Economics, we have now learned, is mainly a matter of creating models that draw on a set of basic principles but add some more specific assumptions that allow the modeller to apply those principles to a particular situation. But what do economists actually do with their models?

Imagine that you are an economic adviser to the premier of your province. What kinds of questions might the premier ask you to answer?

Well, here are three possible questions:

There is a big difference between the first two questions and the third one. The first two are questions about facts. Your forecast of next year’s gasoline tax will be proved right or wrong when the numbers actually come in. Your estimate of the impact of a change in the tax is a little harder to check—revenue depends on other factors besides the tax, and it may be hard to disentangle the causes of any change in revenue. Still, in principle there is only one right answer.

But the question of whether the tax on gasoline should be raised may not have a “right” answer—two people who agree on the effects of a higher gasoline tax could still disagree about whether raising this tax is a good idea. For example, someone who takes public transit or walks to work probably won’t care about the increased gasoline tax but may care about the reduced traffic and pollution. However, a regular car commuter may have the opposite priorities.

This example highlights a key distinction between two roles of economic analysis. Analysis that tries to answer questions about the way the world works, which have definite right and wrong answers, is known as positive economics. In contrast, analysis that involves saying how the world should work is known as normative economics. To put it another way, positive economics is about objective description; normative economics is about subjective prescription.

Positive economics occupies most of the time and effort of the economics profession. And models play a crucial role in almost all positive economics. As we mentioned earlier, the Canadian government uses computer models to assess proposed changes in federal tax policy, and many provincial and territorial governments have similar models to assess the effects of their own tax policies.

It’s worth noting that there is a subtle but important difference between the first and second questions we imagined the premier asking. Question 1 asked for a simple prediction about next year’s revenue—a forecast. Question 2 was a “what if” question, asking how revenue would change if the tax law were changed. Economists are often called upon to answer both types of questions, but models are especially useful for answering “what if” questions.

The answers to such questions often serve as a guide to policy, but they are still predictions, not prescriptions. That is, they tell you what will happen if a policy is changed; they don’t tell you whether or not that result is good. Suppose your economic model tells you that the premier’s proposed increase in gasoline taxes will raise inner city property values but will hurt people who must use their cars to get to work. Does that make this proposed tax increase a good idea or a bad one? It depends on whom you ask. As we’ve just seen, someone who is very concerned about pollution will support the increase, but someone who is very concerned with the welfare of drivers will feel differently. That’s a value judgment—it’s not a question of economic analysis.

Still, economists often do engage in normative economics and give policy advice. How can they do this when there may be no “right” answer?

One answer is that economists are also citizens, and we all have our opinions. But economic analysis can often be used to show that some policies are clearly better than others, regardless of anyone’s opinions.

Suppose that policies A and B achieve the same goal, but policy A makes everyone better off than policy B—or at least makes some people better off without making other people worse off. Then A is clearly more efficient than B. That’s not a value judgment: we’re talking about how best to achieve a goal, not about the goal itself.

For example, two different policies have been used to help low-income families obtain housing: rent control, which limits the rents landlords are allowed to charge, and rent subsidies, which provide families with additional money to pay rent. Almost all economists agree that subsidies are the more efficient policy. And so the great majority of economists, whatever their personal politics, favour subsidies over rent control.

When policies can be clearly ranked in this way, then economists generally agree. But it is no secret that economists sometimes disagree.

Economists have a reputation for arguing with each other. Where does this reputation come from, and is it justified?

One important answer is that media coverage tends to exaggerate the real differences in views among economists. If nearly all economists agree on an issue—for example, the proposition that rent controls lead to housing shortages—reporters and editors are likely to conclude that it’s not a story worth covering, meaning that professional consensus tends to go unreported. But an issue on which prominent economists take opposing sides—for example, whether cutting taxes right now would help the economy—makes a news story worth reporting. So you hear much more about the areas of disagreement within economics than you do about the large areas of agreement.

It is also worth remembering that economics is, unavoidably, often tied up in politics. On a number of issues powerful interest groups know what opinions they want to hear; they therefore have an incentive to find and promote economists who profess those opinions, giving these economists a prominence and visibility out of proportion to their support among their colleagues.

While the appearance of disagreement among economists exceeds the reality, it remains true that economists often do disagree about important things. For example, some well-respected economists argue vehemently that the Canadian government should replace the income tax with a consumption tax. Other equally respected economists disagree. Why this difference of opinion?

One important source of differences lies in values: as in any diverse group of individuals, reasonable people can differ. In comparison to an income tax, a consumption tax typically falls more heavily on people of modest means. So an economist who values a society with more social and income equality for its own sake will tend to oppose a consumption tax. An economist with different values will be less likely to oppose it.

A second important source of differences arises from economic modelling. Because economists base their conclusions on models, which are simplified representations of reality, two economists can legitimately disagree about which simplifications are appropriate—and therefore arrive at different conclusions.

In 2009, British Columbia decided to harmonize its provincial sales tax with the federal Goods and Services Tax (GST) starting in 2010, only to return to the original system after the harmonized sales tax (HST) was defeated in a 2011 referendum. Suppose that two economists were asked for their opinion on the situation. Economist A may focus on the loss of provincial control over the design and collection of sales taxes or the additional sales tax now imposed on certain purchases.⁵ But economist B may think that the right way to approach the question is to ignore sovereignty and broadening of the sales tax base and focus on the ways in which the proposed law would change consumption behaviour and the ways in which firms conduct their businesses. This economist might point to studies suggesting that a harmonized sales tax lowers the cost of operating a business, lowers some prices, and promotes more business investment and job creation, all desirable results.

Because the economists have used different models—that is, made different simplifying assumptions about what is most important—they arrive at different conclusions. And so the two economists may find themselves on different sides of the issue.

Behavioural economics, a relatively new approach to modelling that combines concepts from psychology and economics, also leads to different models, which can cause disagreement among economists. Traditional economic models assume that decision-makers are rational, unemotional, and capable of processing large amounts of information in order to make an optimal choice. Meanwhile, behavioural economics acknowledges that economic decision-makers are human beings who can be irrational, emotional, and may not learn from their mistakes. Some might say the traditional approach describes how the world should be (normative economics) while behavioural economics attempts to describe the world as it really is (positive economics).

Both methods of creating models help us better understand economic decisionmaking, but their differing assumptions can lead to very different results. In finance, for example, the traditional assumptions imply that agents learn from past mistakes and thus do not repeatedly make the same mistakes, resulting in very efficient financial markets, while in behavioural economic models irrational agents can make systematic errors, which can help explain the existence of stock market anomalies.

In most cases such disputes are eventually resolved by the accumulation of evidence showing which of the various models proposed by economists does a better job of fitting the facts. However, in economics, as in any science, it can take a long time before research settles important disputes—decades, in some cases. And since the economy is always changing, in ways that make old models invalid or raise new policy questions, there are always new issues on which economists disagree. The policy-maker must then decide which economist to believe.

The important point is that economic analysis is a method, not a set of conclusions.