TOOLS OF ECONOMIC ANALYSIS

There are two popular approaches to the study of Economics; namely Microeconomics and
Macroeconomics. However, these tools of economic analysis can be divided into three broad
categories:

i. Descriptive
ii. Graphical, and
iii. Use of quantitative models.

The logical description of the economic phenomenon is perhaps the longest and most widely
used technique students are more comfortable with this approach. As such those tools are
considered under the following sub-headings:

(a) Variables:
A variable is something whose value or magnitude can change. In other words, a variable can
take on different values over a period of time. The common variables used in microeconomics
analysis are Price, Income, Taste, etc.
Economists are interested in changes in variables either for their own sake or because of their
impact on other variables in the system. As such variables can be divided into two namely;
‘endogenous’ and ‘exogenous’. A variable is said to be an endogenous variable, if it is
explained within the theory or models, while if it is an exogenous variable, then it means that
although it influences other variables in the system of equations or models but is determined
by factors outside the model. A variable is also called economic or non-economic factor that
changes in quantity and quality over time.
(b) Equations:
These are functional relationships between variables whose values tend to differ depending on
the values assigned to the variables. Equations are important means of stating testable
hypothesis. It is also defined as a mathematical representation of the relationship between two
or more variables, example, if given vertical intercept (A) and the slope (B), a line can be
described in equation form, e.g. Y= A + B (x). Note, Y is the dependent variable, A is the
intercept, B is the slope, and x is the independent variable.

1
And that equations can take any of the following terms:
(i) Definitional Equations:
These define one variable in terms of others. For example, in the theory of demand, demand is
expressed as a function of price or price as a function of demand. That is, Qd = a – b
P = a – bq
(ii) Identities Equations:
This is a state of economic facts (truths that cannot be disapproved) and need not be proven.
Identities do not imply that the items being described or stated are necessarily equal.
(iii) Behavioural Equations:
These equations not only expresses casual relationships between variables but in addition it
specify the manner in which the intervening variables behave, given the changes in others.
Such equations are used to describe the general institutional setting of a model.
(iv) Equilibrium Equations:
The equilibrium equations are used to define prerequisites for the attainment of equilibrium in
a set of equations. For instance, in theory of demand and supply, equilibrium occurs at the
point where quantity demanded equate quantity supplied. As such, demand equation will be
equated to supply equation.
(c) Functional Relationships:
Economists generally conduct their analysis by studying the interrelationship between
variables. Foe example, in demand analysis, demand is said to be a function of price, which
could be expressed as: Qd = f (P)
(d) Graphs:
In using graphs, it is necessary to establish which variable is dependent and which is
independent. It also defined as a diagram showing the relationship between quantities of
variables, typically of two varables, each measured along X and Y pair of axes at the right
angles.

€ Models:

Models and theories are closely related. A model represents a simplified version of reality.
Because real-life behaviours are often too complex to analyse models of them which are
sufficiently simple to be conceptualized, analysed and interpreted and constructed.
Conclusions from these models are then used to draw inferences with regard to the real life
behavior which they represent, the conclusions from them should adequately depict
conclusions on the real life behaviours. One of the important roles of theory is to provide the

2
logical basis for the construction of models. Therefore, economic models constitute the critical
link between economic theory and real life behaviours. Economic models do this by using the
knowledge of economic theory as well as variables, parameters and assumptions to arrive at
conclusions on the real life behaviours. In this regard, we can identify the following types of
models.

(i) Descriptive Model:

The descriptive model presents the facts only but would not state the ways and manner in
which those facts are related.
(ii) Explanatory model:
This brings out the implication of the facts and at the same time makes a categorical statement
on the cause-effect relationship.
(iii) Predictive Models:
The predictive models forecast future events by basing it on the past knowledge
(iv) Policy Model:
This type of model suggests a course of action based on the data collected.

GOALS OF MICROECONOMICS
The following are the major aims of microeconomic analysis
(i) To find out how resources are allocated among individuals, firms, and governments;
(ii) How prices of individual goods are determined;
(iii) How production is shared among the individual participants;
(iv) How individual welfare is enhanced and how consumers maximize their utility.

GOALS OF MACROECONOMICS

Some of the goals of macroeconomics are to:

(i) Achieve full employment

(ii) Price stability

(iii) Rapid economic growth and development

(iv) Even the distribution of income and resources

(v) Balance of Payment Equilibrium.

3
Theory:

A theory is a hypothesis that has been successfully tested, The purpose of any theory is to
predict and explain, for instance, the theory of demand and supply, the law of demand and
supply.

Hypothesis:

A hypothesis is an assertion, that is, it is an (if then) statement that is usually obtained from a
casual observation of a real-world phenomenon. A hypothesis is tested not by the realism of
the assumption but by its ability to predict accurately and explain, and also by showing that
the outcome follows logically and directly from the assumptions.

Data-(Datum):

Data are observations that are used for the measurement of economic relationships. Data may
be primary data or secondary data in nature.

There is also, time series data, cross-sectional data, or longitudinal data (known as panel data.

Time series data:

A time series data is data that is recorded over consistent intervals of time

Cross-sectional data:

Cross-sectional data consist of several variables recorded at the same time.

Pooled data

Pooled data is a combination of both time series data and cross-sectional data.

Panel data:

Panel data is a subset of longitudinal data where observations are for the same subjects each
time.

Data could also be quantitative or qualitative:

4
Quantitative data are data represented numerically, which include anything that can be
counted, measured, or given a numerical value, while qualitative data is non–numeric
information such as in-depth interview transcripts, and diaries.

Table:

A table is a tabular presentation of observations or data or information on variables. The

information being presented might be the result of an economic analysis of the relationship
between variables, e.g. a tabular presentation of the prices and quantity demanded of bread at
different times in a particular location.

Graph:

A graph is usually a representation of the behavior of a variable over time (i.e. a time series
graph) or the relationship between two variables. One variable is plotted on the horizontal axis
and the other on the vertical axis. In economics, the dependent variable is plotted on the
vertical axis while the independent variable is plotted on the vertical axis. A negative
relationship is expected or presented by a line sloping downward from left to right, e.g. the
demand curve. On the contrary, a positive or proportional relationship is graphically presented
by a line slopping upward from right to left, e.g. supply curve.

Nominal and Real Variables:

Nominal variables are variables that are estimated at constant prices in a given or chosen year,
while the real variable is the nominal variable divided by the price index number multiplied by
100.

Nominal Variable
That is real variable × 100(Price Deflator)
Price Index Number

Index Number:

An index number is defined as a specialized average designed to measure the effect of change
in prices or change in a group of related variables over a period of time.

5
Index numbers may be classified in terms of what they measured and in economics and other
commercial series the classifications are;

i. Price index number

ii. Quantity index number
iii. Value index number
iv. Chain index number
v. Consumer price index number

As such, index numbers are further classed into Unweighted and Weighted index numbers.
The Unweighted Index number is further classified into (a). Simple aggregative method and
(b). Simple Average of the relative method while the Weighted index number is also further
classified into (a). Weighted aggregative method and (B). The weighted average of the relative

100
method. The price index formula is P01 = (∈ P ¿ ∈¿P ×
1
0 1
¿

Where € P1 = Total of current year prices, and €P0 = Total of base year prices,

Questions

1. There is no rigid distinction between microeconomics and macroeconomics. Discuss?

2. Discuss in-toto the basic tools of Economics analysis.
3. Are there any differences between normative and positive economics?