Economics

Light on the kinds of assumptions used in Economic Theories.

Before going in deep let me show you the assumption used in perfectly competitive market as an example.

1. There are large number of buyers and sellers present in the market.

2.  Sellers have homogeneous products to offer.

3. Buyers and sellers must be free from any kind of discrimination.

4. Both buyers and sellers are well-informed on prices of product.

5. Firms have free entry and exit facility in the market.

6. Factors of production are mobile.

7. All firms in market aims for profit maximization (social welfare is ignored by firms.)

8. There is no counting of selling and transportation cost.

This above eight points are underlying conditions that need to be present in any market to be said it a perfectly competitive market. Hence, the assumptions are underlying belief that should be there to give theory validation. In economics each and every theory have certain assumption under which the conclusion of study is made. Hence, assumption alters the conclusion of any study.

(source of image is internet)

The assumptions in economic theories are broadly divided into four categories:

a. Behavioural Assumptions: This is also known as psychological assumption which relates with individual human behaviour. Individual acts in two capacity; consumer and producer. As the consumer psychology s/he intends to maximization of satisfaction from the expenditure of his/her limited resources (monetary). On the other side of psychology as producer, individual aims of profit maximization. In short, these rational assumptions in any economic theory is the basic line that ensure validity of proposition with the real world.

b. Institutional Assumptions: By the term institution mean social, political and economic institutions. Ownership of private property, economic liberalism, price system, level/kind of government intervention in the market, market structure present are the institutional assumption. For example; Free entry and exit of firms in the perfectly competitive market.

c. Structural Assumptions: The structural assumptions are of three forms:

                                            i. Natural structure of the economy,

                                            ii. Physical structure (topography) of the economy,

                                            iii. State of technology of the economy.

In the short run these structure are considered static, for e.g., given resources and technology whereas, in the long run these structure changes in interval. For example. capital, labor and technology changes in long run showing dynamic economy. Points need to be noted, the structural assumptions are employed in the investigation of production and growth theories of economics.

d. Ceteris Paribus Assumption: In simple word, it is mean "other things remaining the same". To simplify the concept of theories it is used. To study the impact of one factor, other need to bring (consider) constant which is done by this.  For example, in the law of supply producer supplies the good when price of the product increases and other things remaining the same. These other things is the variables like taste, fashion, desire, habit, income of consumer etc. which have ability to alter the demand of suppliers product. So, to understand the concept in the better way by only focusing on limited extreme it is used.

Happy Reading!