1.5 How Economists Analyze Economic Issues

This observational approach to economic analysis—describing the world as it is, not how we would like it to be—is referred to as positive economics Objective analysis of “what is” in the economy. . The single defining feature of this approach is that economists do not try to impose their beliefs and preferences on anyone else. There’s a big difference, for example, between saying, “Increasing the minimum wage will cause businesses to hire fewer workers,” and saying, “The minimum wage is not rising fast enough.” The difference is that the first statement is testable: It can be either verified or proven false by collecting data and crunching numbers. The second statement, on the other hand, cannot be tested in any meaningful way: It is a statement of someone’s opinion of how the world should be rather than an assertion of fact. Economists refer to such statements as normative economics Statements of “what should be” in the economy. .

Everybody has opinions, but that doesn’t make them right. If you say the minimum wage isn’t rising fast enough, not everyone will agree with you. Business owners facing rising labor costs might think that the minimum wage is rising too fast. That, too, is an opinion. Both of these opinions might be data driven, but they could just as easily reflect the opinion holder’s pro-labor or pro-business sympathies.

In this book, we will take a positive approach. The positive approach prevents us from arbitrarily supporting the interests of the people we happen to like over the interests of people we don’t. In our study of the economy, everybody counts, no matter how much we might dislike them.

The positive approach also helps us avoid making judgments about what is “fair.” Economist Harold Winter of Ohio University illustrates the difficulty in making such judgments in this way: Suppose your instructor has $1,000 to split between two students in your class (let’s call them Velma and Daphne). How should the instructor divide that money? Many of you might say that $500 each, a 50–50 split, is the only fair division. But what if Velma is very rich and Daphne is very poor? Would your answer change? Would it be more fair to give Velma less (say, $100), and Daphne more ($900)?

But one might argue that because Velma already has a lot of money, $500 wouldn’t make her much happier. Conversely, because Daphne is poor, even a tiny amount would bring her great happiness. So maybe it’s most fair to divide the money in a way that brings each girl the same amount of happiness—perhaps $900 to Velma and only $100 to Daphne.

The point is that there isn’t really a right or wrong answer to the question of a fair division of the $1,000. Make a decision about how to divide the money and one person or the other can come up with a reasoned argument why it should be divided differently. That’s true for the $1,000, and it’s generally true for anything produced in an economy that must then be allocated among that economy’s participants. One reason that economists generally stick to the positive approach is because the question of fair division is so hard to decide objectively.

There’s a bigger problem that appears when scarce resources must be allocated. Sometimes people don’t just holler, “That’s not fair!” when they receive a smaller slice than they think they deserve; instead, they take actions to increase the size of their slice. As this book unfolds, you’ll learn that sometimes when people actively pursue bigger slices for themselves, they can cause losses to others that are much larger than their own gains. Cases like these are  analogous to Daphne taking  $5 from Velma, putting $3 in her wallet, and tearing the remaining $2 into confetti.

At a societal level, these kinds of things happen all the time. Every time they happen, society gets poorer. In those circumstances, it might be nice to have an impartial watchdog that cares about society and can offer guidance to help keep society from wasting its scarce resources.

We’ve got just such a watchdog. She is a hypothetical figure economists call the benevolent social planner (BSP). You will see her often in this book. She is all-seeing and all-knowing, able to process the likes, dislikes, and activities of every individual in every society simultaneously. She’s called “benevolent” for a reason: She cares about her people, she understands the environment of scarcity we operate in, and she wants us to extract the greatest amount of happiness from the limited resources we’ve been given. Her only objective is to maximize the size of the economic pie, and she always knows just how to do that. Despite that knowledge, she has no actual authority: She cannot direct us to do more of the things that make us richer and less of the things that make us poorer. She serves in an advisory role only.

We could use the BSP’s advice. This is because we have a natural inclination to focus on our own needs while ignoring the impact we have on others. Consider a policy that makes Kansans $3 richer but Nebraskans $5 poorer. If the Kansas legislature is considering this policy, it makes perfect sense to enact it. But if it’s the federal government considering that same policy, it looks more foolish: It makes the nation $2 poorer.

The benevolent social planner takes that bird’s-eye view of our affairs. She understands why Kansans might want such a law but knows that in the end, such a law will ultimately reduce the material well-being of Nebraska, the United States, and the world as a whole. The benevolent social planner considers everybody equally, no matter where they were born or what they do for a living, and she philosophically rejects any policy that makes someone richer at the greater expense of people elsewhere. In other words, the BSP is a positive economist, one that we will look to often when we evaluate the origins of and solutions to social problems.