Most people bring a bundle of biases and preconceptions when thinking about economic issues. For example, you might think that corporate profits are excessive or that lending money is always superior to borrowing money. Perhaps you believe that government is necessarily less efficient than businesses or that more government regulation is always better than less.
Fallacy of Composition
Another pitfall in economic thinking is the assumption that what is true for one individual or part of a whole is necessarily true for a group of individuals or the whole. This is a logical fallacy called the fallacy of composition; the assumption is not correct. A statement that is valid for an individual or part is not necessarily valid for the larger group or whole.
Example1:You are at a football game and the home team makes an outstanding play. In the excitement, you leap to your feet to get a better view. A valid statement: “If you, an individual, stand, your view of the game is improved.” But is this also true for the group—for everyone watching the play? Not necessarily. If everyone stands to watch the play, nobody— including you—will probably have a better view than when all remain seated.
Example2(economic):An individual farmer who reaps a particularly large crop is likely to realize a sharp gain in income. But this statement cannot be generalized to farmers as a group . The individual farmer’s large or “bumper” crop will not noticeably influence (reduce) crop prices because each farmer produces a negligible fraction of the total farm output. But for all farmers as a group, prices decline when total output increases. Thus, if all farmers reap bumper crops, the total output of farm products will rise, depressing crop prices. If the price declines are relatively large, total farm income might actually fall.
Two important causation fallacies often interfere with economic thinking.
POST HOC FALLACY
You must think very carefully before concluding that because event A precedes event B, A is the cause of B. This kind of faulty reasoning is known as the post hoc, ergo propter hoc or “after this, therefore because of this” fallacy.
Example: Suppose that early each spring the medicine man of a tribe performs a special dance. A week or so later the trees and grass turn green. Can we safely conclude that event A, the medicine man’s dance, has caused event B, the landscape’s turning green? Obviously not. The rooster crows before dawn, but that does not mean the rooster is responsible for the sunrise!
A professional football team hires a new coach and the team’s record improves. Is the new coach the cause? Maybe. But perhaps the presence of more experienced and talented players or an easier schedule is the true cause.
CORRELATION VERSUS CAUSATION
Do not confuse correlation, or connection, with causation. Correlation between two events or two sets of data indicates only that they are associated in some systematic and dependable way. For example, we may find that when variable X increases, Y also increases. But this correlation does not necessarily mean that there is causation—that an increase in X is the cause of an increase in Y. The relationship could be purely coincidental or dependent on some other factor, Z, not included in the analysis.
Here is an example: Economists have found a positive correlation between education and income. In general, people with more education earn higher incomes than those with less education. Common sense suggests education is the cause and higher incomes are the effect; more education implies a more knowledgeable and productive worker, and such workers receive larger salaries.