Eco 101-understanding normative and postive Economics and ceteris paribus

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  Normative and Positive Economics

The normative economist tries to determine the desirability-undesirability of various economic conditions, situations or programs by asking the question: “What ought to or should be/have been?” The positive economist asks: “What is/was/has been?”

While positive economics gathers and analyzes real data – about things that happen or have happened – normative economics relies heavily on value judgments and theoretical scenarios that present subjective results, i.e. how things should be or should have been.

Normative economics tells us what things would be like or would have been like if public policy were or had been Normative statements usually deliver an opinion on economic scenarios instead of providing an objective analysis that presents proven facts.

Positive Economics
Tells you how it is/was

Normative Economics
Tells you how it should/ought to be or should/ought to have been

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Whoever is using normative economics in an argument is usually trying to change economic policies or to influence the decision-making process of lawmakers or captains of industry. (Captains of industry are people who head large and influential companies).

Constructiveness

Normative economics can be extremely useful if it is used by people who are trying to generate new ideas from a series of perspectives – if they aim to trigger real improvements, and they understand the key components of economics and how wealth is created.

However, it cannot ever become the only basis for making important decisions – decisions that affect whole countries, regions or the world – because it does not take an impartial/objective angle that concentrates on real cause-and-effects – in other words, facts.

If normative economics is used purely to criticize a political party, government or policymaker – crying over spilled milk – its usefulness is zero; no good ever comes of this type of approach.

Decision-makers tend to analyze the results of positive economic studies before making thir decisions. They will sometimes look at what is desirable (or not) for the people they represent. In such cases, normative economics will play a part when they decide on economic matters.

Example of normative economics

Imagine we are looking at scenarios in which the government reduced income taxes by 50%:

– A Normative Economic Statement may include the following words:

“The government should reduce income tax by 50%. It would help millions of people by increasing their disposable incomes.”

– A Positive Economic Statement: may include these words:

“While a 50% cut in income tax would help many workers and their families, current government budget constraints make that option both impossible and unfeasible.”

The normative economic statement carries value judgments – it assumes that people’s disposable income levels must be raised.

Normative economic statements are not tested – they are not proven by factual values or any cause and effect that has been legitimized.

The vast majority of economists today concentrate on positive economic analysis – they use ‘what is’ or ‘what was/has been’ occurring in the economy as the basis for any forecasts.

Positive and normative economics are often synthesized in the style of practical idealism. In this discipline, sometimes called the "art of economics," positive economics is utilized as a practical tool for achieving normative objectives, which often involve policy changes or states of affairs.

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                  Ceteris paribus

Economists use ceteris paribus, a cause-and-effect economic analysis, to build and test economic models.Economics' ceteris paribus conditions include:

• The number of consumers in the market

• Consumer tastes or preferences

• Prices of substitute goods

• Consumer price expectations

• Personal income Interpretation

One of the disciplines in which ceteris paribus clauses are most widely used is economics, in which they are employed to simplify the formulation and description of economic outcomes. When using ceteris paribus in economics, one assumes that all other variables except those under immediate consideration are held constant. For example, it can be predicted that if the price of beef increases—ceteris paribus—the quantity of beef demanded by buyers will decrease. In this example, the clause is used to operationally describe everything surrounding the relationship between both the price and the quantity demanded of an ordinary good.

This operational description intentionally ignores both known and unknown factors that may also influence the relationship between price and quantity demanded, and thus to assume ceteris paribus is to assume away any interference with the given example. Such factors that would be intentionally ignored include: a change in the price of substitute goods, (e.g., the price of pork or lamb); a change in the level of risk aversion among buyers (e.g., due to an increase in the fear of mad cow disease); and a change in the level of overall demand for a good regardless of its current price (e.g., a societal shift toward vegetarianism).

The clause is often loosely translated as "holding all else constant." It does not imply that no other things will in fact change; rather, it isolates the effect of one particular change. Holding all other things constant is directly analogous to using a partial derivative in calculus rather than a total derivative, and to running a regression containing multiple variables rather than just one in order to isolate the individual effect of one of the variables. Ceteris paribus is an extension of scientific modeling. The scientific method is built on identifying, isolating, and testing the impact of an independent variable on a dependent variable.

One thing to note is that since economic variables can only be isolated in theory and not in practice, ceteris paribus can only ever highlight tendencies, not absolutes. 

One example of ceteris paribus would be the economic law of supply. According to this law, an increase in price results in an increase in quantity supplied, when keeping others factors constant or ceteris paribus.

Using ceteris paribus, economists can focus solely on the two factors involved: price and supply. When producers are paid higher prices for a product, they will be willing to offer more of the product for sale by increasing production. While the real world is never as simple as this, the idea of ceteris paribus allows economists to look at the theoretical relationship between price and supply.  

Secondary example could be an explanation of the cost of eggs. In the real world, there’s a multitude of factors that would influence this cost, including the availability and health of chickens, the property values of farmland, the growing popularity of veganism reducing demand, or the level of currency inflation. To keep it simple and look solely at supply vs. cost, an economist could apply ceteris paribus. With all other factors constant, a reduction in the supply of egg-laying hens would cause egg prices to rise.

Additional examples might include two-factor relationships between:

*Currency supply and inflation

*Interest rates and GDP

*Minimumwage and unemployment

*Rent control and housing supply

Importance of ceteris paribus

There are several benefits that help explain the importance of ceteris paribus in economics:

They include:

1.Offers a way to create a framework for testing economic models.

2.Makes economic theories more scientific and less philosophical

3.Allows economists to explore multiple variables through testing hypotheses

Limitations:

On the other hand, this concept does have its clear limitations. While ceteris paribus enhances modelling and theoretical thinking, it doesn’t always reflect real world fluctuations. This can reduce the accuracy of economic models. Some critics claim that ceteris paribus allows economists to block out real-world problems or the impact of human nature on economic activity.

As we can see from the examples above, something as simple as the cost of eggs involves multiple factors which should be investigated in real-world modelling. However, it’s still important to understand ceteris paribus, which is used as the foundation of most economic laws.