why is economics useful? and method can economists predict

The Role

and Method

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1.1 ECONOMICS: A BRIEF INTRODUCTION

What is economics?

1.2 ECONOMICS AS A SCIENCE

Why is economics useful?

1.3 ECONOMIC BEHAVIOR

Can economists predict human behavior?

1.4 ECONOMIC THEORY

Why do we need a theory?

1.5 PROBLEMS TO AVOID IN SCIENTIFICTHINKING

What are the key problems to avoid in scientific thinking?

1.6 POSITIVE AND NORMATIVE ANALYSIS

Why is it important that we distinguishbetween positive and normative analysis?

APPENDIX: WORKING WITH GRAPHS

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2 CHAPTER ONE | The Role and Methods of Economics

2 CHAPTER ONE | The Role and Method of Economics

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1.1 Economics: A Brief IntroductionWhy study economics?What is economics?What is scarcity?

WHY STUDY ECONOMICS?

As you begin your first course in economics, you may be asking yourself why you’re here.What does economics have to do with your life? While there are many good reasons tostudy economics, perhaps the best reason is that many issues in our lives are at least partlyeconomic in character. For example, a good understanding of economics would allowyou to answer such questions as: Why do 10 A.M. classes fill up quicker than 8 A.M. classesduring registration? Why is it difficult to find a taxicab after a play on a cold and rainynight in New York City? Why is it so hard to find an apartment in cities such as San Fran-cisco, Berkeley, and New York? Why is teenage unemployment always higher than adultunemployment? Why are the prices of prescription drugs so high? What are the costs ofunanticipated inflation? Will higher taxes on cigarettes reduce the number of peoplesmoking? Why do professional athletes make so much money? Why are unemploymentrates higher in some parts of the country than in others? Why don’t we just get rid of thepenny? Why do U.S. auto producers like tariffs (taxes) on imported cars? The study ofeconomics improves your understanding of these and many other concerns.

Another reason to study economics is that it may teach you how to “think better”—economics helps develop a disciplined method of thinking about problems. While eco-nomics may not always give you clear-cut answers, it will give you something even morepowerful: the economic way of thinking. The problem-solving tools you will develop bystudying economics will prove valuable to you both in your personal and professional life,regardless of your career choice. A student of economics becomes aware that, at a basiclevel, much of economic life involves choosing among alternative courses of action—making choices between our conflicting wants and desires in a world of limited resources.Economics provides some clues as to how to intelligently evaluate these options and de-termine the most appropriate choices in given situations.

When you come across this Web icon in your book, go to the Sexton Web site athttp://sexton.swcollege.com and click on the links that will take you to fun, useful, andinteresting economics or economics-related sites.

ECONOMICS—A WORD WITH MANY DIFFERENT MEANINGS

Some individuals think economics involves the study of the stock market and corporatefinance, and it does—in part. Others think that economics is concerned with the wiseuse of money and other matters of personal finance, and it is—in part. Still others thinkthat economics involves forecasting or predicting what business conditions will be in thefuture, and again, it does—in part.

A Unique Way of Looking at Human BehaviorEconomics is a unique way of analyzing many areas of human behavior. Indeed, the rangeof topics to which economic analysis is applied is quite broad! Many researchers have dis-

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covered that the economic approach tohuman behavior sheds light on socialproblems that have been with us for a long time: discrimination, education,crime, divorce, political favoritism, andmany more. In fact, economics is front-page news almost every day, whether it involves politicians talking about taxcuts, inflation, interest rates, or unem-ployment; business executives talkingabout restructuring their companies tocut costs; or the average citizen trying to figure out how to make ends meeteach month. Economics is all of this and more.

Growing Wants and Scarce ResourcesPrecisely defined, economics is the studyof the allocation of our limited resourcesto satisfy our unlimited wants. Resourcesare inputs, such as land, human effortand skills, and machines and factories, used to produce goods and services. The problemis that our wants exceed our limited resources, a fact that we call scarcity. Scarcity forcesus to make choices on how to best use our limited resources. This is the economic prob-lem: Scarcity forces us to choose, and choices are costly because we must give up otheropportunities that we value. This economizing problem is evident in every aspect of ourlives. Choosing between a trip to the grocery store or the mall, or between finishing a re-search paper or going to a movie, can be understood more easily when one has a goodhandle on the “economic way of thinking.”

ECONOMICS IS ALL AROUND US

Although many things that we desire in life are considered to be “non-economic,” eco-nomics concerns anything that is considered worthwhile to some human being. For in-stance, love, sexual activity, and religion have value for most people. Even these have aneconomic dimension. Consider religion, for example. Concern for spiritual matters hasled to the development of institutions such as churches and temples that provide religiousand spiritual services. These services are goods that many people desire. Love and sex like-wise have received economists’ scrutiny. One product of love, the institution of the fam-ily, is an important economic decision-making unit. Also, sexual activity results in thebirth of children, one of the most important “goods” that humans desire.

Even time has an economic dimension. In fact, perhaps the most precious single re-source is time. We all have the same limited amount of time per day, and how we divideour time between work and leisure (including perhaps study, sleep, exercise, etc.) is a dis-tinctly economic matter. If we choose more work, we must sacrifice leisure. If we chooseto study, we must sacrifice time with friends, or time spent sleeping or watching TV. Vir-tually everything we decide to do, then, has an economic dimension.

Living in a world of scarcity means trade-offs. And it is important that we know whatthese trade-offs are so we can make better choices about the options available to us.

Economics: A Brief Introduction 3

The front pages of our dailynewspapers are filled with ar-ticles related to economics—either directly or indirectly.News headlines might read:Fuel Prices Soar; Should So-cial Security Be Revamped?;Stocks Rise; Stocks Fall; President Vows to IncreaseNational Defense Spending;Health Costs Continue to Rise.

economicsthe study of the allocation ofour limited resources to satisfyour unlimited wants

resourcesinputs used to produce goodsand services

scarcitythis occurs when our wants ex-ceed our limited resources

the economic problemscarcity forces us to choose,and choices are costly becausewe must give up other oppor-tunities that we value

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AMERICANS SCORE POORLY ON ECONOMIC LITERACY

—LYNN BRENNER

AVERAGE AMERICAN GRADE: FThe National Council of Economic Educationtested 1,010 adults and 1,085 high schoolstudents on their knowledge of basic eco-nomic principles.

On average, adults got a grade of 57 percent on a teston the basics of economics. Among high school stu-dents, the average grade was 48 percent.

Almost two-thirds of those tested did not know that intimes of inflation money does not hold its value.

Only 58 percent of the students understood that whenthe demand for a product goes up but the supply doesn’t, its price is likely to increase.

Half of the adults and about two-thirds of the studentsdidn’t know that the stock market brings people whowant to buy stocks together with those who want tosell them.

Just over one in three Americans realize that societymust make choices about how to use resources.

SOURCE: Lynn Brenner, “What We Need to Know About Money,” Pa-rade Magazine, April 18, 1999, pp. 4–7. Reprinted with permission fromParade, copyright © 1999.

IN THE NEWSIn The NEWS

Among Adults Among High School Grade (percent) Students (percent)

A 6 3

B 10 7

C 15 11

D 20 13

F 49 66

1. Economics is a problem-solving science.2. Economics is the study of the allocation of our limited resources to satisfy our

unlimited wants.3. Resources are inputs used to produce goods and services.4. Our unlimited wants exceed our resources, so we must make choices.

1. Why is economics worth studying?2. What is the definition of economics?3. Why does scarcity force us to make choices?4. Why are choices costly?5. Why do even “non-economic” issues have an economic dimension?

Section Check SECTION CHECK

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Economics as a ScienceHow is economics similar to other social sciences?What are macroeconomics and microeconomics?Are microeconomic tools important to macroeconomists?

ECONOMICS IS A SOCIAL SCIENCE

Like psychology, sociology, anthropology, and political science, economics is considereda social science. Economics, like the other social sciences, is concerned with reaching gen-

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1. Economics is concerned with reaching generalizations about human behavior.2. Economics provides tools to intelligently evaluate and decide on choices. 3. Macroeconomics deals with the aggregate, or total, economy.4. Microeconomics focuses on smaller units within the economy—firms and

households, and how they interact in the marketplace.

1. What makes economics a social science?2. What distinguishes macroeconomics from microeconomics?3. Why is the market for running shoes considered a microeconomic topic?4. Why is inflation considered a macroeconomic topic?


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Economic Behavior 5

macroeconomicsthe study of the whole econ-omy including the topics ofinflation, unemployment, andeconomic growth

aggregatethe total amount—such as theaggregate level of output

microeconomicsthe study of household and firmbehavior and how they interactin the marketplace

eralizations about human behavior. Economics is the study of people. It is the social sci-ence that studies the choices people make in a world of limited resources.

Economics and the other social sciences often complement one another. For ex-ample, a political scientist might examine the process that led to the adoption of a certaintax policy, while an economist might analyze the impact of that tax policy. Or while a psy-chologist may try to figure out what makes the criminal mind work, an economist mightstudy the factors causing a change in the crime rate. Social scientists, then, may be study-ing the same issue but from different perspectives.

MACROECONOMICS AND MICROECONOMICS

Conventionally, we distinguish two main branches of economics, macroeconomics andmicroeconomics. Macroeconomics deals with the aggregate, or total economy; it looksat economic problems as they influence the whole of society. Topics covered in macro-economics include discussions of inflation, unemployment, business cycles, and economicgrowth. Microeconomics, by contrast, deals with the smaller units within the economy,attempting to understand the decision-making behavior of firms and households andtheir interaction in markets for particular goods or services. Microeconomic topics includediscussions of health care, agricultural subsidies, the price of everyday items such as run-ning shoes, the distribution of income, and the impact of labor unions on wages. To putit simply, microeconomics looks at the trees while macroeconomics looks at the forest.

Economic BehaviorWhat is self-interest?Why is self-interest not the same as selfishness?

SELF-INTEREST

Economists assume that individuals act as if they are motivated by self-interest and re-spond in predictable ways to changing circumstances. In other words, self-interest is agood predictor of human behavior. For example, to a worker, self-interest means pursu-ing a higher paying job and better working conditions. To a consumer, it means gaininga greater level of satisfaction from their limited income and time.

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ON COURAGE

—DAN MILLMAN

Many years ago when I worked as a volunteerat Stanford Hospital, I got to know a little girlnamed Liza who was suffering from a rareand serious disease. Her only chance of re-covery appeared to be a blood transfusionfrom her 5-year-old brother, who had miracu-

lously survived the same disease and had developed the antibodies needed to combat the illness. The doctor ex-plained the situation to her little brother, and asked the boyif he would be willing to give his blood to his sister. I saw himhesitate for only a moment before taking a deep breath andsaying, “Yes, I will do it if it will save Liza.”

As the transfusion progressed, he lay in a bed next to hissister and smiled, as we all did, seeing the color return to hercheeks. Then his face grew pale and his smile faded. Helooked up at the doctor and asked with a trembling voice,“Will I start to die right away?” Being young, the boy hadmisunderstood the doctor; he thought he was going to haveto give her all of his blood.

SOURCE: Dan Millman, “On Courage,” Sacred Journey of the Peaceful Warrior. © H. K. Kramer, Inc.


CONSIDER THIS:Some people will help others even when the costs are ex-traordinarily high. But more often than not, these cases ofpure selflessness involve close friends or relatives. For ex-ample, we seldom observe employees asking employersto cut their wages and increase their workload to increase

a company’s profits. Or how often do you think customerswalk into a supermarket demanding to pay more for theirgroceries? In short, a great deal of human behavior canbe explained and predicted by assuming people pursuetheir own self-interest.

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produce goods and services. But self-interest can include benevolence. Think of the lateMother Teresa, who spent her whole life caring for others. One could say that it was inher self-interest, but who would consider her actions selfish? Similarly, workers may bepursuing self-interest when they choose to work harder and longer to increase their char-itable giving or saving for their children’s education. So, don’t confuse self-interest withselfishness.

ACTION AND INACTION HAVE CONSEQUENCES

Most economists believe that it is rational for people to anticipate the likely future con-sequences of their own behavior. For example, if someone with a suspended driver’s li-cense chooses to drive an automobile illegally, we presume that the individual consideredthe possible consequences of this action before he made that decision. This does not nec-essarily mean that he will not drive, merely that he considers the consequences of that ac-tion—perhaps a serious jail sentence or an impounded car—before he makes his choice.Or if someone decides to take up smoking, she is presumed by economists to have thoughtabout the consequences of that action. An individual may still decide to smoke, but she

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Economic Theory 7

1. Economists assume that people act as if they are motivated by self-interestand respond predictably to changing circumstances.

2. People try to anticipate the possible consequences of their actions.

1. What do economists mean by self-interest?2. What does rational self-interest involve?3. How are self-interest and selfishness different?


theorystatements or propositionsused to explain and predict behavior in the real world

How is economic theory likea map? Because of the com-plexity of human behavior,economists must abstract tofocus on the most importantcomponents of a particularproblem. This is similar tomaps that highlight the im-portant information (and assume away many minor details) to help people getfrom here to there.

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will have at least considered the potential results of that action. Actions have conse-quences. Even inaction, deciding not do something or not to make a change, has conse-quences: If you choose not to study, you could fail an exam; if you choose not to pay yourincome taxes, you could go to jail; or if you are diagnosed with high blood pressure andchoose not to change your diet, you could have a stroke.

Economic TheoryWhat are economic theories?What can we expect out of our theories?Why do we need to abstract?What is a hypothesis?What is empirical analysis?

ECONOMIC THEORIES

A theory is an established explanation that accounts for known facts or phenomena.Specifically, economic theories are statements or propositions about patterns of humanbehavior that are expected to take place under certain circumstances. These theories helpus to sort out and understand the complexities ofeconomic behavior. We expect a good theory toexplain and predict well. A good economic the-ory, then, should help us to better understandand, ideally, predict human economic behavior.

ABSTRACTION IS IMPORTANT

Economic theories cannot realistically includeevery event that has ever occurred. This is truefor the same reason that a newspaper or historybook does not include every world event thathas ever happened. We must abstract. A roadmap of the United States may not include everycreek, ridge, and gully between Los Angeles andChicago—indeed, such an all-inclusive mapwould be too large to be of value. However, a ©

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1. Economic theories are statements used to explain and predict patterns of hu-man behavior.

2. We must abstract and focus on the most important components of a particularproblem.

3. A hypothesis makes a prediction about human behavior and is then tested.4. We use empirical analysis to examine the data and see if our hypothesis fits

well with the facts.

1. What are economic theories?2. What is the purpose of a theory?3. Why must economic theories be abstract?4. What is a hypothesis? How do we determine if it is tentatively accepted?



hypothesisa testable proposition

empirical analysisthe use of data to test a hypothesis

small road map with major details will provide enough information to travel by car fromLos Angeles to Chicago. Likewise, an economic theory provides a broad view, not a de-tailed examination, of human economic behavior.

DEVELOPING A TESTABLE PROPOSITION

The beginning of any theory is a hypothesis, a testable proposition that makes some typeof prediction about behavior in response to certain changes in conditions. In economictheory, a hypothesis is a testable prediction about how people will behave or react to achange in economic circumstances. For example, if the price of compact discs (CDs) in-creased, we might hypothesize that fewer CDs would be sold, or if the price of CDs fell,we might hypothesize that more CDs would be sold. Once a hypothesis is stated, it istested by comparing what it predicts will happen to what actually happens.

Using Empirical AnalysisTo see if our hypothesis is valid, we must engage in an empirical analysis. That is, wemust examine the data to see if our hypothesis fits well with the facts. If the hypothesis isconsistent with real-world observations, it is accepted; if it does not fit well with the facts,it is “back to the drawing board.”

Determining whether a hypothesis is acceptable is more difficult in economics thanit is in the natural or physical sciences. Chemists, for example, can observe chemical reac-tions under laboratory conditions. They can alter the environment to meet the assump-tions of the hypothesis and can readily manipulate the variables (chemicals, temperatures,and so on) crucial to the proposed relationship. Such controlled experimentation is seldompossible in economics. The laboratory of economists is usually the real world. Unlike achemistry lab, economists cannot easily control all the other variables that might influ-ence human behavior.

FROM HYPOTHESIS TO THEORY

After gathering their data, economic researchers must then evaluate the results to deter-mine whether the hypothesis is supported or refuted. If supported, the hypothesis canthen be tentatively accepted as an economic theory.

Economic theories are always on probation. A hypothesis is constantly being testedagainst empirical findings. Do the observed findings support the prediction? When a hy-pothesis survives a number of tests, it is accepted until it no longer predicts well.

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Problems to Avoid in Scientific Thinking 9

ceteris paribusholding all other things constant

correlation two events that usually occurtogether

causationwhen one event brings on another event

Problems to Avoid in ScientificThinking

What is the ceteris paribus assumption?If events are associated with one another, does that mean one event caused the other tohappen?What is the fallacy of composition?

In our discussion of economic theory, we have not yet mentioned that there are certainproblems that may hinder scientific and logical thinking. In this section, we will discussseveral potential problems to avoid in economic thinking: violation of the ceteris paribusassumption, confusing association and causation, and the fallacy of composition.

VIOLATION OF THE CETERIS PARIBUS ASSUMPTION

One condition common to virtually all theories in economics is usually expressed by useof the Latin expression ceteris paribus. This roughly means “let everything else be equal”or “holding everything else constant.” In trying to assess the effect of one variable on an-other, we must isolate their relationship from other events that might also influence thesituation that the theory tries to explain or predict. To make this clearer, we will illustratethis concept with a couple of examples.

Suppose you develop your own theory describing the relationship between studyingand exam performance: If I study harder, I will perform better on the test. That soundslogical, right? Holding other things constant (ceteris paribus), this is likely to be true.However, what if you studied harder but inadvertently overslept the day of the exam?What if you were so sleepy during the test that you could not think clearly? Or what ifyou studied the wrong material? While it may look like additional studying did not im-prove your performance, the real problem may lie in the impact of other variables, suchas sleep deficiency or how you studied.

Researchers must be careful to hold other things constant (ceteris paribus). For ex-ample, in 1936, cars were inexpensive by modern standards, yet few were purchased; in1949, cars were much more expensive, but more were bought. This statement appears toimply that people prefer to buy more when prices are higher. However, we know fromample empirical observations that this is not the case—buyers are only willing to buymore at lower prices, ceteris paribus. The reason people bought more cars at the higherprices was that several other important variables were not held constant over this period(the ceteris paribus assumption): the purchasing power of dollars, the income of potentialcar buyers, and the quality of cars.

CONFUSING CORRELATION AND CAUSATION

Without a theory of causation, no scientist could sort out and understand the enormouscomplexity of the real world. But one must always be careful not to confuse correlationwith causation. In other words, the fact that two events usually occur together (correla-tion) does not necessarily mean that one caused the other to occur (causation). For ex-ample, say a groundhog awakes after a long winter of hibernation, climbs out of his hole, sees his shadow and then six weeks of bad weather ensue. Did the groundhog cause

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People tend to drive moreslowly when the roads arecovered with ice. In addition,more traffic accidents occurwhen the roads are icy. Sodoes driving slower cause thenumber of accidents to rise?No, it is the icy roads thatlead to both lower speedsand increased accidents.

HEAVY METAL MUSIC AND TEEN SUICIDE

—KAREN R. SCHEEL

Many parents and mental health profes-sionals have watched the rising rate of ado-lescent suicide and the growing popularity of heavy metal music among teenagers andwondered, with some concern, if there is anyconnection between the two phenomena. A

new study . . . offers the first direct assessment of the suici-dal risk of American adolescent heavy metal fans comparedto that of peers who do not like heavy metal music. For thestudy, 121 midwestern public high school students (meanage 17.2) were given two psychological assessments, theReasons for Living Inventory (RFL) and the Suicide RiskQuestionnaire (SRQ) (both measures of risk for suicide), andtheir musical preferences were assessed.

Compared with fans of country, pop/mainstream, rock,and rap music, heavy metal fans had lower scores on theRFL (indicating greater risk of suicide) and they were morelikely to say they occasionally or seriously thought aboutkilling themselves (74 percent versus 35 percent for females;42 percent versus 15 percent for males).

But the author cautions that while these findings “dosuggest that a teenager’s liking of heavy metal music may be

a useful ‘red flag’ for suicidal vulnerability for psychologistsand other professionals who work with adolescents,” sheadds that these findings should not be thought of as indica-tive of imminent suicidal risk and that they “are not sugges-tive of any important causal effects of heavy metal listeningon suicidality.”

SOURCE: Presentation: “Adolescent Heavy Metal Fans: At IncreasedRisk for Suicide?” by Karen R. Scheel, University of Iowa, Session 2173(B-14), August 10, 1996. © 1996 by the American Psychological Associ-ation. Adapted with permission.


CONSIDER THIS:Note how the researcher cautions against any determi-nation of causality. Perhaps the causality runs in theother direction: Kids that are at greater risk for suicidemay like heavy metal music. Perhaps some other vari-ables are causing the correlation, like genetic predis-position, peer pressure, environment, or a host of otherthings.


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™the bad weather? Similarly, Cal Ripkin’s streak of consecutive baseball games playedstarted in 1982—the same year that the Weather Channel began on television. Does thatmean that the two events are systematically related? It is highly unlikely.

Perhaps the causality may run in theopposite direction. While a rooster mayalways crow before the sun rises, it doesnot cause the sunrise; rather the earlylight from the sunrise causes the roosterto crow.

Why Is There a PositiveCorrelation Between IceCream Sales and Crime?Did you know that when ice cream salesrise, so do crime rates? What do you thinkcauses the two events to occur together?Some might think that the sugar “high”in the ice cream causes the higher crimerate. Excess sugar in a snack was actuallyused in court testimony in a murdercase—the so-called “Twinkie defense.”However, it is more likely that crimepeaks in the summer because of weather,more people on vacations (leaving their©

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Positive and Normative Analysis 11

1. In order to isolate the effects of one variable on another, we use the ceterisparibus assumption.

2. The fact that two events are related does not mean that one caused the otherto occur.

3. What is true for the individual is not necessarily true for the group.

1. Why do economists hold other things constant (ceteris paribus)?2. What is the relationship between correlation and causation?3. What types of misinterpretations result from confusing correlation and causation?4. What is the fallacy of composition?5. If U.S. consumers bought more gasoline in 2000, when prices averaged

$1.60 per gallon, than they did in 1970, when prices averaged $0.80 per gallon,does that mean that people want more gas at higher prices? Why or why not?

6. If you can sometimes get a high grade on a test without studying, does that meanthat additional studying does not lead to higher grades? Explain your answer.


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™fallacy of compositionthe incorrect view that what is true for the individual is always true for the group

homes vacant), teenagers out of school, and so on. It just happens that ice cream sales alsopeak in those months because of weather. The lesson: One must always be careful not toconfuse correlation with causation and to be clear on the direction of the causation.

THE FALLACY OF COMPOSITION

One must also be careful with problems associated with aggregation (summing up all theparts), particularly the fallacy of composition. This fallacy states that even if somethingis true for an individual, it is not necessarily true for many individuals as a group. For ex-ample, say you are at a football game and you decide to stand up to get a better view ofthe playing field. This works as long as no one else stands up. But what would happen ifeveryone stood up at the same time? Then, standing up would not let you see better.Hence, what may be true for an individual does not always hold true in the aggregate. Thesame can be said of arriving to class early to get a better parking place—what if everyonearrived early? Or studying harder to get a better grade in a class that is graded on a curve—what if everyone studied harder? All of these are examples of the fallacy of composition.

Positive and Normative AnalysisWhat is positive analysis?What is normative analysis?Why do economists disagree?

POSITIVE ANALYSIS

Most economists view themselves as scientists seeking the truth about the way people behave. They make speculations about economic behavior, and then (ideally) they try toassess the validity of those predictions based on human experience. Their work emphasizeshow people do behave, rather than how people should behave. In the role of scientist, an

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positive analysisan objective testable state-ment—how the economy is

normative analysisa subjective, non-testable statement—how the economyshould be

economist tries to observe objectively patterns of behavior without reference to the ap-propriateness or inappropriateness of that behavior. This objective, value-free approach,utilizing the scientific method, is called positive analysis. In positive analysis, we wantto know the impact of variable A on variable B. We want to be able to test a hypothesis.For example, the following is a positive statement: If rent controls are imposed, vacancyrates will fall. This statement is testable. A positive statement does not have to be a truestatement, but it does have to be a testable statement.

However, keep in mind that it is doubtful that even the most objective scientist canbe totally value-free in his or her analysis. An economist may well emphasize data or ev-idence that supports his hypothesis, putting less weight on other evidence that might becontradictory. This, alas, is human nature. But a good economist/scientist strives to be asfair and objective as possible in evaluating evidence and in stating conclusions based onthe evidence.

NORMATIVE ANALYSIS

Like everyone, economists have opinions and make value judgments. When economists,or anyone else for that matter, express opinions about some economic policy or state-ment, they are indicating in part how they believe things should be, not just facts as tothe way things are. Normative analysis expresses opinions about the desirability of vari-ous actions. Normative statements involve judgments about what should be or whatought to happen. For example, one could judge that incomes should be more equally dis-tributed. If there is a change in tax policy that makes incomes more equal, there will bepositive economic questions that can be investigated, such as how work behavior willchange. But we cannot say, as scientists, that such a policy is good or bad; rather, we canpoint to what will likely happen if the policy is adopted.

POSITIVE VERSUS NORMATIVE STATEMENTS

The distinction between positive and normative analysis is important. It is one thing tosay that everyone should have universal health care, a normative statement, and quite an-other to say that universal health care would lead to greater worker productivity, a testablepositive statement. It is important to distinguish between positive and normative analy-sis because many controversies in economics revolve around policy considerations thatcontain both. When economists start talking about how the economy should work ratherthan how it does work, they have entered the normative world of the policymaker.

DISAGREEMENT IS COMMON IN MOST DISCIPLINES

While economists differ frequently on economic policy questions, there is probably lessdisagreement than the media would have you believe. Disagreement is common in mostdisciplines: Seismologists differ over predictions of earthquakes or volcanic eruption; his-torians can be at odds over the interpretation of historical events; psychologists disagreeon proper ways to rear children; and nutritionists debate the merits of large doses of vitamin C.

The majority of disagreements in economics stem from normative issues, as differ-ences in values or policy beliefs result in conflict. As we discussed earlier in this chapter,economists may emphasize specific facts over other facts when trying to develop supportfor their own hypothesis. As a result, disagreements can result when one economist givesweight to facts that have been minimized by another, and vice versa.

Freedom Versus FairnessSome economists are concerned about individual freedom and liberty, thinking that anyencroachment on individual decision making is, other things equal, bad. People with this

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Positive and Normative Analysis 13

ECONOMISTS DO AGREE

Almost 80 percent of economists agree thatthese statements are correct:

1. A ceiling on rents (rent control) reducesthe quantity and quality of rental housingavailable (93 percent agree).

2. Tariffs and import quotas usually reducegeneral economic welfare (93 percentagree).

3. A minimum wage increases unemployment among theyoung and unskilled (79 percent agree).

4. Cash payments increase the welfare of recipients to agreater degree than do transfers-in-kind of equal cashvalue (84 percent agree).

5. Fiscal policy (e.g., tax cuts and/or government expen-diture increase) has a significant stimulative impact ona less than fully employed economy (90 percent agree).

6. A large budget deficit has an adverse effect on theeconomy (83 percent agree).

7. Effluent taxes and marketable pollution permits repre-sent a better approach to pollution control than imposi-tion of pollution ceilings (78 percent agree).

SOURCE: Adapted from Richard M. Alston, J. R. Kearl, and Michael B.Vaughn, “Is There Consensus Among Economists in the 1990s?” Ameri-can Economic Review, May 1992, pp. 203–209.

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philosophic bent are inclined to be skeptical of any increased government involvement inthe economy.

On the other hand, some economists are concerned with what they consider an un-equal, “unfair,” or unfortunate distribution of income, wealth, or power, and view gov-ernmental intervention as desirable in righting injustices that they believe exist in amarket economy. To these persons, the threat to individual liberty alone is not sufficientlygreat to reject governmental intervention in the face of perceived economic injustice.

The Validity of an Economic Theory Aside from philosophic differences, there is a second reason why economists may differon any given policy question. Specifically, they may disagree as to the validity of a giveneconomic theory for the policy in question. Suppose two economists have identical philo-sophical views that have led them to the same conclusion: To end injustice and hardship,unemployment should be reduced. To reach the objective, the first economist believes thegovernment should lower taxes and increase spending, while the second economist be-lieves increasing the amount of money in public hands by various banking policies willachieve the same results with fewer undesirable consequences. The two economists differbecause the empirical evidence for economic theories about the cause of unemploymentappears to conflict. Some evidence suggests government taxation and spending policiesare effective in reducing unemployment, while other evidence suggests that the primecause of unnecessary unemployment lies with faulty monetary policy. Still other evidenceis consistent with the view that, over long periods, neither approach mentioned here is ofmuch value in reducing unemployment, and that unemployment will be part of our ex-istence no matter what macroeconomic policies we follow.

ECONOMISTS DO AGREE

Although you may not believe it after reading the previous discussion, economists don’talways disagree. In fact, according to a survey among members of the American EconomicAssociation, most economists agree on a wide range of issues, including rent control, im-port tariffs, export restrictions, the use of wage and price controls to curb inflation, andthe minimum wage (see “In the News: Economists Do Agree”).

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Summary

1. Positive analysis is objective and value-free.2. Normative analysis involves value judgments and opinions about the desirabil-

ity of various actions.3. Disagreement is common in most disciplines.4. Most disagreement among economists stems from normative issues.

1. What is positive analysis? Must positive analysis be testable?2. What is normative analysis? Is normative analysis testable?3. Why is the positive/normative distinction important?4. Why are there policy disagreements among economists?5. Is the statement, “UFOs land in my backyard at least twice a week,” a positive

statement? Why or why not?6. Is there any way to determine scientifically if the “rich” pay their “fair share” of

taxes? Why or why not?

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economics 3resources 3scarcity 3the economic problem 3macroeconomics 5aggregate 5

microeconomics 5theory 7hypothesis 8empirical analysis 8ceteris paribus 9correlation 9

causation 9fallacy of composition 11positive analysis 12normative analysis 12

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Key Terms and Concepts

Economics is the study of the allocation of our limited re-sources to satisfy our unlimited wants. Resources are de-fined as the inputs, such as land, human effort and skills,and machines and factories, that are used to produce goodsand services. We all face “the economic problem”—that is,our wants exceed our limited resources, a fact that we callscarcity. Scarcity forces us to choose, and choices are costlybecause we must give up other opportunities that we value,but economics provides the tools to intelligently evaluateand decide on choices. Another reason to study econom-ics is that many issues around us are economic in charac-ter. A good working knowledge of economics is importantfor everyone, whether they are consumers, workers, orpoliticians.

There are two branches of economics: microeconom-ics and macroeconomics. Microeconomics focuses onsmaller units within the economy—firms and households;macroeconomics deals with the aggregate, or total, econ-

omy. Macroeconomics looks at the forest, while microeco-nomics looks at the trees.

Economists assume that it is rational for people to actin their own self-interest and try to improve their lives. Indoing so, people try to anticipate the likely consequencesof their actions as well as their inaction.

Economic theories are statements about patterns ofhuman behavior. In our testing of theories we use empiri-cal analysis to examine the data and see if our hypothesisfits well with the facts. When studying economics we mustbe careful of some pitfalls: violating the ceteris paribus as-sumption, confusing causation and correlation, and thefallacy of composition. It is also important when studyingeconomics to understand the difference between positiveanalysis, which is testable and objective (“what is”), andnormative analysis, which is subjective (“what should orought to be”).

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Review Questions 15

Review Questions

1. Explain the causal links of the following events:a. The people in the last row of the lecture hall

always seem to get the lowest grade. Does thismean that seat selection determines exam grades?

b. For years the stock market would rise the year afterthe National Football League beat the AmericanFootball League in the Super Bowl. Did the Su-per Bowl determine the fate of the stock market?

2. Why should we use the ceteris paribus assumption inthese statements?a. Car prices increased and people bought more cars

as their incomes rose.b. The price of generic shampoo fell and people

bought less of it as their income rose. 3. After reading this chapter, see if you can come up

with a list of ten topics where you think the eco-nomic way of thinking would be helpful in your life.

4. Which of the following topics do you think couldbenefit from the economic way of thinking, and why?a. health careb. the environmentc. politicsd. the lawe. sportsf. the mediag. finance

5. Answer the following questions:a. What is the difference between self-interest and

selfishness?b. Why does inaction have consequences?c. Why is observation and prediction more difficult

in economics than in chemistry?d. Why do economists look at group behavior rather

than at individual behavior?

6. Using the map analogy from the chapter, talk aboutthe importance of abstraction. How do you abstractwhen taking notes in class?

7. Identify which of the following economic statementsare positive and which are normative:

a. A tax increase will increase unemployment.

b. The government should reduce funding for wel-fare programs.

c. Tariffs on imported wine will lead to higherprices for domestic wine.

d. A decrease in the capital gains tax rate will in-crease investment.

e. Goods purchased out of state on the internetshould be subject to state sales taxes.

f. A reduction in interest rates will cause inflation.

8. Evaluate the following statement: “As long as there isscarcity, there will always be poverty.”

9. The following statement represents which fallacy inthinking, and why: “I earn $12 per hour. If I am ableto earn $12 per hour, everyone should be able to findwork for at least that wage rate.”

10. Go to the Sexton Web site for this chapterat http://sexton.swcollege.com and click on the American Economic Association JobOpenings for Economists Web site and pe-ruse the most recent job listings. What typesof jobs are available to those trained in the economicway of thinking?

11. Visit the editorial section of the WashingtonPost Online (go to the Sexton site and clickon Washington Post Online) and read a fewrecent editorials. See if you can identify anypositive or normative statements in theseop-ed pieces.

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Appendix Working with Graphs

In the upper right-hand corner, we see that the graph includesa positive figure for the Y-axis and the X-axis. As we move to the right along the horizontal axis, the numerical values in-crease. As we move up along the vertical axis, the numericalvalues increase.

Y-axisthe vertical axis on a graph

X-axisthe horizontal axis on a graph

Graphs can summarize important data. This Kinko’s ad of aclever resumé shows how to communicate important infor-mation to a potential employer.

pie charta circle subdivided into propor-tionate slices that representvarious quantities that add upto 100 percent

appendixExhibit 1

Plotting a Graph

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Sometimes the use of visual aids, such as graphs, greatly enhances our understanding ofa theory. It is much the same as finding your way to a friend’s house with the aid of a maprather than with detailed verbal or written instructions. Graphs are important tools foreconomists. They allow us to understand better the workings of the economy. To econ-omists, a graph can be worth a thousand words. This text will use graphs throughout toenhance the understanding of important economic relationships. This appendix providesa guide on how to read and create your own graphs.

The most useful graph for our purposes is one that merely connects a vertical line(the Y-axis) with a horizontal line (the X-axis), as seen in Exhibit 1. The intersection ofthe two lines occurs at the origin, which is where the value of both variables is equal tozero. In Exhibit 1, the graph has four quadrants or “boxes.” In this textbook we will beprimarily concerned with the shaded box in the upper right-hand corner. This portion ofthe graph deals exclusively with positive numbers. Always keep in mind that moving tothe right on the horizontal axis and up along the vertical axis each lead to higher values.

USING GRAPHS AND CHARTS

Exhibit 2 presents three common types of graphs. The pie chart in Exhibit 2(a) showswhat college students earn. That is, each slice in the pie chart represents the percent ofcollege students in a particular earnings category. Therefore, pie charts are used to showthe relative size of various quantities that add up to a total of 100 percent.

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What college students earnMonthly income from jobs

Don't havea job

$400 orover

Less than $200

$200–$399

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25%28%

Appendix: Working with Graphs 17

Exhibit 2(b) is a bar graph that shows the most popular tourist attractions in theUnited States. The height of the line represents the annual attendance at these populartourist attractions. Bar graphs are used to show a comparison of the size of quantities ofsimilar items.

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18 CHAPTER ONE | The Role and Methods of Economics18 CHAPTER ONE | The Role and Method of Economics

positive relationshipwhen two variables change inthe same direction

negative relationshipwhen two variables change inopposite directions

variablesomething that is measured bya number, such as your height

time-series grapha type of line chart that plotsdata trends over time

The inline skaters’ practice times and scores in the competi-tion are plotted on the graph. Each participant is representedby a point. The graph shows that those skaters who prac-ticed the most scored the highest. This is called a positive, ordirect, relationship.

appendix A Positive RelationshipExhibit 3

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Exhibit 2(c) is a time-series graph. This type of graph shows changes in the value ofa variable over time. This is a visual tool that allows us to observe important trends overa certain time period. In Exhibit 2(c) we see a graph that shows trends in the inflation rateover time. The horizontal axis shows us the passage of time, and the vertical axis shows usthe inflation rate (annual percent change). From the graph, we can see the trends in theinflation rate from 1961 to 2000.

USING GRAPHS TO SHOW THE RELATIONSHIP BETWEEN TWO VARIABLES

While the graphs and chart in Exhibit 2 are important, they do not allow us to show therelationship between two variables (a variable is something that is measured by a number,such as your height). To more closely examine the structure of and functions of graphs,let us consider the story of Katherine, an avid inline skater who has aspirations of winningthe Z Games next year. To get there, however, she will have to put in many hours of prac-tice. But how many hours? In search of information about the practice habits of otherskaters, she logged onto the Internet, where she pulled up the results of a study conductedby ESPM 3 that indicated the score of each Z Games competitor and the amount of prac-tice time per week spent by each skater. The results of this study (see Exhibit 3) indicatedthat skaters had to practice 10 hours per week to receive a score of 4.0, 20 hours per weekto receive a score of 6.0, 30 hours per week to get a score of 8.0, and 40 hours per week toget a perfect score of 10. What does this information tell Katherine? By using a graph, shecan more clearly understand the relationship between practice time and overall score.

A Positive RelationshipThe study on scores and practice times revealed what is called a direct relationship, alsocalled a positive relationship. A positive relationship means that the variables change inthe same direction. That is, an increase in one variable (practice time) is accompanied byan increase in the other variable (overall score), or a decrease in one variable (practice time)

is accompanied by a decrease in the other variable (overallscore). In short, the variables change in the same direction.

A Negative RelationshipWhen two variables change in opposite directions, we saythey are inversely related, or have a negative relationship.That is, when one variable rises, the other variable falls, orwhen one variable decreases, the other variable increases.

THE GRAPH OF A DEMAND CURVE

Let us now examine one of the most important graphs inall of economics—the demand curve. In Exhibit 4, we seeEmily’s individual demand curve for compact discs. Itshows the price of CDs on the vertical axis and the quan-tity of CDs purchased per month on the horizontal axis.Every point in the space shown represents a price andquantity combination. The downward-sloping line, la-beled demand curve, shows the different combinations ofprice and quantity purchased. Note that the higher you goup on the vertical (price) axis, the smaller the quantitypurchased on the horizontal (quantity) axis, and the lower

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The downward slope of the curve means that price andquantity purchased are inversely, or negatively, related: Whenone increases, the other decreases. That is, moving downalong the demand curve from point A to point E, we see thatas price falls, the quantity purchased increases. Moving upalong the demand curve from point E to point A, we see thatas the price increases, the quantity purchased falls.

Emily’s Demand Curve— A Negative Relationship

appendix A Negative RelationshipExhibit 4

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the price on the vertical axis, the greater the quantity purchased.

In Exhibit 4, we see that moving up the vertical priceaxis from the origin, the price of CDs increases from $5 to$25 in increments of $5. Moving out along the horizontalquantity axis, the quantity purchased increases from zero tofive CDs per month. Point A represents a price of $25 anda quantity of one CD, point B represents a price of $20 anda quantity of two CDs, point C, $15 and a quantity of threeCDs, and so on. When we connect all the points, we havewhat economists call a curve. As you can see, curves aresometimes drawn as straight lines for ease of illustration.Moving down along the curve, we see that as the price falls,a greater quantity is demanded; moving up the curve tohigher prices, a smaller quantity is demanded. That is, whenCDs become less expensive, Emily buys more CDs. WhenCDs become more expensive, Emily buys fewer CDs, per-haps choosing to go to the movies or buy a pizza instead.

USING GRAPHS TO SHOW THERELATIONSHIP BETWEEN THREEVARIABLES

Although only two variables are shown on the axes, graphscan be used to show the relationship between three variables. For example, say we add athird variable—income—to our earlier example. Our three variables are now income,price, and quantity purchased. If Emily’s income rises, say she gets a raise at work, she isnow able and willing to buy more CDs than before at each possible price. As a result, thewhole demand curve shifts outward (rightward) compared to the old curve. That is, withthe new income, she uses some of it to buy more CDs. This is seen in the graph in Ex-hibit 5(a). On the other hand, if her income falls, say she quits her job to go back toschool, she now has less income to buy CDs. This causes the whole demand curve to shiftinward (leftward) compared to the old curve. This is seen in the graph in Exhibit 5(b).

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(a) Downward-Sloping Linear Curve (b) Upward-Sloping Linear Curve

appendix Downward- and Upward-Sloping Linear CurvesExhibit 7

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slopethe ratio of rise (change in theY variable) over the run (changein the X variable)

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The Difference Between a Movement Along and a Shift in the CurveIt is important to remember the difference between amovement between one point and another along a curveand a shift in the whole curve. A change in one of the vari-ables on the graph, like price or quantity purchased, willcause a movement along the curve, say from point A topoint B as shown in Exhibit 6. A change in one of the vari-ables not shown (held constant in order to show only therelationship between price and quantity), like income inour example, will cause the whole curve to shift. Thechange from D0 to D1 in Exhibit 6 shows such a shift.

SLOPE

In economics, we sometimes refer to the steepness of thelines or curves on graphs as the slope. A slope can be either positive (upward sloping) ornegative (downward sloping). A curve that is downward sloping represents an inverse, ornegative, relationship between the two variables and slants downward from left to right, asseen in Exhibit 7(a). A curve that is upward sloping represents a direct, or positive, rela-tionship between the two variables and slants upward from left to right, as seen in Exhibit7(b). The numeric value of the slope shows the number of units of change of the Y-axisvariable for each unit of change in the X-axis variable. Slope provides the direction (posi-tive or negative) as well as the magnitude of the relationship between the two variables.

Measuring the Slope of a Linear CurveA straight-line curve is called a linear curve. The slope of a linear curve between twopoints measures the relative rates of change of two variables. Specifically, the slope of alinear curve can be defined as the ratio of the change in the Y value to the change in theX value. The slope can also be expressed as the ratio of the rise to the run, where the riseis the change in the Y variable (along the vertical axis) and the run is the change in the Xvariable (along the horizontal axis).

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(a) Positive Slope (b) Negative Slope

appendix Slopes of Positive and Negative CurvesExhibit 8

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Key Terms and Concepts

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In Exhibit 8, we show two linear curves, one with a positive slope and one with a neg-ative slope. In Exhibit 8(a), the slope of the positively sloped linear curve from point Ato B is 1/2, because the rise is 1 (from 2 to 3) and the run is 2 (from 1 to 3). In Exhibit 8(b),the negatively sloped linear curve has a slope of – 4, a rise of –8 (a fall of 8 from 10 to 2)and a run of 2 (from 2 to 4), which gives us a slope of – 4 (–8/2). Note the appropriatesigns on the slopes: The negatively sloped line carries a minus sign and the positivelysloped line, a plus sign.

Finding the Slope of a Nonlinear CurveIn Exhibit 9, we show the slope of a nonlinear curve. Anonlinear curve is a line that actually curves. Here the slopevaries from point to point along the curve. However, wecan find the slope of this curve at any given point by draw-ing a straight line tangent to that point on the curve. A tan-gency is when a straight line just touches the curve withoutactually crossing it. At point A, we see that the positivelysloped line that is tangent to the curve has a slope of 1—the line rises one unit and runs one unit. At point B, theline is horizontal, so it has zero slope. At point C, we see aslope of –2, because the negatively sloped line has a rise of–2 units (a fall of two units) for every one unit run.

Remember, many students have problems with eco-nomics simply because they fail to understand graphs, somake sure that you understand this material before goingon to chapter 3.

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SG1-1

chapter 1 Study Guide

Fill in the Blanks

1. Economics is the study of the allocation of resources to satisfywants for goods and services.

2. is the problem that our wants exceed our limited resources.

3. Resources are used to produce goods and services.

4. The economic problem is that forces us to choose, and choicesare costly because we must give up other opportunities that we .

5. Living in a world of scarcity means .

6. deals with the aggregate (the forest), or total economy, whiledeals with the smaller units (the trees) within the economy.

7. Economists assume that individuals act as if they are motivated by and respond in ways to changing circumstances.

8. Economists believe that it is for people to anticipate the likely fu-ture consequences of their behavior.

9. Actions have .

10. Economic are statements or propositions used toand patterns of human economic behavior.

11. Because of the complexity of human behavior, economists must to focus on the most important components of a particular problem.

12. A in economic theory is a testable prediction about how peoplewill behave or react to a change in economic circumstances.

13. analysis is the use of data to test a hypothesis.

14. In order to isolate the effects of one variable on another, we use theassumption.

15. When two events usually occur together, it is called .

16. When one event brings on another event, it is called .

17. The is the incorrect view that what is true for an individ-ual is always true for the group.

18. The objective, value-free approach to economics, utilizing the scientific method, iscalled analysis.

19. analysis involves judgments about what should be or what oughtto happen.

20. “A tax increase will lead to a lower rate of inflation” is a economicstatement.

True or False

1. Choices are costly because we must give up other opportunities that we value.

2. When our limited wants exceed our unlimited resources, we face scarcity.

3. If we valued leisure more highly, the opportunity cost of working would be lower.

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4. Economics is a social science because it is concerned with reaching generalizationsabout human behavior.

5. Microeconomics would deal with the analysis of a small individual firm, whilemacroeconomics would deal with very large global firms.

6. Self-interest cannot include benevolence.

7. According to the National Council of Economic Education, most adults tested inthe United States performed well on economic literacy.

8. Rationality implies that someone with a suspended driver’s license would not drive.

9. For a person to be rational implies that he or she always makes the right choice.

10. Economic theories do not abstract from very many particular details of situationsso they can better focus on every aspect of the behavior to be explained.

11. Determining whether an economic hypothesis is acceptable is more difficult than is the case in the natural or physical sciences in that, unlike a chemist in a chem-istry lab, economists cannot control all the other variables that might influence human behavior.

12. A positive statement must be both testable and true.

13. Normative analysis involves subjective, non-testable statements.

14. The majority of disagreements in economics stem from normative issues.

15. A hypothesis is a normative statement.

Multiple Choice

1. If a good is scarce,a. it only needs to be limited.b. it is not possible to produce any more of the good.c. it is desirable but limited. d. there will always be a shortage of the good at the current price.

2. Which of the following is true of resources?a. Their availability is unlimited.b. They are the inputs used to produce goods and services.c. Increasing the amount of resources available could eliminate scarcity.d. Both b and c.

3. If scarcity were not a fact,a. people could have all the goods and services they wanted for free.b. it would no longer be necessary to make choices.c. poverty, defined as the lack of a minimum level of consumption, would also be

eliminated.d. all of the above would be true.

4 . What do economists mean when they state that a good is scarce?a. There is a shortage of the good at the current price.b. It is impossible to expand the availability of the good.c. People will want to buy more of the good regardless of price.d. Our wants exceed our limited resources.

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SG1-3

5. Economics is concerned witha. the choices people must make because resources are scarce.b. human decision makers and the factors that influence their choices.c. the allocation of limited resources to satisfy virtually unlimited desires.d. all of the above.

6. Scarcity would cease to exist as an economic problem ifa. we learned to cooperate and not compete with each other. b. there were new discoveries of an abundance of natural resources.c. output per worker increased.d. none of the above.

7. Which of the following would not reflect self-interested behavior?a. worker pursuing a higher paying job and better working conditionsb. consumer seeking a higher level of satisfaction with her current incomec. Trying to help others more because the cost of doing so is higherd. Mother Teresa using her Nobel Prize money to care for the poore. none of the above

8. If people are self-interested,a. they will always choose work over leisure.b. they will never choose work over leisure.c. as their preferences for leisure time increase, they are likely to work more.d. as the wages they are offered increase, they are likely to work more.e. both c and d are true.

9. When economists assume that people act rationally, it means they:a. always make decisions based on complete and accurate information.b. make decisions that will not be regretted later.c. make decisions based on what they believe is best for themselves using available

information.d. make decisions based solely on what is best for society.e. commit no errors in judgment.

10. “As a rational person, you would expect individuals to always avoid actions that areillegal.”a. This is a true statement because most people don’t want to suffer the penalties

associated with criminal behavior. b. This is a true statement because most individuals are good citizens and prefer

not to commit crimes. c. This is a false statement because it is expected that individuals will consider the

consequences of their actions and that some will choose to commit illegal actsanyway.

d. This is a false statement because only people with certain genetic predisposi-tions are likely to commit crimes.

11. When we look at a particular segment of the economy, such as a given industry, weare studyinga. macroeconomics.b. microeconomics.c. normative economics.d. positive economics.

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12. Which of the following is most likely a topic of discussion in macroeconomics?a. an increase in the price of a pizzab. a decrease in the production of VCRs by a consumer electronics companyc. an increase in the wage rate paid to automobile workersd. a decrease in the unemployment ratee. the entry of new firms into the software industry

13. An economic theorya. should be as detailed as possible in order to model the complexity of an economy.b. is an abstraction from reality. c. attempts to explain but not predict.d. is unrealistic and therefore of dubious usefulness in explaining what occurs in a

complex economy.

14. Economists use theories toa. abstract from the complexities of the world.b. understand economic behavior.c. explain and help predict human behavior.d. do all of the above.e. do none of the above.

15. The importance of the ceteris paribus assumption is that ita. allows one to separate normative economic issues from positive economic ones.b. allows one to generalize from the whole to the individual.c. allows one to analyze the relationship between two variables apart from the

influence of other variables.d. allows one to hold all variables constant so the economy can be carefully ob-

served in a suspended state.

16. Which of the following statements can explain why correlation between Event Aand Event B may not imply causality from A to B?a. The observed correlation may be coincidental.b. There may be a third variable that is responsible for causing both events.c. Causality may run from Event B to Event A instead of in the opposite direction.d. All of the above can explain why the correlation may not imply causality.

17. Ten-year-old Tommy observes that people who play football are larger than averageand tells his mom that he’s going to play football because it will make him big andstrong. Tommy is: a. committing the fallacy of composition. b. violating the ceteris paribus assumption. c. mistaking correlation for causation. d. committing the fallacy of decomposition.

18. Which of the following correlations is likely to involve primarily one variable caus-ing the other, rather than a third variable causing them both?a. The amount of time a team’s third string plays in the game tends to be greater,

the larger the team’s margin of victory.b. Higher ice cream sales and higher crime rates both tend to increase at the

same time.c. A lower price of a particular good and a higher quantity purchased tend to oc-

cur at the same time. d. The likelihood of rain tends to be greater after you have washed your car.

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19. Which of the following is a statement of positive analysis?a. New tax laws are needed to help the poor. b. Teenage unemployment should be reduced.c. We should increase Social Security payments to the elderly.d. An increase in tax rates will reduce unemployment.e. It is only fair that firms protected from competition by government-granted

monopolies pay higher corporate taxes.

20. “Mandating longer sentences for any criminal’s third arrest will lead to a reduction in crime. That is the way it ought to be, as such people are a menace to society.”This quotationa. contains positive statements only.b. contains normative statements only.c. contains both normative and positive statements.d. contains neither normative nor positive statements.

Problems1. Do any of the following statements involve fallacies? If so, which ones do they

involve?a. Because sitting in the back of classrooms is correlated with getting lower grades

in the class, students should always sit closer to the front of the classroom.b. Historically, the stock market rises in years the NFC team wins the Super Bowl

and falls when the AFC wins the Super Bowl; I am rooting for the NFC teamto win for the sake of my investment portfolio.

c. When a basketball team spends more to get better players, it is more successful,which proves that all the teams should spend more to get better players.

d. Gasoline prices were higher last year than in 1970, yet people purchased moregas, which contradicts the law of demand.

e. An increase in the amount of money I have will make me better off, but an in-crease in the supply of money in the economy will not make Americans as agroup better off.

2. Are the following statements normative or positive, or do they contain both nor-mative and positive statements?a. A higher income-tax rate would generate increased tax revenues. Those extra

revenues should be used to give more government aid to the poor. b. The study of physics is more valuable than the study of sociology, but both

should be studied by all college students.c. An increase in the price of corn will decrease the amount of corn purchased.

However, it will increase the amount of wheat purchased.d. A decrease in the price of butter will increase the amount of butter purchased,

but that would be bad because it would increase Americans’ cholesterol levels.e. The birth rate is reduced as economies urbanize, but that also leads to a de-

creased average age of developing countries’ populations.

3. Are the following topics ones that would be covered in microeconomics or macro-economics?a. the effects of an increase in the supply of lumber on the home-building industryb. changes in the national unemployment ratec. the effect of interest rates on the machine-tool industryd. the effect of interest rates on the demand for investment goods in societye. the way a firm maximizes profits

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why is economics useful? and method can economists predict

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