Economic Theories, Data, and Graphs: Foundations for Microeconomics

Economic Theories, Data, and Graphs

Introduction

This chapter introduces foundational concepts in economics, focusing on the distinction between positive and normative statements, the development and testing of economic theories, the types of economic data, and the graphical representation of economic relationships. These concepts are essential for understanding both microeconomics and macroeconomics.

Positive and Normative Statements

Definitions and Distinctions

• Positive Statements: Statements about what actually is, was, or will be. They are factual and can be tested or validated by reference to evidence.

• Normative Statements: Statements about what ought to be. They depend on value judgments and cannot be evaluated solely by recourse to facts.

Key Points

• Positive statements do not involve value judgments; they are objective.

• Normative statements involve subjective value judgments and are prescriptive.

• Many disagreements among economists stem from the positive/normative distinction.

• Responsible economists clarify which parts of their advice are normative and which are positive.

Example

• Positive: "An increase in the minimum wage will lead to higher unemployment among teenagers."

• Normative: "The government should increase the minimum wage to improve living standards."

Building and Testing Economic Theories

What Are Theories?

An economic theory is an abstraction from reality designed to explain relationships between variables and predict outcomes.

• Variables: Quantities that can take on different values.

• Endogenous (dependent) variables: Explained within the theory.

• Exogenous (independent) variables: Determined outside the theory.

• Assumptions: Conditions under which the theory operates.

• Predictions: Outcomes expected if the theory holds.

Testing Theories

• Theories are tested by comparing their predictions to real-world evidence.

• If a theory conflicts with facts, it is revised or replaced.

• The scientific approach is central: hypotheses are formulated, tested, and refined.

Example

• The law of demand predicts that, ceteris paribus, an increase in price leads to a decrease in quantity demanded.

Applying Economic Concepts

Where Economists Work

Economists apply their skills in various sectors:

• Governments

• Private businesses

• Crown corporations

• Non-profit organizations

• Post-secondary schools

They design methods to analyze and evaluate policies, assess risks, and study economic growth.

Economic Data

Types of Economic Data

• Index Numbers: Measures of variables relative to a base period (assigned value 100).

• Time-Series Data: Observations of a variable over time.

• Cross-Sectional Data: Observations of a variable across different units at a single point in time.

• Scatter Diagrams: Graphs showing the relationship between two variables.

Index Numbers

• Common example: Consumer Price Index (CPI), which tracks the average price paid by consumers for a basket of goods and services.

• Formula:

$ext{Index in given period} = rac{ ext{Absolute value in given period}}{ ext{Absolute value in base period}} imes 100$

Example

• If the price of a basket in 2020 is $120 and in the base year (2010) is $100, then the index for 2020 is $120$.

Graphing Economic Theories

Functions and Relationships

• If variable Y is related to variable X such that each value of X corresponds to only one value of Y, then Y is a function of X: $Y = f(X)$.

• Functions can be expressed verbally, numerically (tables), mathematically (equations), or graphically.

Example

• Consumption function: $C = 800 + 0.8W$, where $C$ is consumption and $W$ is wage income.

Types of Relationships

• Positive (Direct) Relationship: Variables move together in the same direction.

• Negative (Inverse) Relationship: Variables move in opposite directions.

• Linear Relationship: Graphed as a straight line; the slope is constant.

• Non-linear Relationship: Graphed as a curve; the slope changes at different points.

Slope of a Straight Line

• The slope measures the marginal response of one variable to a change in another.

• Formula:

$ext{Slope} = rac{ ext{Change in Y}}{ ext{Change in X}} = rac{ riangle Y}{ riangle X}$

Example

• If reducing pollution by 1 unit costs $1000, and increasing pollution by 2 units costs $2000, the slope is $0.5$.

Non-Linear Functions

• In non-linear functions, the slope (marginal response) changes as X changes.

• Examples include diminishing marginal returns and increasing marginal costs.

Summary Table: Types of Economic Data

Type	Description	Example
Index Number	Relative measure to a base period	Consumer Price Index (CPI)
Time-Series Data	Observations over time	Unemployment rate from 1978-2021
Cross-Sectional Data	Observations across units at one time	House prices in Canadian provinces, 2021
Scatter Diagram	Graph of two variables	Income vs. consumption

Final Word

Economists develop theories and models to understand economic events. Theories are tested and refined through empirical observation and statistical analysis. Data is represented in various forms, including graphs, to illustrate economic relationships and support theoretical predictions.