How to Challenge Assumptions for Top Grades

This "Challenging Assumptions" video highlights critical instances where common economic theories rely on simplified assumptions that may not hold true in real-world scenarios

Key Challenged Assumptions in Economics:

1. Rational Behaviour:
   • Assumption: Consumers act rationally to maximize utility.
   • Challenge: Behavioural economics demonstrates that biases like anchoring, framing, and loss aversion often lead to irrational consumer choices (e.g., overspending on premium brands for status).
2. Ceteris Paribus (All Else Being Equal):
   • Assumption: Economic models isolate variables assuming all other factors remain constant.
   • Challenge: In reality, dynamic interactions between variables (e.g., inflation, consumer confidence) can offset expected outcomes, such as the impact of tax cuts.
3. The Law of Diminishing Marginal Returns:
   • Assumption: Returns diminish after a certain level of input usage.
   • Challenge: Industries with technological advancements or learning effects (e.g., software development) may experience increasing returns.
4. Financial Market Efficiency:
   • Assumption: Markets are perfectly efficient, with prices reflecting all information.
   • Challenge: Market anomalies (e.g., bubbles, crashes) and behavioral finance reveal that emotions and speculation often drive markets, causing inefficiencies.
5. Global Trade Benefits All Parties:
   • Assumption: Free trade is mutually beneficial based on theories like Comparative Advantage.
   • Challenge: Benefits are unevenly distributed, with structural disadvantages for developing countries and potential exacerbation of income inequalities.
6. Higher Minimum Wage Necessarily Causes Unemployment:
   • Assumption: Higher wages lead to job losses as firms reduce hiring.
   • Challenge: Empirical studies (e.g., Card and Krueger) suggest modest wage increases can enhance productivity, reduce turnover, and boost consumer spending without significant job losses.
7. Developing Economies Benefit from Foreign Direct Investment (FDI):
   • Assumption: FDI unequivocally promotes growth.
   • Challenge: FDI can lead to profit repatriation, crowding out local firms, and dependency, with limited long-term developmental impact.
8. Immigration Reduces Real Wages for Native Workers:
   • Assumption: Increased labor supply from immigration depresses domestic wages.
   • Challenge: Immigrants often complement native labor, filling roles that enhance overall productivity and potentially raising wages across the economy.