Common pitfalls in economic analysis

There are two " pitfalls" that should be avoided when conducting economic analysis: the fallacy of composition and the false-cause fallacy. The fallacy of composition is the belief that if one individual or firm

benefits from some action, all individuals or all firms will benefit from the same action. While this may in fact be the case, it is not necessarily so. Suppose an hairdresser's decides to lower the prices it charges on all its services. It believes the lower prices will attract customers away from other hairdressers'. If, however, the other hairdressers' follow suit and lower their prices by the same amount, then it is not necessarily true that all hairdressers' will be better off; while more people may choose to cut their hair, each hairdresser's will receive less money per client, and each hairdresser's market share is unlikely to change. Hence the profits of all hairdressers' could fall.

The false-cause fallacy often arises in economic analysis of two correlated actions or events. When one observes that two actions or events seem to be correlated, it is often tempting to conclude that one event has caused the other. But by doing so, one may be committing the false-cause fallacy, which is the simple fact that correlation does not imply causation. For example, suppose that new tape-recorder prices have steadily increased over some period of time and the new tape-recorder sales have also increased over this same period. One might then conclude that an increase in the price of new tape-recorders causes an increase in their sales. This false conclusion is an example of the false-cause fallacy; the positive correlation between the two events does not imply that there is any causation between them. In order to explain why both events are taking place simultaneously, one may have to look at other factors — for example, rising consumer incomes, inflation, or rising producer costs.

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