Microeconomics: Economic Theories, Data, and Graphs

Chapter 2: Economic Theories, Data, and Graphs

2.1 Positive and Normative Statements

  • Normative Statements:

    • Depend on value judgments.

    • Cannot be evaluated solely by reference to facts.

    • Concerned with what ought to be.

  • Positive Statements:

    • Do not involve value judgments.

    • Are statements about matters of fact.

    • Concerned with what is, was, or will be.

  • Disagreements Among Economists:

    • Often stem from the positive/normative distinction in public discussions.

    • A responsible economist clearly delineates which part of their advice is normative and which is positive.

  • Applying Economic Concepts: Where Economists Work

    • Economists' skills are highly demanded across various sectors:

      • Governments

      • Private businesses

      • Crown corporations

      • Non-profit organizations

      • Post-secondary schools

    • They analyze and evaluate government policies, examine risks to economic growth, and conduct other economic research.

2.2 Building and Testing Economic Theories

  • What Are Theories?

    • Abstractions from reality, providing simplified frameworks to understand complex phenomena.

    • Consist of three main components:

      • Variables: Characteristics that can take on various specific values.

        • Endogenous (Dependent) Variables: Explained within the theory.

        • Exogenous (Independent) Variables: Determined outside the theory.

      • Assumptions: Statements about the conditions under which the theory applies or about the behavior of agents.

      • Predictions: Hypotheses derived from the theory about what will happen under specific conditions.

  • Testing Theories:

    • A theory is tested by confronting its predictions with empirical evidence (facts).

    • The outcome of testing determines the theory's fate:

      • If a theory conflicts with facts, it will be either amended to reconcile with the new facts or discarded and replaced by a superior theory.

      • The scientific approach to knowledge, involving observation, hypothesis formation, testing, and refinement, is central to economic study.

  • The Interaction Between Theory and Empirical Observation (Figure 2-1):

    • The process begins with definitions and assumptions about behavior.

    • Logical deduction leads to predictions (hypotheses).

    • Empirical observation and testing of the theory occur.

    • Conclusion: The theory either does or does not provide a better explanation of the facts than alternative competing theories.

      • If the theory passes the test: No immediate action, but continued scrutiny is necessary.

      • If the theory conflicts with the evidence:

        • The existing theory is modified in light of newly acquired empirical knowledge, OR

        • The theory is discarded in favour of a superior competing theory.

  • Statistical Analysis:

    • Used to test hypotheses, such as