Ragan: Economics

Sixteenth Canadian Edition

Chapter 2
Economic Theories, Data, and
Graphs

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Chapter Outline/Learning Objectives

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2.1 Positive and Normative Statements
• Normative statements depend on value
judgements and cannot be evaluated solely by a
recourse to facts.
– A normative statement is about what ought to be.

• Positive statements do not involve value

judgments. They are statements about matters of
fact.
– A positive statement is about what actually is, was, or
will be.

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Disagreements Among Economists
• Economists often disagree with each other in
public discussions
• Many public disagreements are based on the
positive/normative distinction.
• A responsible economist states clearly which part
of proffered advice is normative and what part is
positive.
APPLYING ECONOMIC CONCEPTS 2-1
Where Economists Work
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2.2 Building and Testing Economic Theories
• What Are Theories?
– A theory is an abstraction from reality.
– A theory consists of:
Ø variables
Ø assumptions
Ø predictions

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Testing Theories (1 of 2)
• A theory is tested by confronting its predictions
with evidence.
• If a theory is in conflict with facts, it will usually be
amended to make it consistent with those facts, or
it will be discarded to be replaced by a superior
theory.
• The scientific approach is central to the study of
economics.

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The Interaction Between and Empirical
Observation Figure 2-1

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Testing Theories (2 of 2)
• A theory is tested by confronting its predictions with
empirical evidence.
• When a theory consistently fails to predict better
than an available alternative, it is either modified or
replaced.

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Statistical Analysis
• Used to test a hypothesis such as “if X increases,
then Y will also increase.”
• Economists must use millions of “uncontrolled”
experiments going on every day in the marketplace.
• The variables that interest economists are generally
influenced by many forces that vary simultaneously.
• The analysis of such data requires the use of
appropriate—and complex—statistical techniques.

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Correlation versus Causation
• Positive correlation means only that X and Y
move together, in the same direction.
• Negative correlation means that X and Y move in
opposite directions.
Ø A finding that X and Y are correlated is not direct
evidence of a causal relationship.

Ø Most economic predictions involve causality.

Establishing causality usually requires advanced
statistical techniques.

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2.3 Economic Data
• Index Numbers
– An index number is a measure of some variable,
conventionally expressed relative to a base period,
which is assigned the value 100.

Absolute value in given period

Value of index in given period = ¥ 100
Absolute value in base period

• More Complex Index Numbers: CPI (Chapter 19)

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Index Values for Steel and Newsprint
Output Figure 2-2

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Graphing Economic Data
• A single economic variable, such as
unemployment, national income, or the average
price of a house, can come in two basic forms:
– Cross-sectional data
– Time-series data

• Another way to represent data is with a scatter

diagram.
– A graph showing two variables, one measured on each
axis.
– Each point represents the values of the variables for a
particular unit of observation.
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Index Values for Steel and Newsprint
Output Figure 2-3

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2.4 Graphing Economic Theories
When one variable, X, is related to another variable,
Y, in such a way that to every value of X there is
only one possible value of Y, we say that Y is a
function of X.
• Example:
• A function can be expressed: When W (wage income) is
– in a verbal statement zero, consumption is $800 a
– in a numerical schedule year. For every extra $1 of
(a table) wage income the person will
increase consumption by
– in a mathematical
0.8($1) or 80 cents.
equation
– in a graph • C= $800 + 0.8W
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Income and Consumption Figure 2-6

Wage Reference
Income Consumption Letter
(w) (C)
$0 $800 p
2 500 2 800 q
5 000 4 800 r
7 500 6 800 s
10 000 8 800 t

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Graphing Functions
• When two variables move together, the variables
are positively related.
• When two variables move in opposite directions, the
variables are negatively related.
• If the graphs of these relationships are straight
lines, the variables are linearly related to each
other.
• A function that is not graphed as a straight line is a
non-linear function.
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The Slope of a Straight Line
• Let X be the variable measured on the horizontal axis
and Y be the variable measured on the vertical axis.
• The slope of a straight line is calculated as Δ Y/ Δ X.

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Non-Linear Functions (1 of 2)
• This figure illustrates diminishing marginal response.
• For non-linear functions, the slope of the curve changes as
X changes. Therefore, the marginal response of Y to a
change in X depends on the value of X.

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Non-Linear Functions (2 of 2)
• This figure illustrates increasing marginal cost

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Functions with a Minimum or Maximum
(1 of 2)

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Functions with a Minimum or Maximum
(2 of 2)

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A Final Word
• We have discussed why economists develop
theories (or models) to help them understand
economic events in the real world.
• We have discussed how they test their theories
and how there is a continual back-and-forth
process between empirical testing of predictions
and refining the theory.
• Finally, we have explored the many ways data can
be displayed in graphs and how economists use
graphs to illustrate their theories.
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