Economic analysis, as we will see throughout this book, draws on a set of basic economic principles. But how are these principles applied? That depends on the purpose of the analysis. Economic analysis that is used to answer questions about the way the economy works, questions that have definite right and wrong answers, is known as positive economics. In contrast, economic analysis that involves saying how the economy should work is known as normative economics.

Imagine that you are an economic adviser to the governor of your state and the governor is considering a change to the toll charged along the state turnpike. Below are three questions the governor might ask you.

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 toll revenue without any increase will be proved right or wrong when the numbers actually come in. Your estimate of the impact of a change in the toll is a little harder to check—the increase in revenue depends on other factors besides the toll, 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 or not tolls should be raised may not have a “right” answer—two people who agree on the effects of a higher toll could still disagree about whether raising the toll is a good idea. For example, someone who lives near the turnpike but doesn’t commute on it will care a lot about noise and air pollution but not so much about commuting costs. A regular commuter who doesn’t live near the turnpike will have the opposite priorities.

This example highlights a key distinction between the two roles of economic analysis and presents another way to think about the distinction between positive and normative analysis: positive economics is about description, and normative economics is about prescription. Positive economics occupies most of the time and effort of economists.

Looking back at the three questions the governor might ask, it is worth noting a subtle but important difference between questions 1 and 2. Question 1 asks for a simple prediction about next year’s revenue—a forecast. Question 2 is a “what if” question, asking how revenue would change if the toll were to increase. Economists are often called upon to answer both types of questions. Economic models, which provide simplified representations of reality using, for example, graphs or equations, 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, but they don’t tell you whether or not that result is good. Suppose that your economic model tells you that the governor’s proposed increase in highway tolls will raise property values in communities near the road but will tax or inconvenience people who currently use the turnpike to get to work. Does that information make this proposed toll increase a good idea or a bad one? It depends on whom you ask. As we’ve just seen, someone who is very concerned with the communities near the road 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 positive economic analysis.

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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 individual 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 beneficial 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 with which to pay rent. Almost all economists agree that subsidies are the preferable policy. (In a later module we’ll see why this is so.) And so the great majority of economists, whatever their personal politics, favor 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? 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 there is no story worth covering, and so the professional consensus tends to go unreported. But when there is some issue on which prominent economists take opposing sides—for example, whether cutting taxes right now would help the economy—that does make a good news story. So you hear much more about the areas of disagreement among economists than you do about the many areas of agreement.

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

Although the appearance of disagreement among economists exceeds the reality, it remains true that economists often do disagree about important things. For example, some highly respected economists argue vehemently that the U.S. government should replace the income tax with a value-added tax (a national sales tax, which is the main source of government revenue in many European countries). Other equally respected economists disagree. What are the sources of this difference of opinion?

One important source of differences is in values: as in any diverse group of individuals, reasonable people can differ. In comparison to an income tax, a value-added tax typically falls more heavily on people with low incomes. So an economist who values a society with more social and income equality will likely oppose a value-added tax. An economist with different values will be less likely to oppose it.

A second important source of differences arises from the way economists conduct economic analysis. Economists base their conclusions on models formed by making simplifying assumptions about reality. Two economists can legitimately disagree about which simplifications are appropriate—and therefore arrive at different conclusions.

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Suppose that the U.S. government was considering a value-added tax. Economist A may rely on a simplification of reality that focuses on the administrative costs of tax systems—that is, the costs of monitoring compliance, processing tax forms, collecting the tax, and so on. This economist might then point to the well-known high costs of administering a value-added tax and argue against the change. But economist B may think that the right way to approach the question is to ignore the administrative costs and focus on how the proposed law would change individual savings behavior. This economist might point to studies suggesting that value-added taxes promote higher consumer saving, a desirable result. Because the economists have made different simplifying assumptions, they arrive at different conclusions. And so the two economists may find themselves on different sides of the issue.

Most such disputes are eventually resolved by the accumulation of evidence that shows which of the various simplifying assumptions made 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 approaches 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.