An economic theory derives laws or generalizations through two methods:

(1) Deductive Method and

(2) Inductive Method.

Deductive Method of Economic Analysis

It is also named as analytical or abstract method. It consists in deriving conclusions from general truths; it takes few general principles and applies them to draw conclusions. The classical and neo-classical school of economists notably, Ricardo, Senior, J S Mill, Malthus, Marshall, Pigou, applied the deductive method in their economic investigations.

Steps of Deductive Method

Step 1: The analyst must have a clear and precise idea of the problem to be inquired into.

Step 2: The analyst clearly defines the technical terms used in the analysis. Further, assumptions of the theory are to be precise.

Step 3: Deduce hypothesis from the assumptions taken.

Step 4: Hypotheses should be verified through direct observation of events in the real world and through statistical methods. (eg) There exists an inverse relationship between price and quantity demanded of a good.

Inductive Method of Economic Analysis

Inductive method, also called empirical method, is adopted by the “Historical School of Economists”. It involves the process of reasoning from particular facts to general principle.

Economic generalizations are derived in this method, on the basis of

1.       Experimentations;
2.       Observations; and,
3.       Statistical methods.

Step 1: Data are collected about a certain economic phenomenon. These are systematically arranged and the general conclusions are drawn from them.

Step 2: By observing the data, conclusions are easily drawn.

Step 3: Generalization of the data and then Hypothesis Formulation

Step 4: Verification of the hypothesis (eg.Engel’s law).

Nature of Economic Laws

A Law expresses a causal relation between two or more than two phenomena. Marshall states that the Economic laws are statement of tendencies, and those social laws, which relate to those branches of conduct in which the strength of the motives chiefly concerned can be measured by money price.

In natural sciences, a definite result is expected to follow from a particular cause. In Economic science, the laws function with cause and effect. The consequences predicted by the data, necessarily and invariably follow.

However, Economic laws are not as precise and certain as the laws in the physical sciences. Marshall holds the opinion that there are no laws of economics which can be compared for precision with the law of gravitation.