Suppose an economist believes that the price level in the economy is directly related to the money supply, or the amount of money circulating in the economy. The economist proposes the following relationship: P=A×M • P=Price Level • M=Money Supply • A=A composite of other factors, including real GDP, that change very slowly over time. How might an economist gather empirical data to test the proposed relationship between money and the price level?
A. Unlike researchers in the hard sciences, economists cannot study complex relationships using data.
B. An economist would look for data on past changes in the money supply, and note the resulting changes in the price level
C. An economist would persuade the Federal Reserve to change the money supply to various levels, and observe the resulting changes in the price level.
D. Economists do not usually develop theoretical models of the economy but only analyze summary statistics about the current state of the economy.
Answer: B. An economist would look for data on past changes in the money supply, and note the resulting changes in the price level
Explanation: Much like researchers in other sciences, such as physics and biology, economists develop theories and models to describe the world based on observed phenomena. Methods of testing such theories, however, differ greatly based on the applicability and feasibility of controlled lab experiments.
Unlike physicists and biologists, economists typically cannot run controlled laboratory experiments to generate data to test their models and theories. This is especially true of models describing the macro economy, such as those relating to the price level, the inflation rate, and the unemployment rate. If an economist wanted to test the above model relating the price level to the money supply, it is unlikely the Federal Reserve would allow the economist to vary the money supply (and potentially drastically affect the economy) simply to test an economic theory. Rather, an economist would likely have to look at available data on previous changes in the money supply and how the price level changed in response.
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