Normative Economics

What is normative economics?

Normative economics is an approach that reflects prescriptive judgments toward economic scenarios. This school of thought emphasizes value judgments rather than facts based on cause-and-effect.

When the government enacts public policy changes, normative economics suggests what may result merely based on judgments. It’s not possible to verify or test normative economics due to its opinion-focused analysis.

Investment professionals use investment portfolio management software to build, track, and manage investments in the economy. Investors may use a combination of normative and positive economics.

Origin of normative economics

Normative economics is tied to Arthur Cecil Pigou’s The Economics of Welfare. In it, Pigou developed the concept of externalities. Following Pigou, the concept of new welfare economics emerged in the 1930s and is considered the second form of normative economics.

In new welfare economics, normative statements about policies and welfare were made using the Pareto Principle to achieve a state of Pareto efficiency.

Subfields of normative economics

Various subfields exist within normative economics. They include:

• Social choice theory: A framework for analysis that combines individual opinions, interests, or welfare to reach a collective decision. Social choice theory translates individual preferences into a collective group preference. 
• Cooperative game theory: This theoretical framework suggests how social situations play out among competing coalitions of players. Cooperative game theory predicts which coalitions will form and what actions groups will take to receive the payoff.
• Mechanism design: Also referred to as reverse game theory, this framework seeks to understand how businesses can achieve outcomes despite individual self-interest and incomplete information getting in the way. 

Normative economics examples

Normative statements contain value judgments and include verbiage such as “have to”, “ought to”, and “must.” Below are some examples of normative economics statements:

• We should cut federal taxes in half. 
• The government ought to provide free healthcare for all citizens.
• We have to provide more state-funded benefits so everyone has enough money to live. 
• Taxes are too high for most people right now, so we must lower them. 
• Inflation is more harmful than unemployment, and we must get inflation under control immediately. 

Normative economics vs. positive economics

Normative and positive economics are two different schools of thought in modern economics. Normative economics emphasizes what the economy should look like based on prescriptive judgments and opinions. Positive economics refers to an objective analysis of economics that relies on facts and can be tested or proven with data.