Week 1_ Wednesday lecture_default_1b389d7d

Introduction

  • Economics is centered around economic models, which help explain key concepts.

  • Today’s discussion includes: opportunity costs, incentives, and relative prices.

Economic Models

  • Economic models are essential as they provide frameworks to understand economic phenomena, particularly when data is limited.

  • Models allow economists to generate predictions that can be tested against real-world data.

  • Renowned philosopher Karl Popper emphasizes that a good theory should explain reality and make accurate predictions.

The Nature of Economic Theories

  • Economics differs from hard sciences (e.g., physics) as controlled experiments are often impractical.

  • Example: The ongoing debate in economics—Does raising the minimum wage lead to higher unemployment?

    • No clear consensus due to the complex interaction of labor markets, necessitating the use of both theory and data.

Importance of Data and Theory

  • Misinterpretations can arise solely from data without theoretical backing.

  • Extrapolation Error: Assuming trends will continue indefinitely without factoring in changes—e.g., predictions of reduced working hours over generations.

    • Historical case: A 1930 prediction erroneously foresaw a 15-hour workweek in 2030 based on observed declines in hours worked.

  • Policies may not transfer universally—e.g., New York's 'broken windows' policing policy cut crime but was ineffective elsewhere due to differing social attitudes.

Correlation vs. Causation

  • Understanding that correlation does not imply causation is vital.

  • Causation: A cause-and-effect relationship—e.g., kicking a table causes pain in the leg.

  • Correlation: Two variables may move together without one causing the other.

    • Example: Ice cream sales and shark sightings both increase in summer but are influenced by weather, not by one causing the other.

  • Spurious Correlation: Confounding relationships can mislead interpretations—e.g., unrelated trends showing correlation purely by chance.

Exercises on Causation

  • Discussion on various scenarios of correlation:

    • Teeth brushing and grades: Correlate, but diligent students may brush teeth more and achieve better grades—implies a third variable driving both behaviors.

    • Violent video games and behavior: Potentially bidirectional causation or concurrent attraction to violence as the third variable.

    • Cheese consumption and tangled sheets: Initially seen as spurious correlation; one argues they might be interrelated through social settings involving alcohol.

    • Police levels and crime: More police presence often correlates with higher crime, suggesting reverse causality where crime necessitates increased policing.

Key Concepts in Economics

  • All Else Equal (Ceteris Paribus): Simplifying assumptions in models to isolate the impact of one variable on another while holding others constant.

  • Incentives: Rewards or punishments impacting decisions

    • Example 1: Increased final test weight changes study behaviors.

    • Example 2: Conservation policies altering black rhino hunting incentives by removing valuable horns.

  • Thinking at the Margin: Considering additional benefits and costs in decision-making—e.g., evaluating marginal costs (like fuel) against total costs.

  • Relative Prices: Understanding decisions based on price comparisons rather than absolute values—e.g., increasing rents versus high home prices prompting choices to rent.

  • Opportunity Cost: Choosing one option over another entails giving up the value of the next best alternative.

    • Example: Choosing to study instead of working could represent the opportunity cost of wages foregone.

  • Economic Rent: The additional payment received beyond what would be necessary to incentivize a decision.

Industrial Revolution Model

  • Shift from labor-intensive to machine-intensive production resulted in greater efficiency and productivity.

  • Historical context:

    • 700 years of stagnant per capita GDP due to the Malthusian trap—population growth negating income gains.

    • Post-1700, the UK experienced dramatic increases in GDP per capita due to industrial growth.

  • Model formation: By focusing on the production of cloth using solely labor and machines, the discussion simplifies choices between capital-intensive and labor-intensive production techniques.

Application of Economic Concepts

  1. Isocost Lines: Representation of cost relationships in production, allowing for cost comparison.

  2. Identification of production technologies preferred based on their position relative to isocost lines.

  3. Changes in Economic Conditions: An increase in wages relative to capital prices necessitates a reevaluation of production strategies, ultimately leading to a preference shift from labor to capital.

Conclusion

  • Understanding economic models relies on the interplay between data and theoretical frameworks.

  • Key concepts such as opportunity costs and incentives shape decision-making processes in economics and provide insights into historical transitions like the Industrial Revolution.

  • The aim is for students to approach economic analysis critically, comprehending not only data trends but also the underlying causal mechanisms.

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