Theoretical economics involves establishing economic theories by gathering ,systematically arranging,and generalizing from facts. Economic theories are tested for validity against facts.Economists use these theories-the most reliable of which are called laws and principles – to explain and analyze economy. Policy economics refers to using the economic laws and principles to formulate economic policies.
The economist draws on the facts to establish cause-effect hypotheses about economic behavior.Then the hypotheses are tested against real world observation and data.Through this process, the economist tries to discover hypotheses that rises to the level of theories and principles(laws)-well-tested and widely accepted generalizations about how individuals and institutions behave.
Economists speak of “hypotheses”,”theories”,”models”,”laws”,and “principles”. Some of these terms overlap but usually represent the degree of confidence in the generalizations. A hypotheses needs and initial testing,a theory has been tested but need more testing;a law or principle is a theory that has provided strong truthfulness,over and over.