1.4 Positive Economic Theory and Analysis

It will be noticed that value judgments and normative elements are unavoidable in economic discussions. Yet economists and researchers take the effort of preserving and developing the scientific content of the subject matter. There is a standard theoretical model generally used and improved upon in most analytical work. This model emerges out of neo-classical techniques introduced at the beginning of this century. Professor Danie M. Hausman in his recent book Inexact and Separate Science of Economics has brought out several basic features of this theoretical model. The important features are :

(A) Marginal Approach: The standard theoretical model used in economics is also called a marginal method or approach. This is because all optimizing decisions are taken ’at the margin’ under this method. Margin or marginal change means infinitesimally small changes in an economic entity under consideration, such as utility, cost, factor services, wage rate, quantity demanded or supplied, etc. Such a small or marginal change is in fact a mathematical tool used in calculus. In mathematics, the first derivative of any algebraic function is known as ’the rate of change.’ In economics, marginal value or quality serves exactly the same purpose. This can be illustrated as:

In each case marginal value indicates the rate of change. With a small variation in the quantity of x, the marginal utility changes at the rate of 2, or with a small change in the quantity of x, marginal revenue changes at the rate of 0.75. In both these examples, the sign of the marginal values is positive. Therefore both marginal utility and marginal revenue tend to increase with every increase in the quantity of x. This however need not always be the case. In the present case, the functions are said to be rising. But there may be falling functions as well, such as that of the cost of production in the initial stages. In that case, value of the marginal cost may be negative. In fact, productive activity normally and beneficially occurs on the falling phase of the average cost curve. This will get clearer as we proceed.

(B)Ceteris Paribus (restrictive) clause : The marginal method of economic analysis deals with the rate of small changes. Moreover, these are instant and isolated changes. We need to concentrate on the effect of such changes on concerned individuals. But actually, economic activity is highly complex and consists of interdependent factors. Therefore such isolated changes can be examined only under highly restricted conditions. We have to make a heroic assumption about the constancy or absence of change in all other related factors or causes. For instance, an individual’s demand for a commodity depends on several conditions such as the price of the commodity (P), prices of its substitutes (Ps), income of the individual (Y), the number of members in his family (N) and the tastes of that individual (Z). Such a relation can be expressed in a functional form as :

d = f (P, Ps, Y, N, Z).

This explains that ’d’, the quantity of a commodity demanded, functionally depends upon five different factors. In other words, any change in any one of these factors can result in a change in the quantity demanded. However, the marginal approach is partial in nature. It attempts to concentrate on any one of these factors at a time, in analyzing its effect. The rest of the factors are assumed to be constant. This is the implication of the Ceteris Paribus a condition which means ’other things remaining equal.’ If we want to concentrate on the isolated effect of changes in the price of the same good (P) on the quantity demanded, then this can be written as :

d = f (P) [Ps, Y, N, Z]const.

Here the second bracket, i.e. […], serves as a Ceteris Paribus assumption in explaining the price-demand relation.