|Two Pitfalls||4. Correlation vs Causation|
|5. Fallacy of Composition|
|6. Positive vs. Normative Economics|
|8. Why Choose Linear Models (Occam's Razor)|
|9. Sample Problems|
|6. Positive vs. Normative Economics|
(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 6 septillion (6 × 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 served as President of France, and was elected in 2012 to raise the income tax. Gerard Depardieu, a film star, left France, and became a Russian citizen. Vladimir Putin offered him a Russian passport.
Russia has a flat tax rate of 13%. He would move to Turkey.)
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. two plus two should be four. ( these are guesses, positive statements.)
Normative issues are often determined by majority voting in democratic countries, and by dictators in other countries.
Positive issues are not 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 discourages many young people to buy 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.
|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.
Jeremy Bentham (1748 - 1832)
John S Mill (1806-1873) Economic Man
Homo Habilis (able man, tool-using man), about 2 mya
Homo Erectus (upright man, hunter-gatherer), about 1 mya
Homo Sapiens (wise man), about 20,000 ya. engaged in farming and domestication of animals.
Homo Economicus (Economic Man)
Benthan proposed "The greatest good for the greatest number." This should the measure of right and wrong in social context (market solution)
(maximize the number of satisfied people ⇒
Everybody is equally important! No dictators.
Bentham's rule may be suspended in emergency.
Siege of Leningrad ⇒ children and workers were deemed more important. Nonworkers received less grains. This solution is wiser than equal allocation in democracy or under communism.)
|Examples||example of assumption which economists do not
want to verify.
We assume individuals are rational (homo economicus)
i.e., (i) consumers maximize welfare, subject to income constraint,
(ii) producers chooses the output levels that maximize profits.
|8. 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,"].
In common vernacular, 'Keep it simple, stupid.' (don't try to come up with "clever" solutions. A simple soution is better than a complex one, even if it looks stupid. KISS is supposedly coined by Kelly Johnson, Lockheed Skunk Works. Eliminate redundant assumptions.)
Implication: If two models yield the same results, choose a simpler model.
Bottom line: Choose a linear model rather than a quadratic model. For instance, p = a - bx, is simpler than p = a - bx + cx2 + dx3, etc.
Car with combustion engine: 30,000 parts (A car works if all parts function properly.)
Papal infallibility is the doctrine defined at the First Vatican Council (of 1869-1870). William of Ockham was a Franciscan monk. He argued that monks should not own properties and that papacy is not infallible (because popes are human beings), and the popes should be subject to the council (e.g, Council of Nicaea) that was assembled to settle religious issues.
(translation: If two theories yield the same prediction, the simpler model is better. If they have the same prediction on the outcome, why add an extra assumption?)
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 or cubed terms).
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.
|9. 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.