Theory and Percentage Change

Q. R. 1 It is often said that a good theory is one that can be refuted by an empirical, data-oriented study. Explain why a theory that cannot be evaluated empirically is not a good theory. Theory, whether in economics or sciences, helps ones predict and succeed in explaining on what they intend to explain relies on convincing assumptions. However, accuracy and validity of theories are important as the more accuracy in the theory, the more success in whatever business or science. Hence, all theories should be tested whether they are practical in the reality.

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If they are not, we should develop and modify them so that ones can make good predictions with current circumstance and match reality, otherwise these theories will be useless. Q. R. 2 Which of the following two statements involves positive economic analysis and which normative? How do the two kinds of analysis differ? a. Gasoline rationing (allocating to each individual a maximum amount of gasoline that can be purchased each year) is poor social policy because it interferes with the workings of the competitive market system. b. Gasoline rationing is a policy under which more people are made worse off than are made better off.

Statement a. involves both positive economic and normative economic analysis. It involves positive analysis as it contains relationship of cause and effect – “because it interferes with the workings of the competitive market system”. Also, it involves normative analysis because it is supplemented by value judgment – “Gasoline rationing is poor social policy”. Statement b. involves positive economic analysis because it is not contain any value judgments, but it only states the effect of gasoline rationing that is “more people are made worse off than are made better off”.

Positive analysis is concerned with explanation and prediction or cause and effect. In a mean time, normative analysis deals with what ought to be or what is the best. EXERCISE 2 The following table shows the average retail price of butter and the Consumer Price Index from 1980 to 2000, scaled so that the CPI = 100 in 1980 |  |1980 |1985 |1990 |1995 |2000 | |CPI |100 |130. 58 |158. 56 |184. 95 |208. 8 | |Retail price of butter |$1. 88 |$2. 12 |$1. 99 |$1. 61 |$2. 52 | |(salted, grade AA, per lb. ) | | | | | | a. Calculate the real price of butter in 1980 dollars. Has the real price increased/decreased/stayed the same from 1980 to 2000? |  |1980 |1985 |1990 |1995 |2000 | |CPI |100 |130. 8 |158. 56 |184. 95 |208. 98 | |Retail price of butter |$1. 88 |$2. 12 |$1. 99 |$1. 61 |$2. 52 | |(salted, grade AA, per lb. ) | | | | | | |Real price |$1. 88 |$1. 62 |$1. 26 |$0. 87 |$1. 21 | | | | | | | |

Real price of butter in year X = (Nominal price in year X) *[pic] The real price had decreased since 1980 until 1995. After 1995 the real price has increased. b. What is the percentage change in the real price (1980 dollars) from 1980 to 2000? The percentage change in the real price from 1980 to 2000 = [pic]* 100 = [pic]* 100 = -35. 64% c. Convert the CPI into 1990 = 100 and determine the real price of butter in 1990 dollars. To convert CPI into 1990 = 100, divide CPI for each year by CPI for 1990, then multiply by 100.   |1980 |1985 |1990 |1995 |2000 | |CPI |100 |130. 58 |158. 56 |184. 95 |208. 98 | |New CPI |63. 07 |82. 35 |100 |116. 64 |131. 80 | To determine the real price of butter in 1990 dollars, use formula : Real price of butter in year X = (Nominal price in year X) *[pic]   |1980 |1985 |1990 |1995 |2000 | |New CPI |63. 07 |82. 35 |100 |116. 64 |131. 80 | |Retail price of butter |$1. 88 |$2. 12 |$1. 99 |$1. 61 |$2. 52 | |(salted, grade AA, per lb. ) | | | | | | |Real price |$2. 8 |$2. 57 |$1. 99 |$1. 38 |$1. 91 | d. What is the percentage change in real price (1990 dollars) from 1980 to 2000? Compare this with your answer in (b). What do you notice? Explain. The percentage change in the real price from 1980 to 2000 = [pic]* 100 = [pic]* 100 = -35. 91% The answer in (b) is -35. 64%. The answer in (d) is -35. 91%. These two answers is almost exactly the same. There is no different between percentage changes in real price regardless of which year is the base year.

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