Econ 432--Chapter 2

1. Econ 432--Chapter 2 Tools of Positive Analysis

2. What is positive analysis? • Positive Economics or Positive Analysis: the study of how the economy works with an objective representation of what has occurred, what is happening, or what is expected to happen. • Since the analysis is positive in nature with no value judgment the reader cannot discern the author’s viewpoint on the subject. • Examples: • Description of economic statistics such as federal expenditures were $4.7 trillion in 2008 • Testing relationships between variables to determine causation or correlation such as if cigarette taxes are increased by 25% what is the predicted impact on tax revenue? • Efficiency considerations (lowest cost, maximum value, etc) are positive in nature

3. Basic terminology • Correlation: • Positive correlation Example: • Negative correlation Example:

4. Terminology continued 2. Causation: when a change in one variable causes a change in another variable. This requires the following three conditions to hold: • Other explanations for any observed correlation must be eliminated. This means you need to rule out other variables that might be affecting Y before claiming that X is causing the change in Y.

5. 3 tools of positive analysis These tools include (1) economic modeling; (2) experimental studies; and (3) observational studies or econometric analysis

6. Using economic models • Economists create economic models to examine hypothetical changes in public policy. • They help to frame the research question and isolate the set of variables that may influence the behavior of interest. • Ex: comparing various taxation options such as a lump sum tax, excise tax, or advalorem tax in terms of tax revenue generated and efficiency (minimal distortion of economic activity)

7. Using experimental studies Experimental studies typically test a hypothesis by comparing two different groups (a treatment group and a control group) and determining if there are significant differences between the two groups outcomes given certain parameters. • Treatment group:. • Control group:.

8. Experimental studies: example Example: My Dissertation: Efficiency and Equity Considerations in Procurement Auctions compared bidding strategies of firms under different preferential treatment structures. The Buy American legislation allows bidding preferences to American firms and increased preferences to minority-owned firms. Part of the dissertation uses experimental techniques in the following way: • Control group: group bidding for contracts with no preferential treatment allowed. • Treatment groups: groups that have differing levels of preferential treatment and/or other factors such as the number of bidders, etc. • Positive Analysis: compare the bidding behavior of 2 groups in which only one parameter has changed and look for statistically significant differences among behavior.

9. Advantages and disadvantages of experimental methods Advantage: There are any number of policies you can study by constructing proper experiments particularly in the absence of any historic data to do traditional econometric analysis. Disadvantages: • experiments require great precision. Conditions must be as close to real world conditions as possible to get reliable results. • Experiments can be expensive and often require several parameters being altered simultaneously and therefore lots of treatment groups are necessary.

10. Experimental studies continued • Some public policies cannot be addressed ethically through experimentation. • Ex: • Some public policies cannot be addressed legally through experimentation • Ex:

11. Observational studies--econometrics • Observational studies: statistical analysis of economic data in order to estimate causal relationships. Basic regression techniques allow you to determine the relative statistical importance of different factors that may be affecting outcomes. • Example: My dissertation • Positive Analysis: using data from South Carolina Procurement Office use basic regression analysis to determine the relative importance of each factor on bidding behavior (number of bidders, type of preferential treatment, etc).

12. Advantages and disadvantages of observational studies Advantages: • data is often available and in many cases less expensive than conducting experimental sessions. • Several factors can simultaneously change and be accounted for in the statistical estimation Disadvantage: • Results may be biased in cases where important variables are omitted • Ex: labor supply analysis finds that people with high after-tax wages work more hours and people with low after-tax wages work less hours suggesting a positive correlation between after tax wages and work hours. • However, what if some underlying factor, such as ambition, plays a role? Those with greater ambition work harder and have higher wages; whereas those with less ambition work less and have lower wages. Ambition is difficult to measure.

13. This course • We will use economic models to study the implications of various public policies (tax policies and social programs). • We will also use basic econometric techniques to examine the importance of different factors (economic and socioeconomic factors) in explaining demand for public programs.