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week 1
Textbook Readings: Chapter 1
Section 1.1
Introduction
Economy → derived from the Greek oikonomos (one who managed a household)
Economics: study of how society manages its scarce resources → resources are usually allocated through the combined choices of various households and businesses
Economists: examine how people make these choices, how much they work, what they buy, how much they save, how they invest their savings, etc. → also how people interact with one another
Examine how buyers and sellers together determine the price at which a good is sold and the quantity that is sold
Analyze forces and trends that affect the overall economy (ex. Growth in average income, population that is unable to find work, rate of rising prices)
Scarcity: society has limited resources and thus is unable to produce all the goods and services people want
Individuals in a society do not always attain the standard of living to which they may aspire
How People Make Decisions
Principle 1: People Face Trade-offs
Making decisions requires trading off one goal for another
Ex. “guns and butter”: the more a society spends on the military, the less it can spend on consumer goods
Ex. clean environment and level of income: laws requiring firms to reduce pollution may raise the cost of producing goods and services
Higher costs = smaller profits, paying lower wages, charging higher prices, etc.
Pollution regulations yield cleaner environment and improved health, yet it may also reduce the incomes of regulated firms’ workers and customers
Ex. efficiency and equality: government policies aimed at reducing inequality (ex. Welfare or unemployment insurance) help members of society who are in need, while other factors (ex. Personal income tax) require more financially successful individuals to contribute more than others to support the government → increases equality but decreases efficiency
When the government redistributes income from the rich to the poor, it reduces the reward for hard work for people at all income levels → people may work less and produce fewer goods and services
Efficiency: society is getting the greatest benefits from its scarce resources
Equality: those benefits are distributed uniformly among society’s members
Principle 2: Cost of Something is What You Give Up to Get it
opportunity cost of an item: what you give up to get it → important to consider when making decisions
Ex. decision to attend college
Main benefits: intellectual enrichment and better job opportunities
Need a place to sleep and food → room and board at college exceed the cost of living and eating at home/apartment
Too busy to spend time working and earning money
Principle 3: Rational People Think at the Margin
Economists often assume that people are rational → in reality, human nature is complex and sometimes deviates from rationality
Rational people: systematically and purposefully do the best they can to achieve their goals given available resources/opportunities
Marginal change: incremental adjustment to an existing plan of action
Rational people make decisions by comparing marginal benefits and marginal costs
Ex. many movie streaming services set the marginal cost of a movie equal to zero
A person’s willingness to pay for a good is based on the marginal benefit that an extra unit of the good would yield → depends on how many units a person already has
Ex. water is essential but plentiful, thus the marginal benefit of an extra cup is small → whereas, no one needs diamonds to survive, but because they are rare the marginal benefit of an extra gem is large
A rational decision-maker takes an action only if the action;s marginal benefit exceeds its marginal cost
Demonstrates why people use streaming services, why airlines sell tickets below average cost, why people pay for more certain services/goods over others
Principle 4: People Respons to Incentives
Incentive: something that induces a person to act (ex. The prospect of a punishment or reward) → plays a central role in economics
People respond to incentives if they make decisions by comparing costs and beneifts
Key to analyzing how markets work → the influence of prices on the behaviour of consumers and producers is crucial to how a market economy allocates scarce resources
Ex. when apple prices rise, people decide to eat fewer apples → simultaneously, apple orchards decide to hire more workers and harvest more apples
Thus, higher price provides incentive for buyers to consume less and for sellers to produce more
Public policymakers also pay close attention to incentives
Many policies change the costs or benegits that people face and may alter their behaviour
Ex. tax on gasoline encourages people to drive more fuel-efficient cars and shift to electric cars → also encourages carpooling, taking public transportation, biking, and living closer to work
Norway: many people drive electric cars due to the high gas taxes
US: many drive SUVs because gas taxes are low
When policymakers fail to consider incentives, their enacted policies may cause unintended consequences
Ex. autosafety: when wearing a seatbelt, the likelihood of surviving an auto accident rises → yet Congress’ laws requiring seat belts as standard equipment on cars also affects behaviour by altering incentives
Driving slowly/carefully is costly because it uses the driver’s time and energy but people do it because the benefit of increased safety is high → icy road conditions (more attentive driving) vs clear road conditions
Buckling makes accidents less costly by reducing risk of injury/death → but when conditions are safer, people drive faster/less carefully
Faster driving = more accidents + seatbelt law does not protect pedestrians who are now more likely to be in an accident (don’t benefit from added protection)
Sam Peltzman 1975 study: auto-safety laws give rise to fewer deaths per acccident, but also more accidents → net result is little change in driver deaths and increase in pedestrian deaths
When analyzing policy, it is important to cinsider direct and indirect effects that work through incentives
If the policy alters incentives, then people may change their behaviour
Section 1.2
How People Interact
Principle 5: Trade Can Make Everyone Better Off
Trade between countries can make each country better off, rather than being a competition
Even when trade in the world economy is competitive, it can lead to win-win outcomes for the involved countries
Otherwise, these countries would have to provide, manufacture, etc. for themselves with no outside help (which can be less efficient or use up more resources)
Trade allows people to specialize in the activities they do best → through trade, people can buy a greater variety of goods/services at a lower cost
Trade allows countries to specialize in what they do best and enjoy a greater variety of goods and services
Principle 6: Markets Are Usually a Good Way to Organize Economic Activity
80s/90s: collapse of Communism in Soviet Union/Eastern Europe was one of the latest transformative events of the last century
Countries in the Soviet bloc operated on the premise that government officials were in the best position to allocate the economy’s scarce resources
Central planners decided what goods and services were produced, how much was produced, and who produced/consumed them
Theory behind central planning: the government needed to organize economic activity to ensure the well-being of the country and of like-minded nations
Most countries that historically have centrally planned economies have now shifted toward market economics
Market economy: the decisions of a central planner are replaced by millions of firms and households
Firms decide who to hire and what to make
Households decide where to work nd what to buy with their incomes
Firms and households interact in the marketplace where prices and self-interest guide decisions
No one appears to being concerned about the well-being of society as a whole → competitive markets contain buyers/sellers of various goods and services, all interested in their own well-being
Despite decentralised decision making and self-interested decision-makers, market economies have proven to be successful in organizing economic activity to promote prosperity
Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776)
Firms and households in competitive markets act as if they are guided by an “invisible hand: that leads them to desirable outcomes
Smith: participants in the economy are motivated by self-interest and the “invisible hand” of the marketplace guides them into promoting general economic well-being
Prices are the instrument that the invisible hand uses to direct economic activity
In a competitive market, sellvers look at the price when deciding how much to supply and buyers look at price when deciding how much to demand
Thus, price reflects both the sellers’ cost of production and the value of the good to buyers
Smith: prices adjust to guide market participants to reach outcomes that maximize the well-being of society as a whole
When a government prevents prices from adjusting to supply and deman, it impedes thet invisible hand’s ability to coordinate the decisions of the firms and households that make up an economy → corollary explains the effect of most taxes on the allocation of resources
Individuals are usually best left to their own devices without the heavy hand of government directing their actions
This philosophy provides intellectual foundation for market economy anda freer society
Taxes distort prices and the decisions of firms and households
explains problems caused by policies that dictate prices (Ex. rent control)
Explains the economic failure of Communist countries where prices were not set in the marketplace, but by central planners
Central planners lacked the amount of complex/ever-changing information about producers’ costs and consumers’ tastes which is reflected in a market economy’s prices
Central planners failed because they try to run the economy
Uber Case Study:
2009: Uber disrupted the highly controlled market for taxis → because they do not roam looking for taxi-hailing pedestrians, they technically are not subject to the same regulations as taxis, while offering a similar service (and being mroe convenient)
Uber cars often charge less than taxis → prices rise significantly when there is a surge in demand (ex. Rainstorm or late on NYE)
While taxis are prevented from surge pricing
Drivers of traditional taxis complain that Uber’s competition reduces their income → Suppliers of goods and services often dislike new competitors
Competition among producers makes a market work well for consumers
Economists say Uber and surge pricing increases consumer well-being
Surve pricing makes consumers pay more at times, but since Uber drivers respond to incentives, it also increases the quantity of car services supplied when they are most needed
Surge pricing also helps allocate the services to those consumers who value them most highly and reduces the costs of searching/waiting for a car
Principle 7: Governments Can Sometimes Improve Market Outcomes
One reason we need government is that the invisisble hand can work its magic only if the government enforces the rules and maintains the institutions that are key to a market economy
Market economics need institutions to enforce property rights so individuals can own and control scarce resources
Ex. farmers will now grow food if they expect their crops to be stolen, etc.
Market participants reply on government-provided police and courts to enforce their rights → invisible hand only works well when the legal system does
Another reason for government is that the invisible hand, while powerful, is not omnipotent
2 broad rationales for government to intervene in the economy and change the allocation of resources that people would choose on their own
To promote efficiency
The invisible hand usually leads markets to allocate resources to maximize the size of the economic pie
Market failure: refers to a situation in which the market does not produce an efficient allocation of resources onits own
Possible cause: externality (impact of one person’s actions on the well-being of a bystander)
Ex. Pollution: when the production of a good pollutes the air and creates health problems for those living near factories, the market may fail to take this cost into account
Possible cause: market power (ability of a single person/firm to unduly influence market prices)
Ex. if everyone needs water but there is only one well in town, the owner does not face competition in which the invisible hand usually keeps self-interest in check
The owner may take advantage of the opportunity by restricting the output of water and charging a higher price
Presence of externalities or market power → leads to well-designed public policy and increased efficiency
To promote equality
While the invisible hand may yield efficient outcomes, it can leave large disparities in well-being
Market economy rewards people according to their ability to produce things that other people are willing to pay for
The invisible hand does not ensure that everyone has adequate resources → inequality may call for government intervention
In practice, many public policies aim to achieve more equal distribution of well-being
Imperfect political processes: some policies are designed to reward the politically powerful, some are well-intentioned but ill-informed, etc.
Invisible hand: ability of competitive markets to reach desirable outcomes, despite the self-interest of market participants
Principle 8: A Country’s Standard of Living Depends on its Ability to Produce Goods and Services
Variation in average income across countries is reflected in measures of quality of life
People in high-income countries have more computers, more cars, better nutrition, better healthcare, and a longer life expectancy than those in low-income countries
Almost all variation in living standards is attributable to differences in countries’ productivity
Productivity: amount of goods and services produced by each unit of labour input
In nations where workers can produce a large quantity of goods and services per hour, most people enjoy a high standard of living
In nations where workers are less productive, most people endure a more meager existence
The growth rate of a nation’s productivity determines the growth rate of its average income
Relationship between productivity and living standards
If productivity is the main determinant of living standards, other explanations must be less important
Ex. while employers and labour unions rise the incomes of workers, the main determinant is the workers’ rising productivity
This relationship has implications for public policy
How a policy will affect living standars → how will it affect the economy’s ability to produce goods and services
To boost living standards, policymakers need to raise productivity by ensuring that workers are well-trained,have the teels neede to produce goods and services, and have access to the best available technology
Lecture: Chapter 1
Incentives: motivate you based on what you like or dislike
Constraints: limits what you can achieve
Budget constraints: determines how much you can spend based on your income and savings
Time constraints: limits how many hours you can spend on any activity
Economics uses common sense in understanding decision-making
Important assumption of economics: every decision maker makes choices in their best interest, given the constraints they face
Microeconomics: referring to individuals and individual consumers/businesses
Resources are scarce
Scarcity: the limited nature of society’s resources
Society has limited resources
Cannot produce all the goods and services people wish to have
Economics: the study of how society manages its scarce resources
Economists study Markets
Market: collection of all the buyers and all the sellers of a good or service
Economy: collection of all the markets in a geographic region
Principle 1: people face trade-offs
Society faces trade-offs
Ex. the more it spends on national defence (guns) to protect its shores
The less it cna spend on consumer goods (butter) to raise the standard of living at home (guns v. butter)
Ex. polution regulaions: cleaner environment and improved health
But at the cost of reducing the incomes of firms’ owners, workers, and customers
Efficiency vs. equality
Efficiency: society gets the most from its scare resources
Equality: prosperity is distributed uniformly among society’s members
Trade-off:
To achieve greater equality, could redistribute income from wealthy to poor
But this reduces incentive to work and produce shrinks the size of the economic “pie”
Principle 2: the cost of something is what you give up to get it
Making decisions
Compare costs wih beneits of alternatives
Need to include opportunity cost
Opportunity cost: whatever must be given up to obtain some item
Ex. going to college → expenses of going to college + time that could be spend working/earning income
Tuition, books, room/board, fees
PLUS foregone wages
Ex. going to the movies → ticket price + value of time spent
Price of a movie ticket
PLUS the value of the time you spend in the theatre
Principle 3: rational people think at the margin
Rational people
Systematically and purposefully do the best they can to achieve their objectives gien the available resources/opportunities
Make decisions by evaluation costs and benefits of marginal changes
Small incremental adjustments to a plan of action
Thinking at the margin: the ability to evaluate how the costs and benefits of the choice change has they consider making small changes to their plan
Ex. cell phone users with unlimited minutes (minutes are free at the margin)
Are often prone to making long/frivolous calls
Marginal benefits of the call > 0
Manager considers whether to increase output
Compares the cost of the needed labour and materials to the extra revenue
Marginal revenue (extra revenue): When greater than the extra cost of production (marginal cost) then the manager will increase production
Principle 4: people respond to incentives
Incentive: something that induces a person to act
Ex. when gas prices rise, consumers buy more hybrid/fuel-efficient cars and fewer gas guzzling SUVs
When cigarette taxes increase, teen smoking falls
Principle 5: trade can make everyone better off
People benefit from trade
People can buy a greater variety of goods and services at lower cost
Countries benefits from trade and specialization
Get a better price abroad for goods they produce
Buy other goods more cheaply from abroad than could be produced at home
Principle 6: Markets are Usually a Good Way to Organize Economic Activity
Market: group of buyers and sellers (need not be in a single location)
“Organizing economic activity” means determining:
What goods and services to produce
How much of each to produce
Who produced and consumed these
Command economy: when a government or political leader unilaterally makes decisions
Severely limits a person/business’ freedom of choice
Bad outcomes
China was a command economy in 195s: government leaders moved farmers off their land to factories to build industrial goods → Great Leap Forward
GLF: China’s attempt to transition from an agricultural economy to an industrial economy
Miscalculated: too much steel was produced and there was too little food (no more farmers to grow crops) → this led to famine and 36 million deaths
Laissez faire economy: where people have complete freedom in choosing their occupation, what they buy, who they buy from, who they work for, and the government is not involved in any significant way of organizing economic activity
Market economy: allocates resources
Decentralized decisions of many firms and households as they interact in markets
Adam Smith: each of these households nd firms act as if “led by an invisible hand” to promote general economic well-being
Prices:
Determine: interaction of buyers and sellers
Reflect the good’s value to buys
Reflect the cost of producing the good
Invisible hand: prices guide self-interested households and firms to make decisions that maximize society’s economic well-being
Principle 7: Governments Cam Sometimes Improve Market Outcomes
Government: enforce property rights
Enforce rules and maintain institutions that are key to a market economy
People are less inclined to work, produce, invest, or purchase if large risk of their property being stolen
Government: promote efficiency
Avoid market failures: market left on its own fails to allocate resources efficiently
Externality: production or consumption of a good affects bystanders (ex. pollution)
Negative externalities: occurs when consumption or production by one person or organization harms someone else
Positive externalities: occurs when someone else’s production or consumption makes another better off
Market power: a single buyer/seller that has substantial influence on market price (ex. Monopoly [when were is only 1 seller of a product])
Government: promote equality
Avoid disparities in economic wwellbeing
Use tax or welfare policies to change how the economic “pie” is divided
Principle 8: Country’s Standard of Living Depends on its Ability to Produce Goods and Services
Huge variation in living standards
Across countries and over time
Average income in rich countries
Is more than 10x average income in poor countries
The US standard of living today
Is roughly 8x larger than 100 years ago
Economist observations:
There are enormous variations in living standards which are measured in output per capita (output produced in a given time period, per person, across countries)
Some countries experiences persistent economic growth over time that leads to increasing standards of living
The main determinants of living standards, as well as growing living standards, is productivity
Economists seekingto help poorer countries develop economic policies that can increase capital investments, increase/improve education and training, and facilitate the adoption of new, more efficient technologies
Productivity: most important determinant of living standards
Quantity of goods and services produced form each unit of labour input
Depends on the equipment, skills, and technology available to workers
Other factors (ex. Labour unions, competition from abroad) have far less impact on living standards
Principle 9: Prices Rise When the Government Prints Too Much Money
Inflation: an increase in overall level of prices in the economy
In the long run
Inflation is almost always caused by excessive growth in the quantity of money, which causes the value of money to fall
The faster the government creates money, the greater the inflation rate
Principle 10: Society Faces a Short-run Trade-off between Inflation and Unemployment
Short-run trade-off between unemployment and inflation
Over a period of a year or two, many economic policies push inflation and unemployment in opposite directions
Other factors can make this tradeoff more or less favourable, but the tradeoff is always present
Fundamental lessons about individual decision making
People face trade-offs among alternative gaols
The cost of any action is measured in terms of foregone opportunities
Rational people make decisions by comparing marginal costs and marginal benefits
People change their behaviour in response to the incentives they face
Fundamental lessons about interactions among people
Trade and interdependence can be mutually beneficial
Markets are usually a good way of coordinating economic activity among people
The government can potentially improve market outcomes by remedying a market failure or by promoting greater economic equality
Fundamental lessons about the economy as a whole
Productivity is the ultimate source of living standards
Growth in the quality of money is the ultimate source of inflation
Society faces short-run trade-off between inflation and unemployment
Active Learning
cost of fixing the transmission = $900
Blue book value is $7,500 is transmission works and $6,200 if it doesnt
Benefit of fixing transmission = $7,500 - $6,200 = $1,300 → thus you should get the transmission fixed
Blue book value is $6,300 if transmission works, $5,500 if it doesn’t
Benefit of fixing the transmission = $6,300 - $5,500 = $800 → thus you should not pay $900 to fix it
Textbook Readings: Chapter 2
Section 2.1
The Scientific Methods: Observation, Theory, and More Observation
Economists use theory and observation like other scientists, however conducting experiments is often impractical
Ex. economists studying inflation cannot manipulate a nation’s monetary policy simply to generate useful data
To substitute for expeiments, economists pay close attention to the natural experiments offered by history
Ex. when a war in the Middle East interrupts the Supply of crude oil, oil prices skyrocket around the world → for consumers of oil/oil products, this even can raise the cost of living
This event provides economists the opportunity to study the effects of a key natural resource on the world’s economies
Studying this yields insights into the economy of the past and helps illustrate and evaluate economic theories of the present
Role of Assumptions
Assumptions simplify the complex world and make it easier to understand
Ex. international trade: we might assume that the world consists of only 2 countries and that each produces only 2 goods → by focusing on only 2 countries and 2 goods, we can focus on the essence of the problem
Art in scientific thinking → deciding which assumptions to make
Ex. want to study whqat happens to the economy when the government changes the number of dollars in circulation → analysis turns to how prices responds
Many prices in the economy change infrequently → this fact leads to making different assumptions for different time horizons
Economists use different assumptions when studying the short-run and long-run effects of a change in the quantity of money
Ex. when studying short-run effects of policy: we may assume that prices do not change much or make the extreme assumption that all prices are completely fixed
Ex. when studying long-run effects of policy: we may assume that all prices are completely flexible
Economic Models
Economists use models to learn about the world → mostly consists of diagrams and equations
Economics models omit many details to allow us to see what is truly important → does not include every feature of the economy or every aspect of human behaviour
Simplify reality to improve our understanding of it
All models are subject to revision when the facts warrant it → key is to find the right model at the right time
Statistician George Box: “All models are wrong, but some are useful”
Circular-Flow Diagram
Economy consists of millions of people engaged in many activities → buying, selling, working, hiring, manufacturing, etc.
In need of a model that explains how the economy is organized and how participants in the economy interact with one another
Circular-flow diagram: the economy includes only 2 types of decision makers → firms and households
Firms: produce goods and services using inputs (ex. Labour, land, capital [buildings and machines]) → factors of production
Households: own the factors of production and consume all the goods and services that the firms produce
Simple way of organizing all the transactions between households and firms in an economy
Households and firms interact in 2 types of markets
Markets for goods and services: households are buyers and firms are sellers
Households buy the output of goods and services that firms produce
Markets for the factors of production: households are sellers and firms are buyers
Households provide the inputs that firms use to produce goods and services
The 2 loops of the diagram are distinct but related
Inner loop: represents the flows of inputs and outputs
Households sell that use of their labour, land, and capital to firms in the markets for the factors of production
Firms then use these factors to produce goods and services which are then soldto households in the markets for goods and services
The firms use some of the revenue from these sales to purchase the factors of production (ex. Paying workers’ wages) → the remainder is profit for the firm owners who are members of the households
Outer loop: shows the flow of dollars
A more complex and realistic diagram would include the roles of government and international trade → these details are not crucial for basic understanding of how the economy is organized
The Production Possibilities Frontier
One of the simplest models → illustrates basic economics ideas
Graph that shows the various combinations of output the economy can possibly produce given the available factors of production and the production technology that firms use to turn inputs into outputs
Shows this economy’s production possibilities frontier
Ex. if the economy uses all its resources in the car industry, it produces 1,000 cars and no computers → if it usesall its resources in the computer industry, it produced 3,000 computers and no cars
The 2 endpoints of the production possibilities frontier represent extreme possibilities
Any point on or beneath the curve is a possible output combination in the economy
Points outside the frontier are not feasible given the economy’s resources
Slope of the production possibilities frontier measures the opportunity cost of a car in terms of computers → opportunity cost various depending on how much of the 2 goods the economy is producing
Because resources are scarce, not every conceivable outcome is feasible → no matter how resources are allocated between 2 industries, the economy cannot produce the umber of cars and computers represented by point C
With the technology available for making cars and computers the economy does not have enough of the factors of production to support that level of output
With the resources it has, the economy can produce at any point on or inside the production possibilities frontier → but cannot produce outside the frontier
An outcome is efficient if the economy is getting all it can from the scarce resources it has available
Points on the frontier represent efficient levels of production → when the economy is producing at such a point, there is no way to produce more of one good without producing less of the other
Point D rerepsents an inefficient outcome → the economy is producing less than it could from the resources it has available
If the source of inefficiency is eliminated, the economy can increase its production of both goods
People face trade-offs (principle)
The production possibilities frontier shows one trade-off that a society faces
Once an economy reaches an efficient point on the frontier, the only way to produce more of one good is to produce less of the other
Ex. When the economy moves from Point A to Point B, society produced 100 more cars at the expense of producing 200 fewer computers
Cost of something is what you give up to get it (principle)
Opportuinty cost: the production possibility frontier shows the opportuinty cost of one good as measured in terms of the other
The opportunity cost of a car in terms of the number of computers is not constant in this economy but depends on how many cars and computers the economy is producing
Ex.
Production possibilities frontier shows the trade-off between the outputs of different goods at a given time, but the trade-off can change over time
Ex. a technological advancement in the computer industry raises the number of computers that a worker can produce each week → this expands society’s set of opportunities
But if the economy devotes some of its resources to the computer industry, it will produce more computers from those resources → result is the PPF shifts outward
PPF shows what happens when an economy grows → society can move production from a point on the old frontier to a point on the new one
Which point it chooses depends on its preferences for teh 2 goods
Simplifies a complex economy to highligh basic ideas: scarcity, efficiency, trade-offs, opportunity cost, economic growth
Microeconomics and Macroeconomics → closely intertwined
Study of economics
Examine the decisions of individual households and firms
Interaction of households and firms in markets for specific goods and services
Operation of the economy as a whole → encompassing all activities in all these markets
Microeconomics: the study of how households and firms make decisions and how they interact in specific markets
Ex. effects of rent control on housing in NYC, impact of foreign competition on the US auto industry, effects of education of workers’ earnings
Macroeconomics: the study of the overall economy
Ex. effects of borrowing by the federal government, changes in the economy’s underenployment rate over time, alternative policies to promote growith in national living standards
Because changes in teh overall econmy arise form the decisions of millions of individuals, macroeconomic developments must consider underlying microeconomic decisions
Ex. team of macroeconomists may study the effect of a federal income tax cut on the overall production of goods and services
But thy emust consider how the tax cut affects households’ decisions about how much to spend on goods and services
Each field has its own set of models, address different questions, etc.
Section 2.2
Economist as Policy Adviser
Roles of economists:
Explain the causes of economic events
Asked to recommend policies to improve economic outcomes
Why Tech Companies Hire Economists
Many high-tech companies find that expertise in economics is useful in their decision making
Goodbye, Ivory Tower. Hello, Silicon Valley Candy Store - Steve Lohr
Airbnb: online lodging marketplace → one of various tehc companies luring economists with the promise of big sets of data and big salaries
Silicon Valley: turning to the dismal science to squeeze money out of old markets and build new ones
Businesses have been hiring economists for years → are usually asked to study macroeconomic trends
Ex. recessions and currency exchange rates to help their employers deal with them
Tech companies: instead of thinking about national/global trends, they are studying the data trails of consumer behaviour to help digital companies make smart decisions that strengthen their online marketplaces in areas such as advertising, movies, music, travel, lodging, etc.
Ex. Amazon, Facebook, Google, Microsoft, Airbnb, Uber → improved efficiency = more profit
Netflix: measuring the effectiveness of advertising
Correlation-or-causation conundrum in economic behaviour: what consumer actions accur coincidentally after people see ads, and what actions are most likely caused by the ads
Airbnb: researching the company’s marketplace of hosts and guest for insights → to help build the business and to understand behaviour
Procrastination: subject of great interest to behavioural economists → looking at bookings:
Are they last-minute, weeks or months in advance, etc.
Current market-design challenge for Amazon and Microsoft: big cloud computing services → facing peak-load problems as many electric utilities do
Economists work in teams with computer scientists and people in business
Tech companies: market design involves economics, engineering, and marketing
Positive vs. Normative Analysis
Positive: describing how the world works
Descriptive; makes claims about how the world is
Can be confirmed or refuted by examining evidence
Normative: describing how one would like to change the world
Prescriptive; making a claim about how the worl ought to be
Evaluation involves values and facts
Positive findings about how the world works can affect normative judgments about what policies are desirable
Normative judgments may influence the positive claims that researchers choose to study
Positive economics proceeds as a science independent of the researcher’s personal values or policy agenda
Much of economics is positive: trying to explain how the economy works
Some is normative: learning how to improve the economy
Economists in Washington
People face trade-offs: trade-offs are involved in most policy decisions
Ex,. a policy might increase efficency at the cost of equality
Ex. might help future generations but hurt current generation
1946: the US President has received guidance from teh Council of Economic Advisers → consists of 3 members and a staff of a few dozen economists
Council: advises the president and write the annual Economic Report of the President (discusses recent economic developments and presents the council’s analysis of current policy issues)
The president also recieves information and advice from economists in many administrative departments
Office of Management and Budget: formulate spending plants and regulatory policies
Department of the Treasury: design tax policy
Department of Labour: analyze data on workers and those looking for work to help formulate labour-market policies
Department of Justice: enforce the nation’s antitrust laws
Economists in teh federal government are also found outside the executive branch
To obtain independent evaluations of polci proposals, Congress relies on teh advice of the Congressional Budget Office
Federal Reserve (institution that sets the nation’s monetary policy) employs hungreds of economists to analyze developments in the US and around the world
John Keynes: “The ideas of economists and political philosophers, both when they are rigt and when they are wrong, are more powerful than is commonly iunderstood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite except from intellectual influences, are usually the slaves of some defunct economists. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic srcibbler of a few years back.”
Why Economists’ Advice is Often Not Followed
Making economic policy in a representative democracy is messy → often good reasons why presidents (and other politicians) do not embrace the policies that economists advocate
Lecture: Chapter 2
Economists play 2 roles:
Scientists: try to explain the world
Policy advisors: try to improve it
Economist as a Scientist
As scientists, economists employ the scientific method
Dispassionate development and testing of theories about how the world works
Scientific method
Develop a testable economic hypothesis
Design an experiment
gather data to test that hypothesis
Check to see if the data gathered supports the hypothesis
If it does: look for additional data to test the hypothesis → the more it holds up to scrutiny, the more confident we can be about its reliability
If it rejects: refine the theory and test again
Assumptions
Simplify the complex world and make it easier to understand
Ex. to study international trade, assume 2 countries and 2 goods
Economists use models to study economic issues
Highly simplified representation of a more complicated reality
Without models, we would have limited mobility to understand how the economy works, or how people, businesses, and other organizations make decisions
Successful models strip away details of the issue being studied that would otherwise make the job of understanding the issue more difficult
Models omit details and include the more important features → in economics these are usually graphs or algebraic equations
Circular flow diagram: (simplest) illustrates the transactions that take place between consumers and businesses
Consumers: want to buy stuff → incentives are actions that allow us to buy what we want (ex. Earn an income)
Businesses: want to make a profit → must hire workers and rent capital goods to produce the goods that people want to buy
vidsua l model of the economy
Shows how dollars flow through markets mong households and firms
2 decision makers:
Firms
buy/hire factors of production., use them to produce goods and services
Sell goods and services
households
Own the factors of production, sell/rent them to firms for income
Buy and consume goods and services
Interaction 2 markets
Market for goods and services
Market for factors of production (inputs)
Production possibilities frontier
Graph: combinations of output that the economy can possibly produce
Given the availability of:
Factors of production and technology
Ex.
2 goods: computers and wheat
1 resource: labour (measured in hours)
Economy has 50,000
Helps us understand the important principles of trade-offs → explicitly shows how we can only produce more of one good/service if we produce less of another good
Inefficnecy: we are not using out resources to their full capacity
We cannot reach points outside the PPF unless we increase labour in the economy or improving
Moving along PPF
Involves shifting resources form the production of one good to the other
Society faces trade-offs
Getting more of one good require sacrificing some of teh other
The slope of the PPF
The opportunity cost of one good in terms of the other
Points of the PPF: possible
Efficient: all resources are fully utilized
Points under the PPF: possible
Not efficient: some resources are underutilized (ex. Workers unemployed, factories idle, etc.)
Points above the PPF: impossible
Slope of the PPF = opportunity cost
Shape of the PPF
Straight line: constant opportunity cost
Bowed outward: increasing opportunity cost
As more units of a good are produced, we need to give up increasing amounts of the other goods produced
Different workers have different skills
Different opportunity costs of producingone good in terms of the other
There is some other resource, or combination, with varying opportunity costs
Economist as policy adviser
Positive statements: descriptive
Attempt to describe the world as it is
Confirm or refute by examining evidence: minimum wage laws cause unemployment
Normative statements: prescriptive
Attempt to prescribe how the world should be: the government should raise the minimum wage
Why Economists Disagree
Economists often give conflicting policy advise
Can disagree about the validity of alternative positive theories about the world
May have different values and thus different normative views about what policy should be accomplished
Yet there are many propositions about which most economists agree
Common strand: each issue is about government intervening in the marketplace
Either changing the incentives people have to freely buy/sell or changing the opportunities to do so
Thus, economists are vary wary of government intervention on various issues/areas
Summary
Economists are scientists
Make appropriate assumptions and build simplified models
The circular flow diagram and the PPF
Microeconomists study decision making by household and firms and their interactions in the marketplace
Macroeconomists study the forces and trends that affect the economy as a whole
Positive statement: assertion about how the world is
Normative statement: assertion about how the world ought to be
As policy advisors, economists make normative statements
Economists sometimes offer conflicting advice
Differentes in scientific judgments
Differences in values
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