2.1 Positive and Normative Advice
Normative Statement: a statement about what ought to be as opposed to
what actually is. (depend on value judgements and cannot be evaluated
solely by a recourse to facts)
Positive Statement: a statement about what actually is (was or will be), as
opposed to what ought to be.
Distinguishing what is actually true from what we would like to be true
requires distinguishing between positive and normative statements.
Economists must state clearly what part of the proffered advice is normative
and what part is positive in public debates.
2.2 Economic Theories
Economists develop theories to explain economic events (i.e. many eggs sold
and the price they are sold for on a given day in Manitoba).
Theories are distinguished by their:
Variable: any well-defined item, such as price or quantity of a
commodity, that can take on various specific values.
Endogenous Variable: a variable that is explained within a
theory (i.e. price of eggs and quantity of eggs). Sometimes
called induced/dependent variable.
Exogenous Variable: a variable that is determined outside the
theory (i.e. the state of the weather). Sometimes called
o This book makes the fundamental assumption
that everyone pursues his or her own self-
interest when making economic decisions. (i.e.
consumer wants to maximize utility)
Direction of Causation
o When economists assume two variables are
related, they are usually assuming some causal
link between the two. (i.e. chicken feed price
lowers = greater supply of eggs)
Conditions of Application
o Assumptions are often used to specify the
conditions under which a theory is meant to hold
(i.e. government absence, not literal, but when a
lack of government input is present in a
situation). 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.
A theory’s predictions are the propositions that can be
deduced from it (hypotheses).
Economic Model: used in two ways by economists, sometimes for an
abstraction designed to illustrate some point but not designed to generate
testable hypotheses, and sometimes as a synonym for theory.
Model: sometimes used by economists to refer to a specific quantitative
version of a theory. (i.e. -10% in chicken feed cost = +8% in egg supply)
2.3 Testing Theories
A theory is tested by confronting its predictions with evidence.
The scientific approach is central to the study of economics: Empirical
observation leads to t