1.2 How do economists approach the world?

Kate Raworth’s model in which the goal of an economy is to meet everyone’s basic needs (the social foundation) without overshooting the planet’s environmental limits (the ecological ceiling).

Economics as a social science

A science is a body of knowledge built by a particular method: explanations are proposed, predictions are derived from them, and the predictions are checked against observation. Physics and chemistry are the classic examples. Economics tries to follow the same method, which is why economists call much of their work “positive”: it aims to describe and explain the world as it is.

Economics differs from the natural sciences in three ways. Its subject is people, who learn, form expectations and change their behaviour when they know they are being studied or when a policy is announced. Controlled experiments are usually impossible, because a government cannot raise taxes in one half of a country simply to see what happens. And the results matter to people’s lives, so values and politics are never far away. These differences explain why economists rely heavily on simplifying assumptions, on careful use of data and on a clear distinction between positive and normative claims.

Positive economics

Positive economics deals with statements about what is, was or will be. A positive statement may be true or false, but it can in principle be checked against evidence. “Raising the price of cigarettes reduces the quantity smoked” is a positive statement; so is “Unemployment in Spain was higher than in Germany in 2024”. If the evidence contradicts a positive statement, the statement is wrong.

Positive economics is built from five connected parts: logic, hypotheses, models and theories, the ceteris paribus assumption, and empirical evidence, with the refutation of claims that fail.

The use of logic

Economists use logic to move from assumptions to conclusions. In deductive reasoning, conclusions follow necessarily from the starting assumptions. If consumers prefer to pay less for the same good, and if the price of a good rises while nothing else changes, then consumers will buy less of it. If the assumptions are true and the reasoning is valid, the conclusion must be true.

In inductive reasoning, a general rule is drawn from many particular observations. An economist who sees that petrol sales fall every time petrol prices rise, in many countries and many years, may conclude that higher prices reduce the quantity of petrol bought. Induction cannot prove a rule, because the next observation might break it, but repeated observations make the rule more reliable.

Logic protects economists from mistaken reasoning, but it cannot tell them whether their assumptions describe the world. A perfectly logical argument built on an unrealistic assumption can still reach a false conclusion, which is why logic is always combined with evidence.

Hypotheses, models and theories

Economic enquiry usually starts with an observation, such as a rise in youth unemployment after a minimum wage increase, which suggests a possible explanation. That explanation is stated as a hypothesis: a claim about how two or more variables are related, precise enough to be tested.

To work out what a hypothesis implies, economists build an economic model. A model is a simplified picture of part of the economy, in words, diagrams or equations. It deliberately leaves out most real-world detail and keeps only the variables thought to matter most, much as a map leaves out every tree so that the roads can be seen clearly.

Familiar models include the production possibilities curve, the circular flow of income and the demand and supply model. Each rests on stated assumptions. The production possibilities curve, for example, assumes a fixed quantity of resources, fixed technology and only two goods. These assumptions are unrealistic in a literal sense, but they make the model simple enough to show one idea, such as opportunity cost, very clearly.

When a hypothesis has been tested many times, in different places and periods, and has not been refuted, it becomes part of an economic theory. A theory is a general explanation, built from linked hypotheses and assumptions, of how part of the economy works. The theory of demand, for instance, combines hypotheses about how price, income, tastes and the prices of related goods affect the quantity demanded.

The cycle never finishes. A theory that survives today’s tests is accepted provisionally, because tomorrow’s data may refute it. New observations then start the cycle again, which is how economic knowledge grows and changes.

The ceteris paribus assumption

In the real economy many variables change at the same time. In a single year the price of bus tickets may rise while incomes grow, petrol becomes more expensive and more people move to the city. If bus journeys rise, it is impossible to say from the raw numbers which change caused it. Economists deal with this problem by changing one variable at a time in their models and holding all others constant.

Every law in economics carries this assumption, stated or not. The law of demand says that a rise in price reduces the quantity demanded, ceteris paribus. Without the qualifier the law would be false in many observed cases, because a price rise is often accompanied by rising incomes or changing tastes that push demand up.

The diagram shows how the assumption works in practice. The movement from A to B along D₁ isolates the effect of the bus fare alone. When another variable changes, such as the price of petrol, the relationship between fare and journeys is not broken; the whole curve shifts to D₂, so that at any fare more journeys are demanded. Separating movements along a curve from shifts of a curve is the ceteris paribus assumption drawn on a diagram.

Ceteris paribus is a tool for thinking, not a description of the world. Its limitation is that in reality other things are rarely equal. This makes testing economic theories difficult, because data from the real world always mix the effect of the variable being studied with the effects of many others.

Empirical evidence

Empirical evidence is information gathered from the real world by observation, measurement or experiment. It is what turns economics from a set of logical arguments into a science. Without it, economists could not tell a theory that explains the world from one that only sounds convincing.

Economists use several kinds of evidence, each with strengths and weaknesses.

A natural experiment is especially useful in economics, because it comes close to holding other things equal without a laboratory. When one area changes a policy and a similar neighbouring area does not, the unaffected area shows what would probably have happened without the change. Card and Krueger’s study of the minimum wage in New Jersey is a famous example.

Correlation and causation

The most common trap in using evidence is to treat correlation as proof of cause. Two variables are correlated when they tend to move together. Countries with more doctors per person tend to have higher incomes, but this does not show that doctors make countries rich; higher incomes may pay for more doctors, or a third factor, such as education, may raise both.

Economists look for causation in three ways: a logical mechanism explaining why one variable should affect the other; the right timing (the cause comes before the effect); and a comparison group that rules out other explanations. Natural experiments and randomised trials are valued because they supply the comparison group.

Refutation

A scientific claim must be falsifiable: it must be stated so that some possible evidence could show it to be wrong. The philosopher Karl Popper argued that this is what separates science from other kinds of belief. “Prices sometimes rise and sometimes fall” cannot be refuted by any observation, so it says nothing useful. “A 10% rise in the price of cigarettes reduces the quantity smoked” could be contradicted by data, so it is a scientific hypothesis.

Under this view, evidence can never finally prove a theory true, because a future observation might contradict it. It can only show that a theory has survived every test so far. A theory is therefore accepted provisionally, and economists remain ready to revise it. The history of economic thought is partly a history of theories that were refuted, or at least badly damaged, by events they failed to predict.

Why refutation is harder in economics

• Other things are rarely equal. When a prediction fails, it may be because the theory is wrong or because some other variable changed at the same time. Economists can often save a theory by blaming an outside factor.

• People respond to theories and policies. If firms and workers expect a policy, they may change their behaviour in advance, so a relationship observed in the past may disappear once policy tries to use it. Robert Lucas made this argument in 1976, and it became known as the Lucas critique.

• Data are imperfect. GDP, unemployment and inflation are estimated, revised and sometimes measured differently between countries.

• Values affect interpretation. Economists who favour a policy may read mixed evidence in its favour.

A clear historical example is the Phillips curve. In the 1960s many economists treated a stable trade-off between inflation and unemployment as established: higher inflation seemed to buy lower unemployment. In the 1970s many countries had high inflation and high unemployment at the same time (stagflation), which contradicted the simple version of the theory and led economists to revise it.

Normative economics

Normative economics deals with statements about what ought to be. These statements depend on a value judgment: a view about what is good or bad, fair or unfair. “The government should raise the minimum wage” and “Unemployment is a more serious problem than inflation” are normative statements. No data can prove them true or false, because people with the same facts can hold different values.

Normative statements are often signalled by words such as “should”, “ought”, “fair”, “better”, “too much” or “unacceptable”. These signal words help, but the real test is whether evidence could settle the statement. “Inflation of 2% is the best target” is normative even without the word “should”, because “best” depends on what people value.

Value judgments in policy making

Positive and normative economics work together in policy making. Positive analysis predicts the consequences of each option: how much a carbon tax would cut emissions, how much revenue it would raise, which households would pay most. Normative judgment then weighs those consequences against goals such as efficiency, equity, sustainability and economic well-being, which often conflict.

A policy choice therefore always contains a value judgment, even when it is presented as a technical decision. Two economists may agree completely about the positive effects of a minimum wage rise, for example that it raises the pay of low-paid workers and may cost some jobs, and still disagree about whether it should happen, because one gives more weight to the gains of those who keep their jobs and the other to the losses of those who do not.

Value judgments also enter earlier than the final choice. They affect which problems are studied, which goals a government sets (an inflation target of 2% rather than 4%), and which groups count most in deciding whether a policy succeeds. Recognising them makes policy debates clearer, because it separates disagreements about facts, which evidence can settle, from disagreements about values, which it cannot.

Equity and equality

Two value-laden words appear constantly in economic debate: equity and equality. They are often confused, but they mean different things. Equality is about sameness: people having the same income, wealth, rights or opportunities. It can be measured, so statements about equality are usually positive.

Equity is about fairness. Because people disagree about what is fair, equity is a normative idea. A fair distribution of income need not be an equal one. Many people consider it fair that a surgeon who trained for twelve years earns more than a student with a summer job, while also considering it unfair that some children are born into poverty and lack access to good schools.

Economists commonly separate two kinds of equity. Horizontal equity means treating people in the same situation in the same way, so that two people with the same income pay the same tax. Vertical equity means treating people in different situations differently in a way that is considered fair, so that people with higher incomes pay a larger share of their income in tax. Progressive income taxes are usually justified on grounds of vertical equity.

A further distinction is between equality of outcome, where people end up with similar incomes or wealth, and equality of opportunity, where people have the same chance to succeed, whatever their background. Many policies, such as free schooling, aim at equality of opportunity rather than of outcome. Whether governments should go further and reduce inequality of outcome is one of the main normative debates in economics, linked to the key concepts of equity and intervention.

Where the line between positive and normative blurs

The distinction is clear in principle but less clear in practice. The words economists choose can carry values: calling a government payment a “handout” or an “investment in people” describes the same thing with different judgments attached. The choice of what to measure is also value-laden; measuring a country’s success by GDP gives no weight to unpaid care work or environmental damage.

Even positive research depends on judgment: which data to use, which variables to hold constant, how much evidence is enough. This does not make the distinction useless. It means that economists should state their assumptions and values openly, so that others can check the positive parts of their argument and disagree, if they wish, with the normative parts.

Economic thought in its historical context

Economic ideas develop in response to the problems of their time. The factory system, mass unemployment in the 1930s, high inflation in the 1970s and climate change each pushed economists to question the theories they had inherited. Knowing where an idea came from helps explain both what it assumes and where its limits lie.

18th century: Adam Smith and laissez faire

Adam Smith, a Scottish philosopher, published An Inquiry into the Nature and Causes of the Wealth of Nations in 1776. It is often treated as the start of modern economics. Smith argued that a nation’s wealth lies in the goods and services its people can produce, not in the gold and silver held by the state, which was the view of the mercantilists who dominated thinking at the time.

The first source of wealth, for Smith, was the division of labour: splitting production into many small tasks, each done by a worker who specialises in it. He illustrated it with a pin factory, where the work was divided into about eighteen separate operations. Specialised workers become more skilful, waste less time moving between tasks and are more likely to invent machinery for their single task.

Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day.

— Adam Smith, The Wealth of Nations, Book I, Chapter 1 (1776)

Smith’s second idea explains how millions of specialised people are coordinated without anyone in charge. In a competitive market, each person pursues their own interest: the baker bakes to earn an income, not out of kindness. Yet to earn that income, the baker must produce what customers want at a price they will pay. Smith described this as being led by an invisible hand to promote the good of society without intending to.

From these ideas came the policy of laissez faire (French for “let do” or “leave alone”): governments should remove restrictions on trade and competition and let markets work. Smith did not argue for no government at all. He gave the state a role in defence, justice and public works that markets would not provide, and he was suspicious of merchants who met to fix prices.

Smith’s ideas still form the basis of the case for the price mechanism and free trade. Their limits are also familiar: markets can fail when there are external costs, when goods are not provided privately, or when firms gain market power, all of which later justify intervention.

19th century: classical economics, the margin and the Marxist critique

The economists who followed Smith, such as David Ricardo, Thomas Malthus and John Stuart Mill, are known as the classical economists. They studied how a market economy grows and how its income is divided between landlords, workers and owners of capital. Classical economics held that free markets use resources efficiently and that the economy as a whole tends towards full employment on its own.

Classical microeconomics: utility

To explain why people buy what they buy, 19th-century economists turned to utility: the satisfaction a consumer gains from consuming a good. The idea came from the philosopher Jeremy Bentham, who argued that people seek pleasure and avoid pain. If consumers choose so as to gain as much utility as possible from a limited income, their choices can be studied systematically, which became the basis of demand theory.

Utility also helped to solve an old puzzle, the paradox of value. Water is essential to life but cheap; diamonds are useless for survival but expensive. Smith could not fully explain this. The answer came with a new way of thinking about choice: at the margin.

The concept of the margin

In the early 1870s William Stanley Jevons in England, Carl Menger in Austria and Léon Walras in Switzerland arrived independently at the same idea. Value depends on the utility of one more unit (marginal utility), not on the total utility of all units. Because water is plentiful, one more litre adds little satisfaction, so its price is low, even though the total utility of water is enormous. Diamonds are scarce, so one more diamond adds a lot.

This “marginal revolution” gave economics its most important tool, marginal analysis. Rational decisions are made by comparing the extra benefit of one more unit of an activity with its extra cost. A firm hires another worker if that worker adds more to revenue than to costs; a student studies another hour if the expected benefit exceeds the value of what is given up. Alfred Marshall combined marginal utility (behind demand) with marginal cost (behind supply) in his Principles of Economics (1890), giving the demand and supply diagram its modern form.

Classical macroeconomics: Say’s law

For the economy as a whole, classical economists relied on an idea associated with the French economist Jean-Baptiste Say, whose Treatise on Political Economy appeared in 1803. Say’s law is usually summarised as “supply creates its own demand”. People produce goods in order to earn income, and they earn income in order to buy other goods. Total income from production is therefore always enough to buy total output.

If this holds, there can be overproduction of a particular good, but never a general glut of all goods. Any income that is saved rather than spent is lent to firms through financial markets and spent on investment, with the interest rate adjusting to make saving equal investment. Wages and prices are flexible, so unemployment disappears as wages fall. The economy therefore corrects itself, and governments need not try to manage total spending. Classical macroeconomics thus supported laissez faire for the whole economy as well as for individual markets.

The Marxist critique

Not everyone agreed that markets left alone produce good results. Karl Marx, a German philosopher and economist who lived in London, set out a critique of capitalism and of classical economics, known as the Marxist critique, most fully in Capital (Das Kapital), whose first volume appeared in 1867. He wrote during the early industrial era, when factory workers, including children, often worked very long hours for low wages in poor conditions.

Marx built on the classical idea that the value of goods comes from the labour used to make them. Workers, he argued, produce more value than they receive in wages. The difference, which he called surplus value, is kept by the owners of capital as profit. Because owners can always replace workers with the unemployed, wages are held down, so workers are exploited and inequality grows.

Marx also rejected Say’s law. Because workers cannot afford to buy all that they produce, capitalism suffers repeated crises of overproduction and unemployment. He predicted that these crises would worsen until workers overthrew the system and replaced private ownership with common ownership. His ideas inspired the planned economies of the Soviet Union, China before its reforms, and others in the 20th century.

Most of Marx’s specific predictions, such as ever-falling real wages in capitalist economies, were not borne out: real wages in industrial countries rose substantially. Planned economies also struggled with inefficiency. Yet his questions about the distribution of income, the power of employers and the instability of capitalism remain part of economics, and they influenced later reforms such as labour laws and welfare states.

20th century: the Keynesian revolution and the counter-revolution

The Great Depression and the Keynesian revolution

The Great Depression of the 1930s was the deepest economic slump of the industrial era. After the US stock market crash of 1929, output fell, thousands of banks failed and, by one widely used estimate, US unemployment reached about 25% in 1933. Unemployment stayed high for years. Classical theory, which predicted that falling wages would restore full employment, offered little explanation for this and little guidance on what to do.

John Maynard Keynes, a British economist, gave a new explanation in The General Theory of Employment, Interest and Money (1936). He argued that the economy can settle at an equilibrium with high unemployment and stay there. When households and firms become pessimistic, they cut spending; one person’s spending is another’s income, so lower spending lowers incomes, which lowers spending further. Wages do not fall easily, and even if they did, lower wages would mean lower incomes and still less spending.

Keynes therefore rejected Say’s law: total demand can fall short of what the economy is able to produce. Saving need not be matched by investment, because firms invest only when they expect profitable sales, not simply because interest rates are low. His policy conclusion was that governments should step in during a slump, raising their own spending or cutting taxes to restore demand, even if this meant borrowing. This was the Keynesian revolution, and it moved the focus of economics from individual markets towards the whole economy, which is why it is often treated as the birth of modern macroeconomics.

The rise of macroeconomic policy

After 1945 Keynes’s ideas shaped economic policy in most high-income countries. The British government’s 1944 White Paper on employment policy and the US Employment Act of 1946 committed governments to aim for high and stable employment. Governments began to collect national income statistics, the basis of today’s GDP data, so that they could measure total demand and manage it.

Macroeconomic policy became an everyday task of governments. Fiscal policy (changes in government spending and taxation) and monetary policy (changes in interest rates and the money supply) were used to stabilise the economy: expanding demand in a downturn and restraining it in a boom. The period from the late 1940s to the early 1970s brought fast growth and low unemployment in many countries, and these results seemed to confirm the Keynesian approach.

The monetarist/new classical counter-revolution

In the 1970s the Keynesian approach ran into serious difficulty. Oil price shocks in 1973–74 and 1979–80 raised costs across the economy. Many countries experienced stagflation: high inflation together with high unemployment and slow growth. Simple Keynesian models suggested that inflation and unemployment move in opposite directions, so expanding demand to cut unemployment seemed only to add to inflation.

The chart shows both rates rising together in the mid-1970s and again around 1980, so Keynesian demand management appeared to have no answer. This gave weight to an alternative set of ideas that had been developing for some time.

Monetarism, led by Milton Friedman at the University of Chicago, argued that inflation is caused by the money supply growing faster than real output. In his presidential address to the American Economic Association, given in December 1967 and published in 1968, Friedman argued that there is a natural rate of unemployment: governments can push unemployment below it only temporarily, and the long-run result of trying is accelerating inflation. Governments should therefore control the growth of the money supply and avoid active attempts to manage demand.

New classical economics, developed in the 1970s by Robert Lucas and others, went further. It assumes that markets clear quickly and that people form rational expectations, using all available information about policy. If people expect a demand expansion to cause inflation, they raise wages and prices at once, so the expansion has little effect on output even in the short run. The economy tends to return to full employment on its own, and active demand management is at best ineffective.

The counter-revolution had large effects on policy. The US Federal Reserve, under Paul Volcker from August 1979, tightened monetary policy sharply: the average federal funds rate reached 19.1% in June 1981. Inflation fell from 13.5% in 1980 to 3.2% in 1983, but unemployment rose to 10.8% at the end of 1982. In the 1980s governments in the UK, the US and elsewhere also turned towards supply-side policies, privatisation, deregulation and lower taxes, and away from using fiscal policy to manage demand.

Sources: Federal Reserve Bank of St. Louis, FRED: FEDFUNDS and UNRATE (2026); World Bank, World Development Indicators (2026).

The debate between the two schools is developed in depth in the study of aggregate demand and aggregate supply, where they lead to different shapes of the aggregate supply curve. Most macroeconomists today combine elements of both: they accept that demand matters in the short run, as Keynes argued, and that expectations and the supply side determine the long run, as the counter-revolution argued.

21st century: psychology, the environment and new models

Dialogue with psychology: behavioural economics

Most 20th-century models assumed that people are rational: they have stable preferences, use all relevant information and choose whatever maximises their utility. From the 1970s, psychologists and economists began to test this assumption with experiments, and found that people behave in systematically different ways. They give too much weight to the first number they see, avoid losses more strongly than they seek equal gains, put off saving, and are influenced by how choices are presented.

Behavioural economics combines economics with psychology to explain these patterns. Daniel Kahneman and Amos Tversky published prospect theory in 1979, and Kahneman received the Nobel Memorial Prize in Economic Sciences in 2002 for bringing psychological research into economics. Richard Thaler won the prize in 2017 for his contributions to behavioural economics; his book Nudge (2008), written with Cass Sunstein, argued that governments can improve decisions by changing how choices are presented, for example by enrolling workers in pension schemes automatically while letting them opt out.

Governments have taken these ideas up: the UK set up its Behavioural Insights Team in 2010, and many other governments followed with similar units. Behavioural economics does not replace the standard model, but it challenges one of its central assumptions and adds new policy tools to taxes, subsidies and regulation. Its ideas, such as bounded rationality and choice architecture, are developed further in the critique of rational consumer choice.

The 2008 financial crisis and the return of Keynes

The global financial crisis of 2008 led to the deepest recession in high-income countries since the 1930s, and it renewed interest in Keynesian ideas. In February 2009 the US government passed a fiscal stimulus of about $787 billion, the American Recovery and Reinvestment Act, justified on Keynesian grounds that public spending should replace collapsing private spending. US unemployment still reached 10.0% in October 2009.

The crisis also raised doubts about the models economists used. Few forecasters predicted it, and the main macroeconomic models gave little role to banks, debt and financial panic. Since then, economists have paid more attention to the financial sector, to the limits of the self-correcting market, and to evidence on how people actually behave in a crisis.

Sources: US Congress, American Recovery and Reinvestment Act (2009); US Bureau of Labor Statistics via FRED, UNRATE (2026).

Economy, society and environment: the circular economy

A second 21st-century development is a growing awareness of interdependence between the economy, society and the natural environment. Traditional models treat the environment mainly as a source of raw materials and a place to dump waste. Climate change, the loss of biodiversity and the depletion of resources have shown that economic activity can damage the natural systems on which future production and well-being depend, which links economics to the key concept of sustainability.

Most production today follows a linear model: resources are taken from the earth, made into products, used and then thrown away. In a circular economy, products are designed to last, to be shared, repaired and reused, and finally remanufactured or recycled, so that materials stay in use and waste is designed out.

The case for a circular economy rests on scarcity and sustainability: if natural resources and the planet’s capacity to absorb waste are limited, an economy that grows by using ever more of them cannot continue indefinitely. Supporters argue that circular practices can also cut firms’ costs and create jobs in repair and recycling. Critics point out that recycling itself uses energy, that many products are hard to recycle, and that circular practices may not be profitable without government intervention such as taxes on landfill or rules on product design.

Doughnut economics

Some economists go further and question whether economic growth should be the main goal at all. Kate Raworth, a British economist, proposed the doughnut economics model in a 2012 paper for Oxfam and developed it in her book Doughnut Economics (2017). The model replaces the goal of ever-rising GDP with a target zone, shaped like a ring.

The inner edge of the ring is a social foundation of twelve essentials, including food, health, education, housing and political voice. The outer edge is an ecological ceiling of nine planetary boundaries identified by Earth scientists, including climate change, biodiversity loss and ocean acidification. In April 2020 the City of Amsterdam adopted the doughnut as a framework for its economic recovery from the COVID-19 pandemic, one of the first governments to use it.

The model has been criticised for being hard to turn into specific policy, because it does not say how to trade off one boundary against another or how to pay for meeting the social foundation. It is better seen as a way of framing goals than as a predictive model.

Sources: Ellen MacArthur Foundation, “Circular economy introduction” (2026); Doughnut Economics Action Lab, “The Amsterdam City Doughnut” (2020).

How far have individuals changed economic thinking?

The history of economic thought is often told through great names: Smith, Marx, Keynes, Friedman. Individual thinkers clearly mattered. Keynes gave governments a new framework for fighting unemployment, and Friedman’s arguments shaped central banking for decades. Their ideas gained influence because they offered clear explanations and practical policies.

Yet in each case events prepared the ground. Smith wrote as trade and industry expanded and old restrictions became costly; Marx as industrial workers lived in poverty; Keynes during mass unemployment that classical theory could not explain; Friedman during stagflation that simple Keynesian models could not explain. Ideas also spread through institutions: universities, central banks and governments that adopted them. A balanced view is that individuals supplied the theories, but crises and evidence decided which theories were adopted, and when.

Case study: testing the minimum wage in New Jersey and Pennsylvania

Basic demand and supply analysis predicts that a minimum wage set above the market wage reduces employment: firms hire fewer workers when labour becomes more expensive, ceteris paribus. For decades many economists treated this as settled. In the early 1990s David Card and Alan Krueger, then at Princeton University, tested the prediction with a natural experiment, and their result became one of the most debated studies in economics.

The natural experiment

On 1 April 1992 New Jersey raised its minimum wage from $4.25 to $5.05 an hour, an increase of about 19%. Neighbouring Pennsylvania kept its minimum at $4.25. Card and Krueger surveyed 410 fast-food restaurants (Burger King, KFC, Roy Rogers and Wendy’s), 331 in New Jersey and 79 in eastern Pennsylvania, shortly before the increase and again in November and December 1992. Fast food was chosen because it employs many low-wage workers and its restaurants are similar across the state border.

Pennsylvania played the role of a comparison group. Restaurants on both sides of the border faced the same economic conditions, the same seasons and a similar regional economy. Any change in Pennsylvania’s employment shows roughly what would have happened in New Jersey without the wage rise. Comparing the change in New Jersey with the change in Pennsylvania is a practical way of holding other things equal, the ceteris paribus assumption applied to real data.

The results

The survey showed that the wage rise was effective: the average starting wage in New Jersey restaurants rose from about $4.61 to $5.08, while in Pennsylvania it was unchanged at about $4.62. Yet employment did not fall. Average full-time-equivalent (FTE) employment per New Jersey restaurant rose from 20.44 to 21.03, a gain of 0.59 workers. In Pennsylvania it fell from 23.33 to 21.17, a drop of 2.16.

The difference between the two changes is 0.59 − (−2.16) = 2.75 FTE workers per restaurant, in New Jersey’s favour. Card and Krueger concluded that they found no evidence that the minimum wage rise reduced employment; if anything, employment rose relative to Pennsylvania. Their result contradicted the prediction of the simple competitive model.

The debate

Many economists doubted the result. David Neumark and William Wascher reanalysed the question using payroll records from fast-food chains, rather than telephone survey answers, and reported falls in employment in New Jersey relative to Pennsylvania. Card and Krueger replied in 2000 with further data that supported their original conclusion. The exchange turned on positive questions, about data quality and method, that evidence could in principle settle.

Since then, hundreds of studies have examined minimum wages in many countries. Several meta-analyses, which combine the results of many studies, find small or no employment effects from moderate minimum wage rises, while others find small negative effects. In 2021 Card shared the Nobel Memorial Prize in Economic Sciences for his empirical contributions to labour economics; Krueger had died in 2019 and the prize is not awarded posthumously.

What the case shows about economic method

• Hypothesis and refutation. A clear prediction of a widely accepted model was tested and appeared to fail, which forced economists to re-examine the model.

• Ceteris paribus with real data. Pennsylvania was used as a comparison group to separate the effect of the wage rise from other influences.

• The role of better theory. One explanation for the result is that employers of low-wage workers have some power to set wages (monopsony power), in which case a moderate minimum wage can raise both wages and employment. The evidence led to a refined theory rather than simply rejecting the old one.

• The limits of one study. The result applies to one industry, one region and one moderate increase. A much larger rise, or a rise in a poorer region, might have different effects. No single study settles a question.

The case also shows where positive economics ends. Even if a minimum wage rise costs some jobs, deciding whether it is worthwhile requires weighing higher pay for many workers against job losses for a few. That is a value judgment about equity and economic well-being, and evidence alone cannot settle it.

Sources: Card, D. and Krueger, A. B., “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania”, _American Economic Review 84(4) (1994), and the authors’ public data set (njmin); Neumark, D. and Wascher, W., American Economic Review (2000); Card and Krueger, American Economic Review (2000); Royal Swedish Academy of Sciences, Nobel Memorial Prize in Economic Sciences (2021)._

Exam practice

Unit 1 content rarely forms a whole question on its own. It is usually examined inside questions on other units: a part asking you to identify a normative statement in a text, a definition of ceteris paribus, or an evaluation that turns on the difference between Keynesian and monetarist/new classical views. Paper 1 part (b) and Paper 2 part (g) answers that use these ideas reach the higher markbands for synthesis and evaluation.

Definitions earn marks only when they are precise. “Ceteris paribus means other things are equal” is incomplete; a full answer explains that all other variables are held constant so that the effect of one variable can be isolated.

A part (b) question on this material usually asks for a judgment about government intervention, drawing on the history of ideas.

Short-answer practice (Paper 2 style)

Summary

• Positive economics makes testable statements about what is; normative economics makes value judgments about what ought to be.

• Economists use logic, hypotheses, models and theories, test them against empirical evidence and reject claims that evidence refutes; theories are accepted only provisionally.

• The ceteris paribus assumption holds other variables constant so that one relationship can be isolated; in the real world other things are rarely equal, which makes testing hard.

• Equality is about people having the same; equity is about fairness and is normative. Policy choices always contain value judgments.

• Smith argued for laissez faire, the division of labour and the invisible hand; classical economists relied on Say’s law; marginal analysis transformed microeconomics; Marx criticised capitalism as exploitative and unstable.

• The Great Depression produced the Keynesian revolution and active macroeconomic policy; 1970s stagflation produced the monetarist/new classical counter-revolution.

• In the 21st century, behavioural economics brings in psychology, and the circular economy and doughnut model respond to the interdependence of economy, society and environment.

• Card and Krueger’s minimum wage study shows the method at work: a natural experiment, a refuted prediction, a long debate and a refined theory.

Self-check

• To do:

  I can explain how economists use logic, hypotheses, models, theories and empirical evidence.

• To do:

  I can define ceteris paribus and explain why economic models depend on it.

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  I can explain what refutation means and why it is harder in economics than in the natural sciences.

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  I can distinguish positive from normative statements and name the words that signal a value judgment.

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  I can explain the role of value judgments in policy making.

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  I can distinguish equity from equality, including horizontal and vertical equity.

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  I can describe the ideas of Smith, the classical economists, the marginal revolution, Say’s law and Marx.

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  I can explain the Keynesian revolution and the monetarist/new classical counter-revolution and the events behind them.

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  I can explain behavioural economics, the circular economy and the doughnut model.

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  I can use the Card and Krueger study to evaluate how scientific economics can be.