"Character is the one thing we make in this world and take with us into the next."
- - Ezra Taft Benson
July 31, 2012
Understanding Economics 101
by Adam Smith

Open up a newspaper or listen to a news show on television and you will hear economists say things that seem to contradict each other. For example, one economist will say passing a trade agreement with another country is bad and will cause people in the United States to lose their jobs, and another economist will say that opening up trade is good and will cause the U.S. economy to grow.

Is economics so abstract that there is nothing that economists can agree on?

It is impossible to explain all of economics in one article. But if you understand a few basic concepts about economics, it will help you understand why economists reach such varying conclusions on the same topic. In this article I will discuss one of those concepts.

Lionel Robbins defined economic as “the science that studies human behavior as a relationship between ends and scarce means which have alternate uses.” In other words, there is a limited amount of stuff that we humans have to allocate, and different things happen when we start allocating it different ways. How should we allocate scarce goods?

The first concept to understand is that there are two kinds of economics — positive and normative economics. Positive economics try to determine facts. Normative economics try to understand the way things ought to be.

Implementing a minimum wage is a good example.

Almost all economists agree that raising the minimum wage increases unemployment. This is a statement of fact, or positive economics. Whether we ought to have a minimum wage is normative economics.

For example, an economist who thinks we should be minimizing unemployment will want to decrease or eliminate the minimum wage. An economist who thinks people who work should at least make a wage that they could live on would be in favor of the minimum wage.

If you heard these two economists on television, they would both be saying their policy is best for people in the lower economic strata. Both policies do help someone poor, but the policies help different poor people. If you are looking for a job, you will like the first policy; if you are working for a very low wage, you will want the second policy.

The first economist basis their desired outcome on positive economics — raising the minimum wage will increase unemployment. The second economist is arguing based on normative economics — what ought to be. Economists are not very clear whether they are discussing positive or normative economics. This makes it very difficult for the general public to really understand the issue and makes the economists seem incompetent. Just know when there is an argument about economics, at least one side is talking about normative economics.

One more example that I mentioned in the first paragraph should help explain the difference between positive and normative economics.

Free trade is often in the news. Should the United State open up its borders for more free trade?

Positive economics tells us that through something called comparative advantage, free trade expands the economies of both countries. The size of the pie increases, and both countries are better off.

The normative economics of free trade is not always so simple. For many years, the steel industry in the United States was protected from outside competition through the use of tariffs. The jobs in the steel industry were good, high-paying jobs, and we as a country were reluctant to relinquish those jobs to overseas employees even though there would be some very positive impacts on the United States economy. Prices of many products would decrease due to lower steel costs.

Do we as a country want to eliminate good, high-paying jobs in exchange for perhaps more jobs that do not pay as much? Decreasing prices really does help those that are poor in the United States. How do we balance all the competing interests with respect to free trade? These are difficult decisions that fall under the umbrella of normative economics.

Perhaps now you can understand why economists have contradicting points of view.

One final point I need to make on normative and positive economics is that politicians routinely state normative economics as facts. Ignore almost everything politicians say about the economy, because by knowing about positive and normative economics you have just surpassed their understanding.

Bookmark and Share    

Why Economics Matter
- - October 20, 2015
- - December 30, 2014
The Chance
- - November 18, 2014
Changing Perceptions
- - October 7, 2014
The Threat
- - August 26, 2014
The Danger of Inversions
- - August 12, 2014
The Wait
- - July 15, 2014
East vs. West
- - June 3, 2014
Let Them Eat Cake
- - May 20, 2014
Ridiculous Averaging
- - May 6, 2014
More by Adam Smith

About Adam Smith

Adam Smith is obviously not the actual name of the author of this column. The real author has worked for two Fortune 500 companies, one privately held company, and a public accounting firm. His undergraduate degree was in accounting, and he earned an MBA for his graduate degree. He also has completed coursework for a PhD. in finance. He continues to be employed by one of the Fortune 500 companies.

The author grew up in the Washington D.C. area but also lived for several years in Arizona. He currently resides with his family on the East Coast.

The author has held various callings in The Church of Jesus Christ of Latter-day Saints.

Copyright © Hatrack River Enterprise Inc. All Rights Reserved. Web Site Hosted and Designed by WebBoulevard.com