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Chapter 2

Chapter 2 Economic Theories.docx

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McGill University
Economics (Arts)
ECON 208
Mayssun El- Attar Vilalta

Chapter 2 Economic Theories, Data, and Graphs 2.1 Positive and Normative Advice  Normative Statement: A statement about what ought to be as opposed to what actually is o govt ought to try harder to reduce unemployment o making judgements about the value of the various things that the govt could do with its limited resources and about the costs and benefits of reducing unemployment o depend on value judgements and cant be evaluated solely by a recourse to facts o inclusion of a value judgement in a statement doesn’t necessarily make the statement normative  Positive Statement: A statement about what actually is (was or will be), as opposed to what ought to be o if the govt wants to reduce unemployment, reducing unemployment insurance benefits is an effective way of doing so o doesn’t rely on judgement about the value of reducing unemployment = if this is what you want to do, this is how you do it o don’t involve value judgements, statements about matters of fact and so disagreements about them are appropriately dealt with by an appeal to evidence o don’t need to be true  Distinguishing what is actually true from what we would like to be true requires distinguishing between positive and normative statements  2 tests: o Is the statement only about actual or alleged facts -> positive o Are value judgements necessary to assess the truth of the statement ->normative Disagreements Among Economists  Due to o Poor communication: don’t define their terms or point of reference clearly o Failure to acknowledge the full state of their ignorance (when evidence is far from conclusive) o Positive/normative distinction: different values for each economist  Agreement on aspects of how the economy works and what happens when govts intervene to alter its workings ( and on mostly positive rather than normative statements) 2.2 Economic Theories Theories  Constructed to explain things; theories of demand and supply, distinguished by their variables, assumptions, and predictions Variables  Variable: any well defined item, such as the price or the quantity of a commodity, that can take on various specific values  Endogenous variable: a variable that is explained within a theory. Sometimes called an induced variable or a dependent variable o Price of eggs and quantity of eggs  Exogenous Variable: a variable that is determined outside the theory. (influences the endogenous variables) Sometimes called an autonomous variable or an independent variable. o The state of weather (affects the # of eggs consumers demand or producers supply) Assumptions  Concern o Motives: assumes everyone pursues his or her self-interest when making economic decisions; assumed to strive to maximize their utility and firms are assumed to try to maximize their profits and know how to get it o Direction of causation: assume that there’s a causal link when one variable is related to another ( producers supply more eggs because price of chicken feed fell, not vice versa) o Conditions of application: to specify the conditions under which a theory is meant to hold. Firms want profit maximization assumption, but sometimes firms want to protect the environment, but profits are still a sufficiently important consideration.  All theory is an abstraction from reality. If it weren’t, it would merely duplicate the world in all its complexity and would add little to our understanding of it. Predictions  The propositions that can be deducted from it: hypothesis Models  Economic Model: a term used in several related ways: o sometimes for an abstraction designed to illustrate some point (to help us organize our thinking and gain crucial insights) but not designed to generate testable hypotheses (because lacks the detail or precision necessary) (ex: circular flow of income and expenditure and the PPB) o sometimes as a synonym for theory, or to refer to a specific quantitative version of a theory-> more precise predictions 2.3 Testing Theories  theory tested by confronting its predictions with evidence  a theory ceases to be useful when it cannot predict better than an alternative theory, and when it consistently fails to predict better than an available alternative, it’s modified/replaced  The scientific approach is central to the study of economics: Empirical observation leads to the construction of theories, theories generate specific predictions, and the predictions are tested by more detailed empirical observation  P.30 figure - Theory and observation are in continuous interaction: assumptions of a theory and the definitions of relevant terms lead theorists to deduce by logical analysis everything that is implied by the assumptions, which are the predictions or the hypotheses of the theory, which is tested by confronting its predictions with evidence. If the theory is in conflict with facts, its amended to make it consistent with those facts, improving the theory, or will be replaced by a superior theory. And process restarts Rejection Vs. Confirmation  Important to create a theory that will explain some observation X that will typically generate a prediction about some other observable variables, Y and Z, which can be tested and may be rejected by the data, in which case the value of the theory is brought into question  Alternative: create a theory and then look for confirming evidence. The problem here is tho that some confirming evidence can be found for any theory even though systematic, objective evidence is failed to be discovered Statistical Analysis  Used to test predictions (like if X increases, Y increases; or, if X falls, Z rises) and to estimate the numerical values of the function that describes the relationship  Economists must use uncontrolled “experiments” in the everyday marketplace  Mass of data from: households deciding what to purchase given changing prices and incomes, firms deciding what to produce and how, govts involved thru taxes, subsidies, and regulations  Variables economists interested in (le
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