Positive correlation exists when two variables move in the same direction. A basic example of positive correlation is height and weight—taller people tend to be heavier, and vice versa. In some cases, positive correlation exists because one variable influences the other. In other cases, the two variables are independent from one another and are influenced by a third variable. The field of economics contains many cases of positive correlation. In microeconomics, demand and price are positively correlated. In macroeconomics, positive correlation exists between consumer spending and gross domestic product (GDP).
In a perfectly positive correlation, the variables move together by the exact same percentage and direction 100% of the time. A positive correlation can be seen between the demand for a product and the product's associated price. In situations where the available supply stays the same, the price will rise if demand increases.
- Positive correlation exists when two variables move in the same direction.
- One of the most common positive correlations is the relationship between demand and price.
- Consumer spending and GDP are two macroeconomic indicators that maintain a positive correlation with one another.
Postive Correlation in Microeconomics
Microeconomics, which analyzes individual consumers and firms, features many instances of positive correlation between variables, one of the most common being the relationship between demand and price. When students study microeconomics and statistics, one of the first concepts they learn about is the law of supply and demand and the influence it has on price. The supply and demand curve shows that when demand increases without a concomitant increase in supply, a corresponding increase in price occurs. Similarly, when a demand for a good or service decreases, its price also drops.
The relationship between demand and price is an example of causation as well as positive correlation. An increase in demand causes the corresponding increase in price; the price of a good or service increases precisely because more consumers want it and therefore are willing to pay more for it. When demand decreases, that means fewer people want a product and sellers must lower its price to entice people to buy it.
In contrast, supply is negatively correlated with price. When supply decreases without a corresponding demand decrease, prices increase. The same number of consumers now compete for a reduced number of goods, which makes each good more valuable in the eye of the consumer.
Positive correlation also abounds in macroeconomics, the study of economies as a whole. Consumer spending and GDP are two metrics that maintain a positive relationship with one another. When spending increases, GDP also rises as firms produce more goods and services to meet consumer demand. Conversely, firms slow production amid a slowdown in consumer spending to bring production costs in line with revenues and limit excess supply.
Like demand and price, consumer spending and GDP are examples of positively correlated variables where movement by one variable causes movement by the other. In this case, consumer spending is the variable that effects a change in GDP. Firms set production levels based on demand, and demand is measured by consumer spending. As the level of consumer spending moves up and down, production levels strive to match the change in demand, resulting in a positive relationship between the two variables.