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How Economists Work: Economics

This chapter discusses how economists work, including: - Distinguishing between positive and normative statements - How economists develop theories using definitions, assumptions, and conditions of applicability - How economic theories are tested using evidence and predictions - How economic data is graphed and indexed over time - How functional relationships between economic variables are represented through words, schedules, equations, and graphs - How marginal values are measured as the change in one variable from a change in another, represented by slope lines on graphs

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Aakash Gupta
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116 views29 pages

How Economists Work: Economics

This chapter discusses how economists work, including: - Distinguishing between positive and normative statements - How economists develop theories using definitions, assumptions, and conditions of applicability - How economic theories are tested using evidence and predictions - How economic data is graphed and indexed over time - How functional relationships between economic variables are represented through words, schedules, equations, and graphs - How marginal values are measured as the change in one variable from a change in another, represented by slope lines on graphs

Uploaded by

Aakash Gupta
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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ECONOMICS
ELEVENTH EDITION

LIPSEY & CHRYSTAL

Chapter 2
HOW ECONOMISTS WORK

Slides by Alex Stojanovic

2- 2

Learning Outcomes

Difference between positive and normative statements How economists set out their theories How economic data are handled and graphed How economic relations are represented in diagrams How marginal values are measured

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Linear Pollution Abatement

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8 6 4 2

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Abatement Expenditure, E [000]

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Linear Pollution Abatement

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Abatement Expenditure, E [000]

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Linear Pollution Abatement

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-1000 P E

Slope = P/ E = -1000/2000 = -0.5

4 +2000 2

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Abatement Expenditure, E [000]

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Linear Pollution Abatement

The slope of the line indicates the marginal reduction in pollution for every increase of 1 of abatement expenditure. It is constant at 0.5 indicating that every extra 1 spent on abatement reduces pollution by one half a tonne.

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Nonlinear Pollution Abatement

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8 6 4 2 0 2 4 6 8 10 12 14 16 18 20 22 24 Abatement Expenditure, E [000]

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Nonlinear Pollution Abatement

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10 8 6 4 2 0 2 4 6 8 10 12 14 16 18 20 22 24 Abatement Expenditure, E [000]

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Nonlinear Pollution Abatement

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10 8 6 +2000 4 +3000 2 0

P E

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Abatement Expenditure, E [000]

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Nonlinear Pollution Abatement

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P E

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Abatement Expenditure, E [000]

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Nonlinear Pollution Abatement

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10 8 6 +2000 4 +3000 +3000 2 4 6 8 10 12 14 16 18 20 22 24 E 2 0

P E P

-500

Abatement Expenditure, E [000]

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Non-linear Pollution Abatement

In this example, pollution falls non-linearly as abatement expenditure rises. When pollution is 8,000 tonnes per year an additional expenditure of 3,000 reduces pollution by 2,000 tonnes. The marginal return for 1 additional expenditure is P/E or 2,000/3,000 which is 2/3rd of a tonne per 1 spent on abatement. When pollution has already been reduced to 3,000 tonnes, an extra 3000 spent on abatement only reduces pollution by 500 tonnes. The marginal return for 1 of additional expenditure, P/E is now only 500/3000 or one sixth of a tonne per 1 spent.

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Navigation Aids
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8 2 4 6 8 10 12 14 16 18 20 22 24 Expenditure on Navigation Aids, E [000]

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Navigation Aids
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8 2 4 6 8 10 12 14 16 18 20 22 24 Expenditure on Navigation Aids, E [000]

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Navigation Aids
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2 +3000

8 +500 E S 2 4 6 8 10 12 14 16 18 20 22 24 Expenditure on Navigation Aids, E [000]

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Navigation Aids
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E 4 +500 E 2 +3000 +3000 S

8 +2000 S 2 4 6 8 10 12 14 16 18 20 22 24 Expenditure on Navigation Aids, E [000]

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Navigation aids
In this example, network externalities cause the number of safe passages to increase at an increasing rate as more is spent on navigational aids. For example, an increase in expenditure on navigational aids by 3,000 when expenditure is 6,000 raises safe passages by 500 from 3,500 to 4,000. The marginal return to 1 extra on navigational aids is 500/3,000 or 0.167it takes 60 to get one more safe passage (3,000/500). However, when 14,000 is already being spent, a further increase of 3,000 increases safe passages by 2,000 from 6,000 to 8,000. The marginal return from 1 spent on aids is now 2,000/3,000 or 0.667it only takes 1.5 extra spending to get one more safe passage (3,000/2,000).

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Aid Saturation

Expenditure on Navigation Aids

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Aid Saturation

S1

E1 Expenditure on Navigation Aids

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Aid Saturation

S2

S1

E1 E2 Expenditure on Navigation Aids

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Aid Saturation
Up to E1, expenditure on navigation aids encounters increasing marginal returns. Between E1 and E2 expenditure encounters decreasing marginal returns. Each additional 1 spent increases the number of safe passages by less than the previous 1 of expenditure. At E2 safe passages reach a maximum of S2. Further expenditures encounter negative marginal returns. Each additional 1 spent lowers the number of safe passages.

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Abatement Saturation

Abatement Expenditure

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Abatement Saturation

P1

Abatement Expenditure

E1

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Abatement Saturation

Up to E1, each additional 1 of expenditure reduces pollution, but at a diminishing amount for each 1. At expenditure E1, pollution reaches a minimum of P1. If further amounts are spent, pollution actually rises.

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CHAPTER 2: HOW ECONOMISTS WORK

Positive and Normative Advice


A key to the success of scientific inquiry lies in separating positive questions about the way the world works from normative questions about how one would like the world to work.

Economic Theorizing
Theories are designed to explain and predict what we see. A theory consists of a set of definitions of the variables to be employed, a set of assumptions about how things behave, and the conditions under which the theory is meant to apply.

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CHAPTER 2: HOW ECONOMISTS WORK

A theory provides conditional predictions of the type if one event occurs, then another event will also occur. An important method of testing theories is to confront their predictions with evidence. The term model has a number of meanings, including: [a] a synonym for theory, [b] a precise realisation of a general theory, with a specific numerical relation in place of each general relation posited by the theory, [c] an application of a general theory to a specific case, and [d] a simplified set of relations designed to study one specific force in isolation

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CHAPTER 2: HOW ECONOMISTS WORK

Economic Data Index numbers express economic series in relative form. Values in each period are expressed in relation to the value in the base period, which is given a value of 100. Economic data may be graphed in three different ways. Cross-section graphs show observations taken at the same time. Time-series show observations on one variable taken over time. Scatter diagrams show points each one of which refers to specific observations on two different variables.

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CHAPTER 2: HOW ECONOMISTS WORK

Graphing Economic Theories


A functional relation can be expressed in words, in a schedule giving specific values, in a mathematical equation, or in graph. A graph of two variables has a positive slope when they both increase or decrease together and a negative slope when they move in opposite directions.

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CHAPTER 2: HOW ECONOMISTS WORK

Measuring Marginal Values


The marginal value of a variable gives the amount it changes in response to a change in a second variable. When the variable is measured on the vertical axis of a diagram its marginal value is measured by the slope of the tangent line to the point in question and approximated by the slope of the line joining two nearby points.

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