Questions for Review
1. It is often said that a good theory is one that can be refuted by an empirical, data-oriented study. Explain why a theory that cannot be evaluated empirically is not a good theory. A theory is useful only if it succeeds in explaining and predicting the phenomena it was intended to explain. If a theory cannot be evaluated or tested by comparing its predictions to known facts and data, then we have no idea whether the theory is valid. If we cannot validate the theory, we cannot have any confidence in its predictions, and it is of little use. 2. Which of the following two statements involves positive economic analysis and which normative? How do the two kinds of analysis differ?
a. Gasoline rationing (allocating to each individual a maximum amount of gasoline that can be purchased each year) is poor social policy because it interferes with the workings of the competitive market system.
Positive economic analysis is concerned with explaining what is and predicting what will be. Normative economic analysis describes what ought to be. Statement (a) is primarily normative because it makes the normative assertion (i.e., a value judgment) that gasoline rationing is “poor social policy.” There is also a positive element to statement (a), because it claims that gasoline rationing “interferes with the workings of the competitive market system.” This is a prediction that a constraint placed on demand will change the market equilibrium. b. Gasoline rationing is a policy under which more people are made worse off than are made better off.
Statement (b) is positive because it predicts how gasoline rationing affects people without making a value judgment about the desirability of the rationing policy. 3. Suppose the price of regular-octane gasoline were 20 cents per gallon higher in New Jersey than in Oklahoma. Do you think there would be an opportunity for arbitrage (i.e., that firms could buy gas in Oklahoma and then sell it at a profit in New Jersey)? Why or why not? Oklahoma and New Jersey represent separate geographic markets for gasoline because of high transportation costs. There would be an opportunity for arbitrage if transportation costs were less than 20 cents per gallon. Then arbitrageurs could make a profit by purchasing gasoline in Oklahoma, paying to transport it to New Jersey and selling it in New Jersey. If the transportation costs were 20 cents or higher, however, no arbitrage would take place.
4. In Example 1.3, what economic forces explain why the real price of eggs has fallen while the real price of a college education has increased? How have these changes affected consumer choices?
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Pindyck/Rubinfeld, Microeconomics, Eighth Edition
The price and quantity of goods (e.g., eggs) and services (e.g., a college education) are determined by the interaction of supply and demand. The real price of eggs fell from 1970 to 2010 because of either a reduction in demand (e.g., consumers switched to lower-cholesterol food), an increase in supply due perhaps to a reduction in production costs (e.g., improvements in egg production technology), or both. In response, the price of eggs relative to other foods decreased. The real price of a college education rose because of either an increase in demand (e.g., the perceived value of a college education increased, population increased, etc.), a decrease in supply due to an increase in the cost of education (e.g., increase in faculty and staff salaries), or both.
5. Suppose that the Japanese yen rises against the U.S. dollar—that is, it will take more dollars to buy a given amount of Japanese yen. Explain why this increase simultaneously increases the real price of Japanese cars for U.S. consumers and lowers the real price of U.S. automobiles for Japanese consumers.
As the value of the yen grows relative to the dollar, it takes more dollars to...
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