have done differently?

Thank you for reading and cheers!

[Postscript: WXN and his batch of economics students achieved 100% A/B for H2 Economics and 100% Distinction/Merit for H3 Economics in the 2013 economics examinations. They worked hard and performed well, so it is not all my credit. Congratulations!]