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.