Positive and normative economics

Topic 1. Introduction to labor Economics

The labor market

The labor market is like other markets in that a commodity (labor services) is bought and sold. It differs from most product markets in several important ways. Among these differences are:

· labor services are rented, not sold,

· labor productivity is affected by pay and working conditions, and

· the suppliers of labor care about the way in which the labor is used.

Labor economics examines the effects of each of these differences

Positive and normative economics

Economists distinguish between positive and normative economics. Positive economics involves an attempt to describe how the economy operates using the scientific method. Economists engaged in positive economic analysis build economic models that consist of testable hypotheses. Normative economics, on the other hand, relies on value judgments to evaluate the overall functioning of the economy.

Some examples might help to illustrate the distinction between positive and normative analysis. Suppose an economist says: "Earnings increase with education because education raises a worker's productivity." This is an example of positive economic analysis because this question can involve a testable hypothesis. Suppose another economist argues that society should subsidize education for all individuals. This is an example of normative economic analysis because it involves a value judgment about what is best for society.

Economic theories rely on a process of abstraction. This sometimes sounds intimidating, but that's primarily because of a common misunderstanding concerning what is meant by abstract analysis. Think about other uses of the term "abstract." Examples that often come to mind are abstract art and abstracts of journal articles. What do these cases have in common? Abstract art is an attempt to represent a complex reality by a reliance on simple shapes and forms. Journal article abstracts are short, simplified, summaries of the material in the article. As these examples should suggest, abstraction is simply a way of simplifying reality so that it may be more easily understood. Abstraction in economic analysis involves focusing on the most important and essential relationships while suppressing the less essential details. To engage in this type of analysis in a meaningful way, economists rely on the ceteris paribus assumption. Ceteris paribus means: "all other things constant." By invoking this assumption, economists attempt to focus on the most essential relationships while holding constant those factors that are less fundamental. This makes it possible to come up with relatively simply theories (called economic models) that rely on a small number of hypotheses.

The validity of an economic model is generally evaluated by how well it can explain and predict behavior. Economists tend to focus on testing the predictions of a model, rather than on examining the assumptions of a model. Presumably, though, a model's predictive ability will be affected by whether or not the assumptions are consistent with individual behavior. Economists rely on statistical analysis (called econometric analysis) to evaluate the predictive success of their models.