Lecture 01
Introduction and Math Review

What's Most Important

  • The most important part of any economic model are the assumptions.
  • A model with good assumptions should make good predictions.


Scope and Method of Economics

  • Studying economics will teach you a way of thinking.
  • You will learn to use three key concepts in your daily lives:
    • efficient markets
    • marginalism and
    • opportunity cost


Efficient markets

  • Profit opportunities are rare because everyone is looking for them.
  • Efficient markets eliminate profit opportunities immediately.
  • Ex. You'll never find a good parking space, because if there was a good one, it would already be taken before you got there.



  • Average Cost -- total cost divided by quantity
    • If I spend 300 hours preparing 30 lessons for you, then my average cost is 10 hours per lesson.

  • Sunk Cost -- costs that can no longer be avoided because they have already been "sunk"
    • If I teach this class again next semester, I will have already sunk 300 hours into preparation.

  • Marginal Cost -- cost of producing one more unit
    • Next semester I can recycle my notes, so my marginal cost per lesson will equal 75 minutes.
    • (Compare that with my current 10 hours!)


Opportunity Cost

  • We all face choices because resources are "scarce."
  • We cannot spend more time or money than we have, so we have to give up one opportunity to take advantage of another.

  • If I have a choice between earning $1000 per month by teaching this course OR earning $500 per month by working at McDonald's, then:
    • It takes me one month to produce $1000 worth of teaching.
    • It takes me one month to produce $500 worth of hamburgers.

  • Q:   What's my opportunity cost of teaching?
  • A:   Half a hamburger per unit of teaching.
one month $1000 of teaching one month $500 of hamburgers = $500 of hamburgers $1000 of teaching   = 1 2 hamburgers teaching


Math -- Tools for Economic Analysis

  • point plotting (X,Y):
    • the first point in a pair lies on the X axis (horizontal axis)
    • the second point in a pair lies on the Y axis (vertical axis)
  • The following equation is plotted in red squares:
  • and its line is drawn by connecting points: (0,20), (1,15), (2,10), (3,5) and (4,0)
  • the slope of a line is the change in y divided by the change in x
    • y decreases from 15 to 10 when x increases from 1 to 2
    • so the slope is -5
  • the y-intercept is the value of y, when x=0
    • y=20 when x=0
    • so the y-intercept is 20


  • slope is positive if y increases as x increases
  • the equation below (and plotted in blue circles) has positive slope:

  • slope is negative if y decreases as x increases
  • the equation below (and plotted in red triangles) has negative slope:


Analyzing Graphs

  • Suppose that the relationship between income and consumption is:
  • where:
    • C = consumption
    • Y = income

  • The income coefficient (0.60) is the marginal propensity to consume.
    • consumption increases as income increases, but
    • a $1000 increase in income only increases consumption by $600

  • At higher income levels, consumption is less than income. (Higher income households save).
  • At lower income levels, consumption is greater than income. (Lower income households dissave).

  • Along the 45 degree line, income equals expenditure.


A Few More Definitions

  • Model -- formal statement of a theory (often presented mathematically)

  • Variable -- a measure that can change (for example: income and consumption)
    • dependent variable
    • independent variable
    • In the example above, consumption depends on income.

  • Parameters -- value which remain constant in an equation (in the example above: 0.60 and 14,000)
  • Ceteris Paribus -- "all else equal"

  • How does an increase in investment, I, affect national income, Y?
  • To determine the effect of investment alone (on income), we must hold all other variables constant.


Micro vs. Macro


  • Studies the decision-making of individuals, households and firms
  • Studies the distribution of wealth and income


  • Studies the behavior of the economy as a whole
  • Explores the factors that affect:
    • Gross Domestic Product
    • the price level
    • the unemployment rate


Positive vs. Normative Economics


  • No judgements
  • Just asking how the economy operates


  • Makes judgements
  • Evaluates the outcomes of economic behavior
  • Makes policy recommendations


Economic Policy

  • Positive -- economic policy starts with positive theories and models to develop an understanding of how the economy works
  • Then economic policy normatively evaluates outcomes on the basis of:
    • Efficiency -- Is the economy producing what people want at the least possible cost?
    • Equity -- Is the distribution of wealth fair?
    • Growth -- Increase in total output of the economy.
    • Stability -- steady growth, low inflation and full employment
  • And recommends (normative) courses of action to policy-makers (presidents, congressmen, etc.)

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