This exercise will show you how different theories (models) can lead to very different courses of action. Suppose we ask the following question: Does income inequality promote economic growth and society's overall prosperity? Suppose two economists come up with the following theories (models):
Economist A believes that wealth accumulation in just a few hands increases savings because consumption is necessarily limited. Higher savings, in turn, allow investing in new production facilities that increase the country's overall income and everybody is better off. So, Economist A advocates a non-equalitarian society.
Economist B thinks that a very unequal distribution of wealth will increase capacities of production beyond the purchasing power of an essentially poor mass of consumers. For a while, consumers will increase their consumption, and prosperity, by borrowing from the rich, but eventually they will not be able to repay their debts and the economy will collapse for lack of demand. At that point, investing in new production facilities becomes unnecessary. In conclusion, Economist B thinks that extreme income inequality is counterproductive.
a. What are the policy implications of the two theories? (In other words, does it matter which theory is correct?)
b. How would a scientist determine which theory is correct?
c. Under what conditions would each of the two models be correct? Could one use both models under different circumstances?

Question

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The Answer of This exercise will show you how different theories (models) can lead to very different courses of action. Suppose we ask the following question: Does income inequality promote economic growth and society's overall prosperity? Suppose two economists come up with the following theories (models):
Economist A believes that wealth accumulation in just a few hands increases savings because consumption is necessarily limited. Higher savings, in turn, allow investing in new production facilities that increase the country's overall income and everybody is better off. So, Economist A advocates a non-equalitarian society.
Economist B thinks that a very unequal distribution of wealth will increase capacities of production beyond the purchasing power of an essentially poor mass of consumers. For a while, consumers will increase their consumption, and prosperity, by borrowing from the rich, but eventually they will not be able to repay their debts and the economy will collapse for lack of demand. At that point, investing in new production facilities becomes unnecessary. In conclusion, Economist B thinks that extreme income inequality is counterproductive.
a. What are the policy implications of the two theories? (In other words, does it matter which theory is correct?)
b. How would a scientist determine which theory is correct?
c. Under what conditions would each of the two models be correct? Could one use both models under different circumstances?

This Exercise Will Show You How Different Theories (Models) Can