Методические указания: профессиональный английский язык для студентов 5 и 6 курсов заочного факультета специальность 060800: Экономика и управление




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Methodological considerations in contemporary economics

Economists are sometimes confronted with the charge that their discipline is not a science. Human behaviour, it is said, cannot be analyzed with the same objectivity as the behaviour of atoms and molecules. Value judgments, philosophical preconceptions, and ideological biases must interfere with the attempt to derive conclusions that are independent of the particular economist espousing them. Moreover, there is no laboratory in which economists can test their hypotheses.

This argument raises issues for all of the social sciences. Only a very general reply can be given here. Economists are wont to distinguish between "positive economics" and "normative economics." Positive economics seeks to establish facts: Will a subsidy to butter producers lower the price of butter? Will a rise in wages in the automobile industry reduce the employment of automobile workers? Will devaluation improve the balance of payments? Does monopoly foster technical progress? Normative economics, on the other hand, is not concerned with matters of fact but with questions of policy, of "good" or "bad": Should the goal of price stability be sacrificed to that of full employment? Should income be taxed at a progressive rate? Should there be legislation in favour of competition?

Positive economics in principle involves no judgments of value; its findings may be as impersonal as those of astronomy and meteorology, two natural sciences that are also denied the advantage of conducting laboratory experiments. As the British philosopher David Hume argued 200 years ago, there is no logical way to deduce "ought" from "is" or prescriptions from descriptions; all statements of fact are ethically neutral. In that sense a value-free economics is possible (at least in principle): if economics is about the application of means to achieve given ends, there would seem to be no reason why one cannot analyze the allocation of means to achieve any end. This is not to deny that most of the interesting economic propositions involve the addition of definite value judgments to a body of established facts, that ideological bias creeps into the very selection of the questions that economists investigate, that what is a means from one point of view may be an end from another, nor even that much practical economic advice is loaded with concealed value judgments, the better to persuade rather than merely to advise. This is only to say that economists are human. The commitment of economists the world over to the ideal of value-free positive economics (or to the candid declaration of personal values in normative economics) serves as a defense against the attempts of special interests to bend the science to their own purposes. The best assurance against bias on the part of any particular economist is the criticism of other economists. The best protection against special pleading in the name of science is the professional standards of scientists.

Methods of inference

But how, one may ask, are facts established in a science that cannot conduct experiments? In essence, the answer is: by means of statistical inference. Economists typically begin by describing the area under study according to what they feel to be important. Then they construct a "model" of the real world, deliberately repressing some of its features and emphasizing others; they abstract, isolate, and simplify, thus imposing order on a world that at first glance appeared disorderly. Having evolved an admittedly unrealistic representation of the real world, they then manipulate the model by a process of logical deduction, arriving eventually at some prediction or implication that is of general significance. At this point, they return to the real world to see whether or not the prediction is borne out by observed events.

But the observable events that are available to test a theory never exhaust the population of all such events: they are merely a sample of it. This raises the problem of statistical inference; namely, what can be inferred about a population from a sample of the population? The theory of statistical inference is simply an agreed-upon procedure for making such inferences, but in the nature of the case it never succeeds in removing all elements of judgment from an inference. Thus the empirical truths of economics are invariably surrounded by a band of doubt, and economists speak of them as "probable" or "likely"; they are propositions in which economists have "a certain degree of confidence" because it is unlikely that they could have come about by chance.

It follows that judgments are at the heart of both positive and normative economics. It is easy to see, however, that judgments about "degrees of confidence" and "statistical levels of significance" are of a totally different order from those that crop up in normative economics. When men say that every individual should be allowed to spend his income as he likes, that people should not be free to control material resources and to employ others, or that governments must offer relief for the victims of inexorable economic forces, they are making the kind of value judgments that laymen have in mind when they accuse economists of producing personal preferences in the guise of scientific conclusions. There is no room for such value judgments in positive economics.

Microeconomics

Since Keynes, economic theory has been of two kinds: macroeconomics — or the study of the determinants of national income — and the traditional microeconomics. The latter approaches the economy as if it were made up only of business firms and households (ignoring governments, banks, charities, trade


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unions, and all other economic institutions) interacting in two kinds of markets — product markets and markets for productive services, or factor markets. Households appear as buyers in product markets and as sellers in factor markets, where they offer men, machines, and land for sale or hire. Firms appear as sellers in product markets and as buyers in factor markets. In each type of market, price is determined by the interaction of demand and supply, and the problem of microeconomic theory is to say something meaningful about the forces that make up demand and supply.

Theory of choice

At first it appears that all one can say is that everything depends on everything else. But firms and households do not behave in a vacuum. Firms face certain technical constraints in producing goods and services, and households have definite preferences for some products over others. It is possible to express the technical constraints facing business firms by writing down a series of "production functions," one for each firm. A production function is simply a kind of equation that expresses the fact that the output of a firm depends on the quantity of inputs it employs and, in particular, that inputs can be technically combined in different proportions to produce a given level of output. A production engineer could calculate, on the basis of existing technical knowledge, the largest possible output that could be produced with every possible combination of inputs and in this way could define a boundary to the range of production possibilities open to a firm. By itself this does not tell how much the firm will produce or what mixture of products it will make or what combination of inputs it will adopt: these depend on the prices of products and the prices of inputs (or "factors of production"), which have yet to be determined. One may assume that the firm is motivated in a particular way: it wants to maximize profits, which are defined as the difference between the sales value of its output and the money outlays required to obtain its inputs. It will, therefore, select that combination of inputs that minimizes the costs of producing any given quantity of output and will select from the range of possible combinations of products that combination that maximizes its revenues. This is to say that it always tries to move along its production function, along the edge of the boundary of technical possibilities. But where it ends depends, in part, on the demand for its products. This leads to the part played by households in the system.

Households are endowed with definite "tastes" that can be expressed in a series of "utility functions," one for each household. A utility function is an equation like a production function, expressing the fact that the pleasure or satisfaction that households derive from consumption depends on the products that they purchase and on the various ways in which they combine these products in consumption to yield a given level of satisfaction. The utility function need not be specified in the

same detail as a production function. One may think of it as a general description of the household's preferences between all the paired alternatives with which it will be confronted. Here, too, it is necessary to assume something about motivation to make any progress: the assumption is that households seek to maximize satisfaction, distributing their given incomes among available consumer goods in such a way as to derive the largest possible "utility" from consumption. Their incomes, however, remain to be determined.

The purpose of production functions in economic theory is to provide an anchor in the bedrock of technology from which to derive the "supply curves" of firms in product markets and the "demand curves" of firms in factor markets. Similarly, the purpose of utility functions is to provide an anchor in subjective "tastes" from which to derive the "demand curves" of households in product markets and the "supply curves" of households in factor markets. All of these demand and supply curves express the quantities demanded and supplied as a function of prices, not because price is the only determinant of economic behaviour but because the purpose is to have a theory of price determination. Much of economic theory is devoted to showing how various production and utility functions, coupled with certain assumptions about behaviour, lead to demand and supply curves in which the quantity demanded is inversely related and the quantity supplied positively related to price. The figure depicts these relationships (curves would be just as suitable as straight lines).

Not all demand and supply curves look alike. The essential point is that most demand curves are negatively inclined, while most supply curves are positively inclined. This may seem a modest result for a great deal of effort, but the argument has powerful implications. The participants in a market will be driven automatically to the price at which the two curves intersect; this price p is called the "equilibrium" price or "market-clearing" price because it is the only price at which supply and demand are equal. If it is a market for butter, any change in the production function of dairy farmers or in the utility function of butter consumers or in the prices of cows, grassland, and milking equipment or in the incomes of butter consumers or in the prices of nondairy products that consumers buy can be shown to lead to definite changes in the equilibrium prices of butter and in the equilibrium quantity of butter produced. Better still, the effects of a government ceiling on the price of butter or of a tax on butter producers or of a price-support program for dairy farmers can be predicted with almost perfect certainty. As a rule, the prediction will refer only to the direction of change (the price will go up or down); but if the demand and supply curves of butter can be defined in quantitative terms on the basis of past data, one may be able to predict the actual magnitude of the change.


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Theory of allocation

This analysis of the behaviour of firms and households is to some extent symmetrical: all economic agents are conceived of as ordering a series of attainable positions in terms of an entity they are trying to maximize. For a firm these attainable positions are essentially input combinations; for a household they are product combinations. From the maximizing point of view, some combinations are better than others; the best combination is called the "optimal" or "efficient" combination. The rule for efficient, optimum allocation may now be stated baldly: an optimum allocation is one that equalizes the returns of the marginal or last unit to be transferred between all the possible uses. In the theory of the firm, an optimum allocation of outlays among the factors of production implies that the "marginal physical product" of an additional dollar devoted to hiring the services of any one of the factors is the same for all factors; the so-called law of eventually diminishing marginal productivity, a property of a wide range of production functions, ensures that such an optimum exists. In the theory of consumer behaviour an optimum situation obtains when the consumer has distributed his given income in such a way that the "marginal utility" of each additional dollar spent on any of the products purchased is equal for all products; the "law of eventually diminishing marginal utility," a property of a wide range of utility functions, ensures that such an optimum exists. These are merely particular examples of the "equimarginal principle," which is not only at the core of the theory of the firm and the theory of consumer behaviour but also underlies the theory of money, of capital, and of international trade. In fact, the whole of microeconomics is nothing more than the spelling out of this principle in ever wider contexts.

The equimarginal principle is, of course, applicable to any decision that involves alternative courses of action. Economics furnishes a technique for thinking about decisions, whatever their character and whosoever makes them. Military planners may, for example, consider a variety of weapons in the light of a single objective, that of damaging an enemy; some of the weapons are effective against the enemy's army, some against the enemy's navy, and some against his air force; the problem is to find an optimal allocation of the defense budget, one that equalizes the marginal contribution of each type of weapon. But defense departments rarely have single objectives; along with maximizing damage to an enemy there may be another objective, such as minimizing losses from attacks. In that case, more than the equimarginal principle is needed for a decision; it is necessary to know how the department ranks the two objectives in order of importance, since different rankings will imply different optima. But a ranking of objectives is simply a utility function or a preference function.

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In other words, when an institution pursues multiple ends, decisions about how to achieve them require a weighting of the ends. Every decision involves a "production function"— a statement of what is technically feasible — and a "utility function"; the equimarginal principle is then invoked to provide an efficient, optimal strategy. This applies just as well to the running of hospitals, churches, and schools as to the conduct of a business enterprise, to the location of an international airport as well as to the design of a development plan for an underdeveloped country. This is why economists crop up in what seem to be the most unlikely places, advising on activities that are obviously not being conducted for economic reasons.

Macroeconomics

There is, however, an approach to economics in which the foregoing considerations do not apply. That is the field known as macroeconomics. In macroeconomics one is concerned with the aggregate outcome of individual actions. Keynes's "consumption function," for example, which relates aggregate consumption to national income, is not built up from individual consumer behaviour; it is simply an empirical generalization. The focus is on income and expenditure flows rather than on markets. Purchasing power flows through the system from business investment to consumption, but it leaks out at two places in the form of personal and business savings. Counterbalancing the savings are investment expenditures in the form of new capital goods, houses, and so forth, which constitute a source of new injections of purchasing power in every period. Since savings and investments are carried out by different people for different motives, there is no reason why "leakages" and "injections" should be equal in every period. If they are not equal, national income, the sum of all income payments to the factors of production, will rise or fall in the next period. When planned savings equal planned investment, income will be at an equilibrium level, that is, a level at which it can sustain itself; when the plans of savers do not match those of investors, the level of income will go on changing until the two do match. One can complicate this simple model by making investment a function of the interest rate; by introducing the government budget, the money market, labour markets, imports and exports, foreign investment; and so forth. But all this is far removed from the problem of resource allocation and from the maximizing behaviour of individual economic agents.

The result is a kind of intellectual schizophrenia in which the techniques of microeconomics do not carry over fully into macroeconomics and vice versa. This is widely held to be an unsatisfactory state of affairs; economists have in recent years sought to build a bridge between the individual consumer and the overall

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consumption function and between the individual investor and the behaviour of aggregate investment. Nevertheless, the bridge remains incomplete, and the student of economics must be prepared to work with two boxes of tools.

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