|6. Positive vs. Normative Statements|
(vs. = versus)
different opinions about what is (measurable,
It is common knowledge that economists often disagree. These differences result from different assumptions or hypotheses about how things are or from different views about how things ought to be.
• Positive statements deal with assumptions about
the state of the world and some conclusions.
Example 1: The weight of the earth is 1 septillion (1024)
Normative statements contain a value judgment.
They contain words such as " have to," "ought to," "must," "should" or nonquantifiable adjectives such as "important," that cannot be objectively measured. Accordingly, normative statements cannot be verified by scientific methods.
Example: At present, unemployment is a more serious problem than inflation.
The tax rate on the top earners (more than 1 million euros) should be 75% (Francois Hollande was elected in 2012 to raise the tax. Gerard Depardieu, a film star, would move to Russia.)
• Verifying the validity of a positive statement
is often difficult in practice.
Oviously, some statements are a mixture of positive and normative statements.
Exception: "should" or "must" as a guess is not normative.
example: This should be a recession-proof business. (this is a guess.)
Normative issues are often determined by majority voting in democratic countries, and by dictators in other countries.
Positive issues cannot be determined by majority voting.
|some are mixed sentences||
"Since the price of oil is likely to rise in the future, we should develop more nuclear energy."
(positive part + normative part)
1. A cut in wages will reduce the number of people who are willing to work.
2. High interest rates prohibit many young people from buying their first home.
3. The government should reduce the number of minority members in the military and increase the number of whites.
4. The government ought to supply a medical insurance scheme for everyone free of charge.
5. The government ought to behave in such a way as to ensure that resources are used efficiently.
6. Hong Kong government should increase its budget allocation to reduce the number of illegal immigrants from China.
|The verifying process often requires some judgment as regards to the specific method to be adopted to verify a claim.|
To verify the law of demand (demand curve is negatively sloped), one has to observe the consumption pattern over a period.
Costs increase as the length of the observation period increases.
How long should one observe the consumer? (normative)
How large the sample should be to confirm the result?
(normative) 1%? 10%? 100?
To verify a positive statement, one has to be content
with a small sample. Biased opinions are based on small samples.
Those who keep making the same mistake believe that their samples are too small. The same move may eventually produce a different result.
|7. Axioms: Unwritten Assumptions of Economic Models|
|Axioms||Verifying the validity of a positive statement is not simple.
It actually involves making some assumptions about the state of the world.
So economists lump all these things that they do not want to verify into a set of assumptions, and start from there. These assumptions are accepted as self-evident truth.
|Two Examples||example of assumption which economists do not
want to verify.
A. We assume individuals are rational.
Real world problems are much more complicated than those we study in this course. For instance, there are many irrational people out there. Or most of the rational people are sometimes irrational. A certain behavior may appear to be irrational, but it may be rational in a broader framework. That is, there may be a good reason for an apparently irrational behavior.
(i) It is difficult to predict the behavior of irrational individuals.
(ii) The fraction of irrational individuals is small and their decisions do not alter the overall pattern of consumer behavior.
|B. We assume that economic decisions are solely based on
In reality, economic decisions are partly affected by noneconomic factors. (Similarly, some noneconomic decisions may be partly influenced by economic factors).
Economics does not explain everything.
|8. SHORT RUN AND LONG RUN ANALYSIS|
|Decision variables||N decision variables (X,Y,Z,...) or (X1, X2, ..., Xn)|
does not refer to a fixed time interval (e.g., six months)
Short Run is a time period in which consumers and producers did not have enough to make all adjustments to a change in a parameter (e.g., price change).
At least one variable is allowed to adjust to a new situation.
|Long Run||LR is a time period in which consumers and producers made all adjustments to a change in a parameter.|
|How short is a short run and how long is a long run?||There is no right answer that applies to all cases. It depends on the problem in question.|
|Example||Consider a sudden increase in the oil price by OPEC.
The immediate impact: a sudden increase in the prices of refined oil and other products that use oil.
After a while, consumers
switch to fuel-efficient automobiles and appliances.
How short is a short run and how long is a long run? This is a difficult question to answer. It depends on the problem in question.
In the case of oil price increase by OPEC in 1973, Milton Friedman predicted a decline in oil prices shortly thereafter. However, oil prices rose continuously through the 1970s, and began to decline only in 1980. GM and Chrysler Corporations thought that the oil price increase was temporary and resisted a move to manufacture fuel-efficient cars. As a result, American auto manufacturers lost a sizeable market shares to the Japanese manufacturers.
|9: Why choose Linear Models|
(Because of simplicity. Other things equal, use simpler models)
Occam's Razor: Plurality must not be assumed without necessity ["Pluralitas non est ponenda sine neccesitate"]. This saying is attributed to a 14th century logician and Franciscan friar William of Ockham.
(translation: If two theories yield the same prediction, the simpler one is better.)
For instance, in the absence of convincing reasons, linear models should be used instead of nonlinear models (because nonlinear models require more variable (e.g., squared variables).
Typical demand functions are written as Q = Q(p,I,t).
p = price, I = income, t = other variable.
In many empirical models, linear functions are often used. For example,
Q = a - bp.
This means bp = Q- a, or p = (Q-a)/b.
In reality, no demand curves are linear. However, in the interests of simplicity, demand curves and many other functions are often linearized. Also, when nonlinearity is suspected, linearity can be tested empirically.
|10. True or False|
1. Determining whether an economic theory or hypothesis is acceptable is more difficult than in the physical sciences because, unlike a chemist or physicist, we cannot control all other variables that may influence human behavior.
2. Microeconomics deals with the analysis of the behavior of small individual firms, whereas macroeconomics deals with large global firms.
3. A positive statement must be both testable and true.
4. A normative statement is not testable.
5. The majority of disagreements in our society on economic matters stem from normative issues.
6. An economic theory/hypothesis is a normative statement.
|11. Partial and General Equilibrium Analyses|
Partial equilibrium analysis uses the ceteris paribus assumption. This is a Latin phrase which means "other things being equal." In practice, other things are never "equal" or remain the same. However, if the changes in the other things are small, the ceteris paribus is a reasonable approximation.
Which is right?
It depends on the purpose.
Partial equilibrium analyses are used in two situations:
1. When we are interested the effect of an event on one industry only. An example is a labor strike which occurs only in one industry with a negligible impact on other industries.
Partial equilibrium analysis was popularized by the English economist, Alfred Marshall. (1842-1924) Most of the time, we use this approach. This approach permits graphical analyses.
General Equilibrium analysis is concerned with the effects of a change (in policy variable or exogenous conditions) after all sectors have made adjustment to the new situation.
For instance, the import quota on automobiles will have impacts on gasoline, steel, aluminum, glass, platinum, and other industries, and these in turn will have further impacts on the auto industry.
8. Are the following statements normative or positive, or do they contain both normative and positive statements?
|Both normative and positive statements.|
|b. The study of physics is more valuable than that of sociology, but both should be studied by all college students.||Normative statements.|
|c. An increase in the price of corn will decrease the amount of corn purchased. However, it will increase the amount of wheat purchased.||Positive statements.
|d. A decrease in the price of butter will increase the amount of butter purchased, but that would be bad because it would increase Americans’ cholesterol levels.||Both normative and positive statements.|
e. The birth rate is reduced as economies urbanize,
but it also leads to a decreased average age of developing countries’
9. In the debate about clean air standards we have often heard the statement, " A nation as rich as the United States should have no pollution ," or "To minimize air pollution, the US should produce no oil."
Why is this a normative statement? Would it help
you make a decision on national air quality standards? Describe two positive
statements that might be useful in determining the air quality standards.
Answer: This is a normative statement because it is a matter of opinion.
Examples of positive statements:
"imposing zero pollution standards will significantly reduce the industrial output of the U.S. economy” or
“zero pollution standards will improve health of Americans and will (or will not significantly) contribute to a reduction in health care costs in America.” (This may not be true, but its validity can be verified.)
Western Method: First, choose MBAs/Drs from top business schools.
Then recycle them among the business firms.
Problem: The rich and well-educated do not understand the middle class. The current economic mess may have been the result of the inability of policy makers that have ignored or forgotten the middle class.
Paul Volcker: 1979-1987 (during the Great Inflation era, 1980-1984,
Carter era). Harvard MA.
Alan Greenspan: 1987-2006, Fed Chairman, dropped out of Columbia Univ. Eventually received a PhD from NYU in 1977.
Ben Bernanke, 2006-2009, Harvard BA, MIT PhD, 1979.
Janet Yellen, 2010-2017, Yale.
Japan: Choose CEOs internally. They understand every aspect
of a firm’s operation, and set wages fairly.