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The Fallacy of Composition in Economics: Definition & Examples

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  • 0:01 Definition of Fallacy…
  • 1:37 Examples of Fallacy of…
  • 4:28 Lesson Summary
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Lesson Transcript
Instructor: Aaron Hill

Aaron has worked in the financial industry for 14 years and has Accounting & Economics degree and masters in Business Administration. He is an accredited wealth manager.

Learn what the fallacy of composition is and why this type of reasoning can lead to the wrong conclusions in a variety of economic situations. Find out how your ability to save money as compared to the country as a whole is a great example of this fallacy.

Definition of Fallacy of Composition

Have you ever been at a sporting, musical, or community event and thought to yourself, 'If we leave a few minutes early, we can beat all the traffic?' You might discover that everyone else was thinking the same thing, and it still ends up taking a long time to get out of the parking lot. You'll only manage to beat traffic when just a few people are thinking that way, but not when everyone at the event has the same idea. This phenomenon has to do with the fallacy of composition.

The fallacy of composition arises when an individual assumes something is true of the whole just because it is true of some part of the whole. For example, if you stand up at a concert, you can usually see better. You may then directly infer that if everyone stands up, everyone can see better. But you know it doesn't work that way and will lead to obscured views for the majority of attendees. Therefore, what might be true for one individual in the crowd is not true for the whole crowd.

Why does this fallacy exist, and why do we think this way sometimes? The answer is that we usually reason and draw conclusions from our own situation and individual experiences. It is easiest to examine our situation, and then reason that the same actions would have the same results for society and the economy as a whole. Although this may be true in some circumstances, it is not always. Sometimes, it may simply be reasoning that results from not having all the necessary facts and information. You may only know what you have experienced yourself. Let's look at some more concrete examples.

Examples of Fallacy of Composition

Paradox of Saving (also known as paradox of thrift) - This is a classic example of the fallacy of composition. It is the belief that if one individual can save more money by spending less, then society or an entire economy can save more money by spending less. However, this simply isn't true. The fact is that society can save more only by spending more. It seems crazy, right? But if everyone reduced spending, then the demand for products and services would decline. This decline would lead to lower growth and revenue for businesses. As a result, businesses might have to lower wages or lay off individuals. People would have less income and would save even less. What is true for an individual in the economy is not necessarily true for the whole economy.

Real Estate Market - You may have heard that the real estate market is hot in your neighborhood or city. People are selling houses within a few days of listing them on the market. Your friend told you that he is looking for a house, but every time he puts an offer down, someone else gets it first! However, what is happening in Arizona, California, or Florida may be totally different than what is happening for the rest of the U.S. real estate market. Although a specific state or city may have booming real estate sales, it doesn't mean that most of the other cities in the country are experiencing the same thing.

Unemployment Rate - Much like the real estate market, the number of people looking for jobs can vary drastically from state to state. For example, in March of 2014, you may live in Rhode Island and have a hard time finding a job because the state has an 8.7% unemployment rate. You think to yourself, 'It must be just as hard to find a job anywhere in the United States.' The fact is, though, unemployment in Nebraska was only 3.7% for the same month, and North Dakota's was only 2.6%! The national average was 6.7%, which is still better than Rhode Island. So don't assume that because unemployment is high in your area, it is high everywhere else!

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