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Online Lecture 2 - The Scientific Method, The PPF, Normative and Positive Economics

Economists seek to understand economic behavior through developing theories and models to explain observations and make predictions. They observe complex behaviors and generalize using hypotheses tested with the scientific method. Models like production possibility frontiers are used to illustrate concepts like scarcity, choice, and opportunity cost. Economists provide both positive analysis that describes economic systems and normative recommendations involving value judgments.

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32 views

Online Lecture 2 - The Scientific Method, The PPF, Normative and Positive Economics

Economists seek to understand economic behavior through developing theories and models to explain observations and make predictions. They observe complex behaviors and generalize using hypotheses tested with the scientific method. Models like production possibility frontiers are used to illustrate concepts like scarcity, choice, and opportunity cost. Economists provide both positive analysis that describes economic systems and normative recommendations involving value judgments.

Uploaded by

wmanjonjo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPSX, PDF, TXT or read online on Scribd
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HOW DO ECONOMIST WORK?

• Economics is a social science

• we explore what it means to be ‘scientific’ in


terms of economics
Methodology of economists
• Economist seek to understand the world
by developing theories (economic
principles) and models that explain some
of the things that have been seen and to
predict some of the things that will be
seen.
• Economists observe complex economic
behaviour and generalize.
• Economic theories: - these are broad
generalizations about complex economic
behaviour (hypotheses)
• E.g. there is negative relationship
between price and the quantity
demanded, ceteris paribus.
Scientific method
 Observe a phenomenon

 Make simplifying assumptions and


formulate a hypothesis

 Generate predictions and

 Test the hypothesis


What are these assumptions?
• Holding all other things held constant
(ceteris paribus)
• This helps to simplify reality and focus on
the relationships that interest us.
• Usually study at least two variables of
interest. e.g. money supply and interest
rates, income and quantity demanded of
a product.
Common fallacies (pitfalls) in economic reasoning

• The post hoc fallacy


- it is quite tempting to look at two events that
happen in sequence and assume that the first
caused the second to happen. This is not always
the case. Like after this therefore because of
this.” Committed when it is assumed that
because one thing occurred after another, it
must have occurred as a result of it.
• The fallacy of composition
- erroneous belief that what is true for a part is
necessarily true for the whole.
- theories that seem to work well when applied
to individuals, often break down when they are
applied to the whole. Often leads to incorrect
conclusions
• Failure to hold all other things constant (ceteris
paribus)
Using economic models
• Introduce simple diagrams: the visual style
makes it easier to demonstrate economic
principles.
• Models – an abstraction designed to illustrate
some point but not designed to generate
testable hypotheses.
• Models can be described with – words; math or
pictures (graphs)
• Graphs – plot economic variables: bars,
histograms, line, pie chats, e.t.c.
• Statistical analysis – mathematical manipulation
of economic data
Production possibility frontier (PPF)
• Model of scarcity, choice and opportunity
cost
• Choice between 2 goods
• PPF shows maximum combination of 2
goods given current resources.
• A “production possibility frontier [is] a
graph that shows the various combinations
of output that the economy can possibly
produce given the available factors of
production and the available technology”.
It assumes that all resources are used
efficiently.
We need to ask and answer the following questions.
• How can we use a diagram to illustrate the concept of
an economic problem?
• What does the model of a PPF enable us to predict
about the notions of scarcity, choice and opportunity
cost?
• Assumptions necessary to represent production possibilities in
a simple production possibilities curve model:
1. efficiency
2. fixed resources
3. fixed technology
4. two products
Production Possibility Frontier

Two goods produced here


are shoes and bread.
Shoes
A What does point A tell us?
What does point E tell us?
S1 C What about points C and D?

D
S2

E
O
B1 B2 Bread
Production Possibility Frontier

Point A – all available resources


are being used to produce shoes
Point E– all available resources
shoes are being used to produce bread
A Points C and D- resources allocated
between each product in different
S1 C combinations

D
S2

E
O
B1 B2 bread
Production Possibility Frontier

How does this model help


shoes us understand the concepts
A
of choice and opportunity cost?
The economy must choose
S1 C Between points along the PPF.

D
S2

E
O
B1 B2 bread
Production Possibility Frontier

Assume we are initially at point C


Shoes What is the opportunity cost of
A
choosing to move to point D?
S1 C

D
S2

E
O
B1 B2 Bread
Production Possibility Frontier

Assume we are initially at point C


shoes What is the opportunity cost of
A
choosing to move to point D?
To gain B2 minus B1 of bread,
S1 C we give up
S1 minus S2 of shoes
Loss of
Shoes

D
S2
Gain of
Bread
E
O
B1 B2 Bread
Production Possibility Frontier

Shoes Add a point to the diagram to


A indicate scarcity.
Any point outside the PPF
S1 C represents an unattainable
Combination – due to scarce
resources

D
S2

E
O
B1 B2 Bread
Production Possibility Frontier

Shoes Add a point to the diagram to


A indicate an inefficient use of
resources.
S1 C

D
S2

E
O
B1 B2 Bread
Production Possibility Frontier

Shoes Add a point to the diagram to


A indicate an inefficient use of
resources.
S1 C Any point inside the PPF
represents an inefficient use
of resources.
Point F- inefficient use of resources
F

D
S2

E
O
B1 S2 Bread
Production Possibility Frontier

Shoes What shocks to the model


A would cause the PPF to
shift
• Inwards
S1 C
• Outwards?

D
S2

E
O
B1 B2 Bread
• Inefficiency, unemployment and
underemployment are illustrated by a point
inside the production possibilities curve.
• Economic Growth can also be illustrated with
a production possibilities curve. An outward
shift to the right of the curve.
can happen if
– if there are more resources or better technology.
– Growth will change the potential output of the
economy, hence the shift of the entire curve.
Summary
 Scarcity – unattainability of combinations
 Choice – selection of attainable combinations
 Opportunity Cost – downward sloping
 Concavity – reveals increasing opportunity costs. The economic
rationale for increasing oc is that economic resources are not
completely adaptable to alternative uses.
Economic Analysis: Positive and Normative Advice
• Economist give two broad types of advice:
a) normative.
b) positive
• positive economics
• normative economics
Positive economics
• attempt to describe how the economy functions
• Deals with facts and avoids value judgements.
• It attempts to set forth scientific statements about economic behaviour.
• Positive statement – is a statement about what actually is as opposed to
what ought to be and how it works.
• Resolved by analysis and empirical evidence -relies on testable
hypotheses
Normative economics
• It involves value judgements about what the
economy should be like – eg to evaluate or
recommend alternative policies
• No right or wrong answers because they involve
ethics and values rather than facts.
• Normative statement – a statement about what
ought to be done as opposed to what actually is
• Resolved through political debate and decisions,
and not by economic analysis alone
Example
• Suppose want to advice government about
resource idleness
• Government ought to try harder to reduce
UE. This is normative advice- making a
judgements about the value of various things
that the government could do with its limited
resources and about the costs and benefit of
reducing UE.
• If government want to reduce UE, reducing
UE insurance benefits is an effective way of
doing so. This is positive advice – no value
judgements but giving ;exact’ way of doing it.

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