Guide To Normative Economics, Definition, Characteristics, and Example

Jan 04, 2024 By Triston Martin

Normative economics focuses on assessing the desirability of various economic policies, scenarios, and conditions by examining what should ideally occur or be. This branch of economics is opinion-based, evaluating what is desirable or preferable. For instance, suggesting that the government aims for a certain percentage of economic growth or targets a specific inflation rate falls under normative economics assumptions.

This field is also frequently associated with behavioral economics, especially when using cognitive psychology to direct people toward decisions that can be called favorable imperceptibly. Nudging refers to this technique of designing the environment in which choices are made to steer people toward particular decisions.

Unlike positive economics, which describes economic realities as they are, normative economics assumptions seek to solve problems and suggest improvement. It also helps determine economic policy and guide important decisions by telling people what to do to achieve better economic results.

Historical Perspective of Normative Economics

The roots of normative economics example can be traced back to the early 20th century with “old-style welfare economics,” largely influenced by Pigou’s work in "Economics of Welfare." This approach laid the groundwork for what normative economics would become. In the 1930s, a new phase emerged: "new welfare economics.” This approach leaned on the Pareto Principle and the Compensation Principle to evaluate whether policies benefited overall welfare.

More recently, normative economics includes social choice and public economics. The field of public economics studies how the public sector affects society and the economy and answers the question of how the government's actions influence the macroeconomy. Whereas social choice theory employs voting procedures to aggregate individual preferences into an artifact of collective choices, it gives a natural view of group decision-making.

Prominent Figures in Normative Economics

Adam Smith

The notorious 18th-century Scotsman Adam Smith commands a special position in economics and philosophy. He is chiefly recognized for his seminal works: The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations.

In The Theory of Moral Sentiments, Smith argues that sympathy is the spring whereby all social actions are propelled forward. His theory about moral sentiments and the role of sympathy in determining rules and justice provides an essential basis for present-day normative economics example. Smith's insights not only revolutionized the thinking of his time but still shape economic theories to this day. His writings, especially in The Wealth of Nations, launched the foundations for classical economics, emphasizing the free market and division of labor.

Amartya Sen

20th-century eminent Indian economist Amartya Sen, a Nobel prize winner, has made important contributions to the field. Sen expounds on the relationship between positive and normative economics in his book Economic Behavior and Moral Sentiments. He says that welfare economics considerably impacts real behavior and that ethical considerations are important in this field. Sen notes that these moral aspects have received little attention in welfare economics.

Sen's work points to freedom as a yardstick for welfare and development. He also developed new ways to evaluate poverty and inequality, focusing on more than just income. His capability approach transformed how welfare is measured, identifying it with what people can do or be. Sen's theories have impacted many walks of life, including establishing the Human Development Index in the United Nations. Today, his wisdom still permeates economic thought and policy decisions, urging a more humane and participatory economy.

Examples of Normative Economics

Normative economics involves subjective viewpoints that express individual opinions on economic situations or policies. These opinions are shaped by personal values and beliefs rather than objective analysis. For instance, the idea that government regulation of oil prices can control inflation is a subjective opinion. Similarly, the view that a central bank's independence should be limited reflects personal judgment.

The effectiveness of special economic Zones, the choice for revolution over regressive taxation, and the notion that businesses must compensate for pollution are all opinions. Those statements do not necessarily stem from empirical proof but from individual perspectives.

As mentioned above, Amartya Sen, a famous welfare economist and Nobel Prize recipient, categorizes normative statements into sorts. In line with Sen, basic statements are impartial to empirical statistics or theories. On the other hand, non-primary statements are grounded in authentic understanding. For instance, a 2018 observation by the Brookings Organization found that unique Economic Zones (SEZs) in India contributed extensively to the country's export growth, accounting for approximately 30% of general exports. This data offers an authentic foundation to assess the fulfillment of SEZs, contrasting with the subjective view that SEZs are unsuccessful.

In taxation, a record via the Organization for Monetary Co-operation and Improvement (OECD) in 2020 confirmed that nations with modern tax structures, like Denmark and Sweden, had decreased earnings inequality. This statistical evidence helps the preference for innovative taxation from an empirical perspective.

Comparing Normative and Positive Economics

Normative economics is key to generating innovative ideas by considering various perspectives. However, it shouldn't be the foundation for making significant economic decisions. This is because normative economics analysis lacks an objective stance, focusing on subjective viewpoints rather than concrete facts and their implications.

On the other hand, positive economics is grounded in verifiable and testable facts. This approach allows for the breakdown of economic statements into observable realities. Economists and analysts prefer this method because it provides a measurable and factual basis for their work. Positive economics aids government officials and business leaders in making informed policy decisions, relying on data-driven evidence.

Despite the objectivity of positive economics, leaders and decision-makers also factor in normative economics analysis. This approach assesses what is desirable or undesirable for a community or organization. When combined with positive economics, normative economics offers a range of opinion-based solutions that reflect the views of individuals or communities on various economic initiatives. These perspectives are vital for leaders in shaping policies.

As an example, a study carried out in 2020 confirmed that 60% of ECU policymakers trusted a combination of normative and tremendous monetary analyses while planning social welfare reforms. Similarly, a survey of enterprise leaders in the US in 2021 discovered that seventy 5% considered both normative and fine economics in their strategic planning, mainly regarding environmental sustainability projects.

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