More than a century ago, the French mathematician Laplace thought that, with sufficient data and time for computation, we could see the future as clearly as the present. In today’s age of uncertainty, we know this is not so; there is an inherent unpredictability in even the most precise physical sciences. The social sciences are even less precise than the physical sciences, for they involve more complex relationships and must attempt to predict human behavior. More and more today, economists must cope with the fact that uncertainty pervades economic life.
In the last 40 years, economics has been in the forefront of developing tools that explain how uncertainty affects human behavior. As a result of this work, we now understand more about chess strategies, about how to invest in the stock market, and even about the arms race.
One of the first principles to understand is that economic laws hold on average and not in every particular case. For example, economics would hold that, other things equal, lower gasoline prices raise the amount of gasoline used. A skeptic would retort, “But my cousin Jane hasn’t changed her driving habits at all.” Or, “You say that lower unemployment tends to raise inflation. What about 1983? It didn’t happen then!”
The critics have apt observations; economics is not an exact science. Rather:
Economic laws hold true only. on the average, not as exact relationships.
Figure 1-2 gives a preview of a vital statistical relationship whereby consumption (spending by households on goods like food, clothing, and housing) can be related to income. Note that the dots do not fall exactly on the line, as they might in chemistry or astronomy. This consumption-income relationship illustrates that even very accurate-looking economic laws are still only approximate, not exact.
What lies behind the consumption-income relation in Figure 1-2 is a country of 90 million households, each spending a certain amount in light of its income, wealth, tastes, and idiosyncratic elements. The consumption of individual households may be highly unpredictable in a given year, depending on whether they bought a new car or went on a long vacation or were unemployed. But individual differences largely disappear when overall behavior is examined. The law of averages states that the average behavior of groups will be much more predictable than the behavior of individuals.
Thus, even when there are enormous differences in individual behavior (such as consumption or saving or buying gasoline) we can often see great regularities of overall community behavior.