Economic Methodology (DP IB Economics)

Positive & Normative Economics

What is positive economics?

• Positive economics is concerned with objective statements of how a market or an economy works 

• These positive economic statements are based on empirical evidence and tend to be statements of fact

• They can be proven to be true or false

• Examples of positive economic statements include

  • The unemployment rate in India has fallen from 8% to 7.3% in the past twelve months

  • Increasing the minimum wage last year in the UK resulted in improvements to wage inequality

  • Prices in the EU have risen dramatically, partly due to the 20% increase in the price of oil
     

What is normative economics?

• Normative economics focuses on value judgements

• These judgements are built around opinions and beliefs as to what the best economic policies or solutions may be

• These judgements are called normative economic statements

• Normative economic statements are often the basis for the manifestos  of political parties and the different economic agendas they put forward

• Examples of normative economic statements include

  • Every economy should aim to provide free healthcare for its citizens

  • Corporation taxes in an economy should be higher than personal income taxes

  • The best way to deal with a rise in crime is to employ more police

The Role of Positive Economics

• As a social science, Economics deals with complex and continuously changing human interactions

• For this reason it is harder to examine a relationship between two variables and always conclude it is exactly the same (as can be done in Science or Maths)

• There are a number of tools which are utilised in economic analysis to help ensure that positive (factual) statements can be made with a higher degree of reliability
   

1. The use of logic

• When analysing markets, a range of assumptions are made about the rationality of economic agents involved in the transactions
  

• In classical economic theory, the word 'rational' means that economic agents are able to consider the outcome of their choices and recognise the net benefits of each one

• Rational agents will select the choice which presents the highest benefits

  • Consumers are assumed to act rationally. They do this by maximising their utility

  • Producers are assumed to act rationally. They do this by selling goods/services in a way that maximises their profits

  • Workers are assumed to act rationally. They do this by balancing welfare at work with consideration of both pay and benefits

  • Governments are assumed to act rationally. They do this by placing the interests of the people they serve first in order to maximise their welfare

2. The use of hypotheses, models and theories

• The social sciences use a variation of the scientific method of research which is called the social scientific method

• There is an inability to make scientific experiments the results of which can be proven time and time again

  • This is due to the complexity of human nature and the significant number of social interactions that are taking place in any economy at any given point in time
     

• The steps in the social scientific method are similar to the scientific method but there is a key difference
   

The social scientific method uses empirical research to gather data

• Empirical research is collected through observations, surveys, opinion polls etc.

  • The results of the same hypothesis can vary significantly when conducted by different researchers at different time periods and between different places and cultures
     

• Refutation is the act of a statement or theory being proved to be wrong by the empirical evidence

  • Refutation helps to determine if an economic statement is positive
     

• Economic models are developed by economists once a hypothesis has been repeatedly proven or rejected in different circumstances

  • A model is a simplified version of reality

  • All models make a range of assumptions. These are often generalisations about behaviour, choices and likely outcomes

  • These assumptions are necessary so as to account for complex human behaviour and constantly changing variables

  • When evaluating different models, the underlying assumptions should always be considered

3. The ceteris paribus assumption

• Due to the large number of variables that can influence any particular economic interaction in society, economists create models using the principle of ceteris paribus

  • Translated from Latin, ceteris paribus means 'all other variables remain constant'

  • It allows economists to simplify and explain causes and effects, even if the explanation is somewhat limited by the assumptions

  • E.g. There are many factors that affect the level of unemployment in an economy (interest rates, consumer confidence, firms' investment, government policies etc.).  Using ceteris paribus, economists  can simplify the economic model to analyse just two variables (e.g. unemployment and interest rates)

Rational Decision Making

• When analysing markets, a range of assumptions are made about the rationality of economic agents involved in the transactions
  

• In classical economic theory, the word 'rational' means that economic agents are able to consider the outcome of their choices and recognise the net benefits of each one. Rational agents will select the choice which presents the highest benefits

  • Consumers are assumed to act rationally. They do this by maximising their utility

  • Producers are assumed to act rationally. They do this by selling goods/services in a way that maximises their profits

  • Workers are assumed to act rationally. They do this by balancing welfare at work with consideration of both pay and benefits

  • Governments are assumed to act rationally. They do this by placing the interests of the people they serve first in order to maximise their welfare
    

• In many ways, the assumption of rational decision making is flawed. For example, consumers are often more influenced by emotional purchasing decisions than a rational computation of net benefits

The Role of Normative Economics

• Value judgements influence governments' choices with regards to the economic policies they choose to adopt and spend money on 

  • The USA spends more money on imprisoning drug users than rehabilitating them

  • In the UK, the Government has recently increased its spending on rehabilitation

  • To say the UK approach is better would be a normative statement

  • To say that the UK government spends more per head on rehabilitation would be a positive statement
     

• Equity is concerned with economic fairness in the distribution of resources

  • Individuals and societies have different views on what is fair and this influences government policy

    • E.g. Some countries believe it is fair for all of their citizens to be able to access healthcare, irrespective of their ability to pay, whereas other countries believe that 'no pay, no access' is fair
       

• Equality is concerned with everyone being equal and having equal recognition

  • Equality is often a normative concept. When are all people equal? When do people all have equal opportunities?

  • Statistics on inequality would be considered to be positive economic statements

    • E.g. In 2018, women in the USA were paid 12% less than men in comparable jobs