Philosophy of Economics Part II: Positive Economics

Presentation to the Melbourne Philosophy Forum, May 24, 2009

Part II on The Philosophy of Economics (Positive Economics)

1.0 Positive economics is the study of economics as a science, independent of normative concerns. "Positive" in this sense means quantifiable, not good!

1.1 The split between positive and normative in philosophy is evident in David Hume in "Treatise Concerning Human Understanding", the "is"/"ought" fork, to G.E. Moore's notion of the "naturalistic fallacy"; a naturalistic fallacy when a moral claim is placed on a natural property.

1.2 For example: A positive economic theory might describe how money supply growth affects inflation, but it does not provide any instruction on what policy ought to be followed.

2.0 Group (A) in an overview of positive economics can include: Scarcity and Modelling, Elasticity of Supply and Demand, Marginal Analysis, Advantages of Specialisation.

2.1 Scarcity is the relationship between the availability of a good (supply) and the desire of a good (demand). General claim is that wants are unlimited but resources are limited therefore all goods exist in some degree of scarcity. Lionel Robbins defined economics (1932) as "the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses."

2.2 Elasticity is the ratio of the percent change in one variable to the percent change in another variable. An "elastic" good is one whose price elasticity of demand has a magnitude greater than one. Similarly, "unit elastic" and "inelastic" describe goods with price elasticity having a magnitude of one and less than one respectively. In good with inelastic demand is typically one which is a necessity with no clear substitutes (e.g., food and water as an aggregate good) and a good with inelastic supply is typically a natural resource with no obvious substitutes. Study of the price elasticity of supply and the price elasticity of demand for US products was undertaken by Hendrik S. Houthakker and Lester D. Taylor. Hendrik S. Houthakker, Lester D. Taylor. (1970). Consumer Demand in the United States: Analyses and Projections. Harvard University Press.

2.3 The marginal evaluation of a good is the metric of responsiveness with the addition of one more unit. For example, the marginal utility of a good or service is the utility gained from one more unit. For example the utility gained from the first bar of chocolate, then the second and a third and so forth. Same applies for marginal costs etc.

2,4 Opportunity costs is the loss opportunities forgone for making a decision. The decision to take a holiday means the monies expended there are monies that may have been spent on home improvements (for example). Related to opportunity cost is the advantages of specialisation and advantage.

2.5 Division of labour increases the productivity of labour (cf., Adam Smith and the pin factory) which also allows improvements in quality as well as quantity. However excess division of labour can cause disconnection from the total production, and loss of motivation from boredom. Plato's Republic argued for "natural inequality" arising from division of labour. Marx argued that the "necessary evil" of a technical division of labour should not equate with changes in political rights. Marx's idea of communism did not have a division of labour.

2.6 Comparative advantage is the gain from specialisation based on the ability of a person or a country to produce a particular good at a lower marginal cost and opportunity cost than another person or country. It is possible for a person or country to be absolutely less competent in the production of all goods and services but still comparatively better in some areas than others. Comparative advantage explains how trade can create value for both parties even when one can produce all goods with fewer resources than the other. The net benefits of such an outcome are called gains from trade.

3.0 Group (B) in an overview of positive economics can include: the economic calculation problem. How do you distribute resources effectively and efficiently? Can you rationally plan what everyone needs or do you need a market? Are some economic goods better suited for one mechanism or another?

3.1 The economic calculation problem is a planning without a price mechanism. Originally called the "socialist calculation problem" by Ludwig von Mises in 1920 and expounded by Friedrich Hayek. Money, as a means of exchange, allows many different goods to be analysed in terms of their cost. Without market prices
decisions made will therefore be largely arbitrary, resulting in inefficiencies due to complexity (somewhat alleviated by input-output analysis by Leontif in 1970)

3.2 Lack of a price mechanism also means lack of consumer control; production decisions in the hands of the producers leads to a 'conspiracy against the public', whereby producers deliberately make poor quality goods.

3.3 A fully planned economy cannot allow for entrepreneurship, in the satisfaction of new wants; the ex ante problem - it is impossible to predict, for example, what how many copies of an LP a new popular music band will be required especially if the band does not even exist yet.

3.4 This said, there are some goods which are well suited for planning mechanism - those with relatively low numbers of inputs; for example large scale infrastructure (e.g., roads)

4.0 Set (c) Macroeconomics studies the economy as a whole (e.g., aggregate demand and aggregate supply) and the use of fiscal and monetary policy to direct market cycles.

4.1 The Great Depression led to the development of macroeconomics as microeconomic behaviour led to aggregate individual adoption of liquid cash to result in further downfall in productivity, which increased the demand for money to be held liquid rather than invested and so forth.

4.2 Fiscal policy is the use of government spending and revenue collection to influence the economy. Government expenditure is best in the areas which reduce negative externalities (pollution) and enhance positive externalities (network effects, education, health). Government revenue collection requires to be that which causes minimal loss in trades ("deadweight loss"), easy to collect and administrate and payable by those taxed. Fiscal policy can result in a balanced budget, a deficit budget and a surplus budget. In general, a deficit budget should be used to stimulate an economy, with monies saved from times of economic surplus being used to pay for this. In practise, unless government expenditures genuinely increase productivity the recessionary pressures are enhanced but delayed.

4.3 Monetary policy is the control of the money supply and the rate of interest. Like fiscal policy, monetary policy is referred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy involves raising interest rates in order to combat inflation.

And.. to finish on a normative question.

What is the appropriate description for those who continue to assert an economic theory contrary to positive facts? Is it a religion?

Plus: "The Principles of Economics Translated" - a short, humorous video.