January 7, 2011

Positive vs. Normative Economics

Economic theories have two principal functions. One is to explain the nature of economic activity.  A better understanding  of how changes in one economic variable affects another,  equips us in dealing  with the environment in which we live. An explanation on the nature of economic activities directly or indirectly affecting our well being is a useful decision making tool. For example, if there is an increase in the prices of basic food commodities, what will happen to our purchasing power as consumers?   A straightforward explanation on the cause and effect relationship of economic variables - price and consumption in this example, is a positive economic statement.  It describes the relationship.
The other function of economic theory is to predict what will happen to the economy. If we will be able to predict what is likely to happen to the key economic variables which impact on our lives, we will be prepared to take necessary actions if we don’t like the predicted consequences. What we desire to happen or what should happen is the realm of normative economics.
It is therefore important to distinguish a positive economic statement from a normative economic statement. 

Positive economics  is the study of the causal relationships that exist in the economy.   It just states what  the relationship is. There are no value judgements involved.   The statement “if taxes on tobacco is doubled,  there will be substantial reduction in tobacco consumption” is a positive economic statement.  It just states what is the situation. “If government subsidy to basic education is reduced, there will be higher drop-outs among children of poor families”, is another positive economic statement.

Normative economics on the other hand, is a study of what economic relationships ought to be.  Value judgements play an integral part in the ranking of possible objectives and the choices to be made among them. It usually pose the question “What should happen?” or “What ought to be.”  Taking the tobacco example, a normative statement would be “Taxes on tobacco should be raised by 100% to substantially reduce tobacco consumption”.  Notice the the term should in the statement. In the education example, a normative economic statement would likely be, “The government should continue to subsidize basic education to minimize drop outs”.

From these illustrations, we can deduce that statements of economic policy makers in government are normative economics in nature. A policy maker however, cannot just issue economic policies without proper understanding of the basic causal relationship of economic variables involved. Policy makers should be aware that economic prescriptions should be rooted on a sound positive economic analysis.  Economic policy making- a deliberate intervention in economic activity with the intent of altering the course it will take- is therefore an enormous responsibility.

To sum it up, positive economics is descriptive (what is)  while normative economics is prescriptive (what ought to be). Some economists have an apt distinction: positive economics is mathematical while normative economics is moral.

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