What is the best way to test an economic theory?

Answer 1

The best way (as with any theory) is to find empirical proof, which is easier said than done. Ideally, if you are able to express your theory in an equation, you can try to find data to support the theory. An example might illustrate this:

Suppose you come up with a theory that lower corporate tax rates will increase GDP growth, your structural equation looks like this:

GDP growth= beta * tax

You expect that beta (the effect of taxes on GDP growth) is negative, since higher taxes lower GDP growth. You could now test this by gathering data across the world for various countries, their corporate tax rates and their GDP growth and see if beta is indeed negative (granted there are a couple of potential problems with this approach...)

Hope this helps.