“Economic theory is not a collection of dictums laid down by pompous authority figures. Mainly, it is a menagerie of thought experiments--parables, if you like--that are intended to capture the logic of economic processes in a simplified way. In the end, of course, ideas must be tested against the facts. But even to know what facts are relevant, you must play with those ideas in hypothetical settings.”
Here is the link to the article the quote is from: The Accidental Theorist. He has a brilliant example of how labor saving technology does not increase unemployment.
University of Rochester economist Steven Landsburg wrote the following in his book The Armchair Economist: Economics & Everyday Life:
“But as Aesop discovered some time ago, the details of reality can disguise essential truths that are best revealed through simple fictions. Aesop called them fables and economists call them models." (p. 34)
"Economists love fables. A fable need not be true or even realistic to have an important moral. No tortoise ever really raced against a hare, yet “Slow but steady wins the race” remains an insightful lesson.” (p. 40)
So when you see an economics professor draw PPFs on the board which show the tradeoff between houses and cars or when we draw supply and demand curves, we know that these are "simple fictions." But, by assuming, for example, that there is a society that makes only two goods and has one resource (labor, say), we can learn something important, like the The Law of Increasing Opportunity Cost.
Adam Smith used literature, too (even though his personal library contained no prose fiction). See the book Adam Smith: An Enlightened Life by Nicholas Phillipson. The book mentions that Smith thought that fiction would help develop a "science of the heart." Here is a passage from a podcast by Phillipson:
"The Theory of Moral Sentiments does not appear to be written by a shy man. It's an aggressively, as you say, authoritative, set of fascinating observations about all kinds of people. Certainly people that Smith knew. But, you'd think he'd know them pretty well, and for a shy person, it's a little bit shocking. It is. He goes far more deeply into the process of how the human personality is made, how we acquire a sense of identity, than virtually anyone else, apart from Jean-Jacques Rousseau, with whom he had lot of awkward relationship--a literal relationship--that is to say, throughout his life. He is a very, very revealing person. For a shy person, that's intriguing. One of the things that's fascinating about the Theory of Moral Sentiments in that context is to look at the examples he gives of how he responds to different sorts of social pressures, social circumstances. The examples very often seem rather dated to us. The thing I found interesting was just how much he was drawing on what, in contemporary terms, were conventional examples. In literature, in 18th century moral journalism, and so forth, examples his contemporaries and students would have recognized the moment they heard them. He takes these familiar examples that by and large people know about and then presses them harder. It's the way in which this intelligence takes ordinary experience, in the ordinary world in which we live and presses these examples further and invites us to think more and rather more clearly about the implications. To us, some of the examples are a bit obscure; some of the philosophy that a person today is not as familiar with. On the other hand, there are many examples in the book of social phenomena that are timeless. Guilt, shame, pride, the pursuit of money, dignity, integrity--these are the themes that run through the Theory of Moral Sentiments (TMS) that are timeless."