Chapter 2-Tools of Positive Analysis Public economics
1 Chapter 2 – Tools of Positive Analysis Public Economics
Policy analysis is hard Why is it so hard to tell what's going on with government actions? Consider lowering income tax rates. Will lowering taxes increase work efort and labor supply? Unlike the physical and natural sciences, difficult to perform carefully controlled experiments on the economy Oftentimes, there is no control groupon comparison group" for a policy
2 Policy analysis is hard • Why is it so hard to tell what’s going on with government actions? – Consider lowering income tax rates. Will lowering taxes increase work effort and labor supply? • Unlike the physical and natural sciences, difficult to perform carefully controlled experiments on the economy. • Oftentimes, there is no “control group” or “comparison group” for a policy
Alternatives to an experiment Use of statistical tools to study impact of public policies Will use the debate over the effect of taxes on labor supply to illustrate how positive analysis is done in public finance
3 Alternatives to an experiment • Use of statistical tools to study impact of public policies. • Will use the debate over the effect of taxes on labor supply to illustrate how positive analysis is done in public finance
Role of economic theory Consider analyzing table 2. 1 As marginal tax rates have increased average weekly hours have decreased from 1955to2001 Can we conclusively say that taxes have depressed labor supply? No Nonlabor income rose(dividends, interest) Attitudes may have changed
4 Role of economic theory • Consider analyzing Table 2.1 – As marginal tax rates have increased, average weekly hours have decreased from 1955 to 2001. – Can we conclusively say that taxes have depressed labor supply? No. • Nonlabor income rose (dividends, interest) • Attitudes may have changed
Table 2.1 Table 2.1 Income tax rates and labor supply Marginal Federal Tax Rate Average Weekly (percent) Hours 1955 20.00 % 39.6 1960 20.00 38.6 1965 17.00 38. 1970 19.48 37.1 1975 22.00 36.1 35.3 1985 29.05 34.9 1990 34.5 34.5 2001 22.65 4.5 MTax Policy Center, Historical Combined Income and Employee Tax Rates for a Family of Four, " URI http://www.taxpolicycenter.org/taxfacts/overview/combined_family.cfmJanuary15.2003 TEconomic Report of the President, 2002.(Washington DC: US Government Printing Office. 2002), p. 376
Table 2.1
Role of economic theory In reality, an unlimited number of factors change over time, and could affect labor supply Economic theory helps isolate a small set of variables that are important influences on behavior
6 Role of economic theory • In reality, an unlimited number of factors change over time, and could affect labor supply. • Economic theory helps isolate a small set of variables that are important influences on behavior
Role of economic theory Theory would suggest that person maximizes utility -and would include factors like the persons own wage rate Theory is often too simple -may ignore important considerations. But whole point of model building is to reduce a problem to its essentials
7 Role of economic theory • Theory would suggest that person maximizes utility -- and would include factors like the person’s own wage rate. • Theory is often too simple – may ignore important considerations. But whole point of model building is to reduce a problem to its essentials
Role of economic theory In this labor supply case, the after-tax wage changes with the policy Theory predicts that the effect on hours is ambiguous The substitution effect predicts that as the wage(price of leisure)falls, consumers substitute toward leisure The income effect says that if leisure is a normal good consumers consume less of it as income falls Only empirical work-analysis based on observation as opposed to theory -can answer this question 8
8 Role of economic theory • In this labor supply case, the after-tax wage changes with the policy. – Theory predicts that the effect on hours is ambiguous. – The substitution effect predicts that as the wage (price of leisure) falls, consumers substitute toward leisure. – The income effect says that if leisure is a normal good, consumers consume less of it as income falls. • Only empirical work – analysis based on observation as opposed to theory – can answer this question
Methods of Empirical Analysis There are three main methods Interviews Experiments Econometric studies
9 Methods of Empirical Analysis • There are three main methods: – Interviews – Experiments – Econometric studies
Methods of Empirical Analysis Interviews Most straightforward way to find out whether a policy will affect behavior is to ask Reporters often do this Pitfalls of interviews The fact that people say something about their behavior does not make it true People may be embarrassed about the subject, or have other“ agendas. 10
10 Methods of Empirical Analysis • Interviews – Most straightforward way to find out whether a policy will affect behavior is to ask. – Reporters often do this. • Pitfalls of interviews – The fact that people say something about their behavior does not make it true. – People may be embarrassed about the subject, or have other “agendas