No Such Thing as a Free Lunch: Principles of Economics (Part 2)

Economics is everywhere, and understanding economics can help you make better decisions and lead a happier life.

Tyler Cowen

The Scope and Method of Economics

(Part B)

by

Charles Lamson

The Scope of Economics

Microeconomics and Macroeconomics

Microeconomics deals with the functioning of individual industries and the behavior of individual economic decision-making units: business firms and households. Firms' choices about what to produce and how much to charge, and households' choices about what and how much to buy, help to explain why the economy produces the things it does.

Another big question addressed by microeconomics is who gets the things that are produced. Wealthy households get more than poor households, and the forces that determine this distribution of output are the providence of microeconomics. Why does poverty exist? Who is poor? Why do some jobs pay more than others? 

Macroeconomics looks at the economy as a whole. Instead of trying to understand what determines the output of a single firm or industry or the consumption patterns of a single household or group of households, macroeconomics examines the factors that determine national output, or national product. Microeconomics is concerned with household income; macroeconomics deals with national income.

Whereas microeconomics focuses on individual product prices and relative prices, macroeconomics looks at the overall price level and how quickly (or slowly) it is rising (or falling). Microeconomics questions how many people will be hired (or fired) this year in a particular industry or in a certain geographic area, and the factors that determine how much labor a firm or industry will hire. Macroeconomics deals with aggregate employment and unemployment: how many jobs exist in the economy as a whole, and how many people who are willing to work are not able to find work.

 To summarize: Microeconomics looks at the individual unit---the household, the firm, the industry. It sees and examines the "trees." Macroeconomics looks at the whole, the aggregate. It sees and analyzes the "forest."

The Diverse Field of Economics

Individual economists Focus their research and study in many diverse areas. Many of these specialized fields are reflected in the advanced courses offered at most colleges and universities. Some are concerned with economic history or the history of economic thought. Others focus on international economics or growth in less developed countries. Still others that study the economics of cities (urban economics) or the relationship between economics and law.

Economists also differ in the emphasis they place on theory. Some economists specialize in developing new theories, whereas others spend their time testing the theories of others. Some economist hope to expand the frontiers of knowledge, whereas others are more interested in applying what is already known to the formulation of public policies.

Economics encompasses a broad range of inquiry and is linked to many other disciplines.

The Method of Economics

Economics asks and attempts to answer two kinds of questions, positive and normative. Positive economics attempts to understand behavior and the operation of economic systems without making judgments about whether the outcomes are good or bad. It strives to describe what exists and how it works. What determines the wage rate for unskilled workers? What would happen if we abolished the corporate income tax rate? The answers to such questions are the subject of positive economics. 

In contrast, normative economics looks at the outcomes of economic behavior and asks whether they are good or bad and whether they can be made better. Normative economics involves judgments and the prescriptions for courses of action. Should the government subsidize or regulate the cost of higher education? Should medical benefits to the elderly under Medicare be available only to those with incomes below some threshold? Should the United States allow importers to sell foreign-produced goods that compete with U.S. products? Normative economics is often called policy economics.

Of course most normative questions involve positive questions. To know whether the government should take a particular action, we must know first if it can and second what the consequences are likely to be. (For example, if we lower import fees, will there be more competition and lower prices?)

Some claim that positive, value free economic analysis is impossible. They argue that analysts come to problems with biases that cannot help but influence their work. Furthermore, even in choosing what questions to ask or what problems to analyze, economists are influenced by political, idealogical, and moral views.

Although this argument has some merit, it is nevertheless important to distinguish between analyses that attempt to be positive and those that are intentionally and explicitly normative. Economists who ask explicitly normative questions should be forced to specify their grounds for judging one outcome superior to another.

Descriptive Economics and Economic Theory Positive economics is often divided into descriptive economics and economic theory. Descriptive economics is simply the compilation of data that describe phenomena and facts. Examples of such data appear in the Statistical Abstract of the United States, a large volume of data published by the Department of Commerce every year that describes many features of the U.S. economy. Massive volumes of data can now also be found on the Internet. As an example look at www.bls.gov (Bureau of Labor Statistics).

Where do all these data come from? The Census Bureau collects an enormous amount of raw data every year, as do the Bureau of Labor Statistics, the Bureau of Economic Analysis, and non-government agencies such as the University of Michigan Survey Research Center. One important study now published annually is the Survey of Consumer Expenditure, which asks individual households to keep careful records of all their expenditures over a long period of time. Another is the National Longitudinal Survey of Labor Force Behavior, conducted over many years by the center for human resource development at the Ohio State University.

Economic theory attempts to generalize about data and interpret them. An economic theory is a statement or set of related statements about cause and effect, action and reaction. One of the first theories you will encounter in this analysis is the law of demand, which was most clearly stated by Alfred Marshall in 1890: When the price of a product rises, people tend to buy less of it; when the price of a product falls, they tend to buy more.

Theories do not always arise out of formal numerical data. All of us have been collecting observations of people's behavior and their responses to economic stimuli for most of our lives. We may have observed our parents reaction to a sudden increase or decrease in income or to the loss of a job or the acquisition of a new one. We all have seen people standing in line waiting for a bargain. Of course, our own actions and reactions are another important source of data. 

*MAIN SOURCE: CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 6-9*

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