Model Building and Gains from Trade
The Scientific Method of Economics
● Economics works the same way Mythbusters does in the was they use scientific methods to
answer questions about different real world phenomena further explaining how the world works
○ Four Steps
1. Researchers observe a phenomenon that interest them
2. Based on these observations, researcher develop a hypothesis, which is a
proposed explanation for the phenomenon
3. Then they construct a model to test the hypothesis
4. They look for opportunities to test how well the model (which is based on the
hypothesis) works
a. After they collect data they use statistical methods to verify, revise, or
refute the hypothesis
Positive and Normative Analysis
● Positive statement can be tested and validated
○ Can be thought of as a description of “what is”
○ Ex. “the unemployment is declining” is a positive statement because it can be tested by
gathering data
○ Positive economic- deals with facts and figures that can be tested and reality and cause
and effect relationships
■ Ex. as taxes are cut by 10% in the middle class(cause), spending in the state of RI
goes up 20% and output of products rises by 25%(effect)
■ As income goes down 20%, demand for gasoline went down 10% and
unemployment rate in the U.S went up from 5% to 14%
■ If something happening then blank
■ A positive statement could be false
● Normative statements is an opinion that cannot be tested or validated; it describes “what out to
be”
○ Opinions or judgment
○ What can not be tested or validated
○ Ex. “an unemployed worker should receive financial assistance to help make ends meet”
■ Starbucks should not raise their coffee prices
● Recession is when you have 2 or more consecutive quarters of declining output
○ Review ^
Economic Models
● Ceteris Paribus means other things being equal or all else equal and is used to build economic
models
○ Ex. Your income does not change it doesn't rise or fall
, ■ The price of arizona
○ It allows economists to examine a change in one variable while holding everything else
constant
● Three type of two variable relationship
1. Direct
2. Inverse
3. independent variable
● Inverse relationship
○ Income tax get cut peoples pay goes up
○ Oranges in florida becoming scarce because of the hurricane
■ As price goes down quantity and demand goes up
● Independent variable
● Direct
Practice Problems
QUESTION: Which of the following statements are positive and which ones are normative?
1. Winters in Arkansas are too cold.
a. normative
2. Everyone should work at a bank to learn the true value of money.
a. normative statements
3. The current exchange rate is 0.7 British pound per U.S. dollar.
a. positive statements
4. On average, people save 15% on insurance when they switch to Geico.
a. Positive statements
5. Everyone ought to have a life insurance policy.
a. Normative statment
6. University of Virginia graduates earn more than Duke University graduates.
a. normative statements
7. Harvard University is the top educational institution in the country.
a. normative statements
8. The average January temperature in Fargo, North Dakota, is 56°F.
a. normative statements
What is a Production Possibilities Frontier?
● Production possibilities frontier(PPF) is a model that illustrates the combinations of outputs a
society can produce if all of its resources are being
○ The higher mouth of wings being made the lower amount of pizza that are produced
■ This presents a trade off and opportunity cost
○ When society is producing a good the only way to get more of a good is to accept less of
another
○ When there are more resources (such as addition workers) are available for the
production of either pizza or wings, the entire PPF shifts upward and outward
○ Two types of ppf curves
The Scientific Method of Economics
● Economics works the same way Mythbusters does in the was they use scientific methods to
answer questions about different real world phenomena further explaining how the world works
○ Four Steps
1. Researchers observe a phenomenon that interest them
2. Based on these observations, researcher develop a hypothesis, which is a
proposed explanation for the phenomenon
3. Then they construct a model to test the hypothesis
4. They look for opportunities to test how well the model (which is based on the
hypothesis) works
a. After they collect data they use statistical methods to verify, revise, or
refute the hypothesis
Positive and Normative Analysis
● Positive statement can be tested and validated
○ Can be thought of as a description of “what is”
○ Ex. “the unemployment is declining” is a positive statement because it can be tested by
gathering data
○ Positive economic- deals with facts and figures that can be tested and reality and cause
and effect relationships
■ Ex. as taxes are cut by 10% in the middle class(cause), spending in the state of RI
goes up 20% and output of products rises by 25%(effect)
■ As income goes down 20%, demand for gasoline went down 10% and
unemployment rate in the U.S went up from 5% to 14%
■ If something happening then blank
■ A positive statement could be false
● Normative statements is an opinion that cannot be tested or validated; it describes “what out to
be”
○ Opinions or judgment
○ What can not be tested or validated
○ Ex. “an unemployed worker should receive financial assistance to help make ends meet”
■ Starbucks should not raise their coffee prices
● Recession is when you have 2 or more consecutive quarters of declining output
○ Review ^
Economic Models
● Ceteris Paribus means other things being equal or all else equal and is used to build economic
models
○ Ex. Your income does not change it doesn't rise or fall
, ■ The price of arizona
○ It allows economists to examine a change in one variable while holding everything else
constant
● Three type of two variable relationship
1. Direct
2. Inverse
3. independent variable
● Inverse relationship
○ Income tax get cut peoples pay goes up
○ Oranges in florida becoming scarce because of the hurricane
■ As price goes down quantity and demand goes up
● Independent variable
● Direct
Practice Problems
QUESTION: Which of the following statements are positive and which ones are normative?
1. Winters in Arkansas are too cold.
a. normative
2. Everyone should work at a bank to learn the true value of money.
a. normative statements
3. The current exchange rate is 0.7 British pound per U.S. dollar.
a. positive statements
4. On average, people save 15% on insurance when they switch to Geico.
a. Positive statements
5. Everyone ought to have a life insurance policy.
a. Normative statment
6. University of Virginia graduates earn more than Duke University graduates.
a. normative statements
7. Harvard University is the top educational institution in the country.
a. normative statements
8. The average January temperature in Fargo, North Dakota, is 56°F.
a. normative statements
What is a Production Possibilities Frontier?
● Production possibilities frontier(PPF) is a model that illustrates the combinations of outputs a
society can produce if all of its resources are being
○ The higher mouth of wings being made the lower amount of pizza that are produced
■ This presents a trade off and opportunity cost
○ When society is producing a good the only way to get more of a good is to accept less of
another
○ When there are more resources (such as addition workers) are available for the
production of either pizza or wings, the entire PPF shifts upward and outward
○ Two types of ppf curves
