Question

Find an example of an economic observation that can be plausibly explained in multiple ways. Outline each potential explanation. Explain why it matters which explanation is correct

Answer 1

An economic explanation can be an increase in the GDP of the country. Now, it can happen due to many reasons like:

(1) Increase in the government expenditure, for instance before the elections or increased spending on military

(2) Increase in the demand by the consumers due to an increase in the purchasing power and thus a higher consumption expenditure

(3) Increase in the investments made by firms due to improved business conditions and an optimistic future outlook of profits for the firm.

(4) Increased exports from the country due to a depreciation of the home currency

Now, it is important to understand which factor has led to an increase in GDP to understand the true causality and inform policy decisions. For instance, if it is due to (1), there may be only a cyclical increase and GDP will slow down in the future if not policy action is taken. On the other hand, factord like (2) and (3) are more robust channles that will affect long term growth rates and thus we can be reasonaly confident that GDP will be high for a considerable futur =e and make policy decisions accordingly.