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Chapter 2

Chapter 2 - Economic Theories, Data, and Graphs.docx

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ECON 101
Robert Gateman

2.1 Positive and Normative Advice 09-29-2012  Normative statements – what ought to be, value judgments  Positive statement – what actually is, was or will be; matters of fact; disagreements are dealt with evidence o Does not need to be true  Distinguishing what is actually true from what we would like to be true requires distinguishing between positive and normative statements. Disagreements Among Economists  Poor communication  Failure to acknowledge the full state of their ignorance  Different economists have different values, and these normative views play a large part in most discussions of public policy 2.2 Economic Theories 09-29-2012  Economists understand the world through theories and models Theories  Constructed to explain things  Ex. Theories of demand and supply  Distinguished by their variables, assumptions, and predictions  Variables o Well defined item o Endogenous variable – explained/determined within a theory, dependent variable o Exogenous variable – independent/manipulated variable  Assumptions o Motives  Everyone pursues his or her own self interest when making decisions to maximize their utility o Direction of Causation  Causal link between two variables  Cause and effect, one causes/affects the other o Conditions of Application  Specify the conditions under which a theory is meant to hold  Predictions – propositions that can be deduced from the theory (aka hypothesis)  All theory is an abstraction from reality. If it were not, it would merely duplicate the world in all its complexity and would add little to our understanding of it. Models  Economic model o Abstraction designed to illustrate some point, organize our thinking and gain crucial insights o Not designed to generate testable hypotheses, lacks detail o May also mean theory 2.3 Testing Theories 09-29-2012  A theory ceases to be useful when it cannot predict better than an alternative theory.  Empirical evidence may suggest inadequacies that require development of better theories  Inspired guess may lead to a theory  Interaction between theory and empirical observation o Definitions and assumptions about behavior  Logical deduction  Predictions/hypothesis  Empirical observation/testing theory o Conclusion: does or does not provide a better explanation that existing theories  If insufficient, theory discarded or modified then goes through the process again  The scientific approach is central to the study of economics: empirical observation leads to the construction of theories, theories generate predictions, and the predictions are tested by more detailed empirical observation. Rejection vs. Confirmation  Key part of scientific approach: a theory that will explain an observation  Alternative to rejection of theory: create a theory then look for supporting evidence Statistical Analysis  Used to test such predictions and to estimate the numerical values of the function that describes the relationship  Test whether a (causal) relationship exists or not  If it doesn’t exist, provide an estimate of the magnitude of that relationship Correlation vs. Causation  Causal relationship – a change in X is predicted to cause a change in Y  Correlation – if X and Y consistently move together in
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