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
- 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!)
- 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.
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:
- Suppose that the relationship between income and consumption is:
- 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
- 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.)