EC4101: Ch 1. First Principles & Tools of Economic Analysis

The Scientific Method (Observation, theory and more observation)

  • Economists use abstract models to explain how a complex, real world operates; models are simplified representations of a particular feature of the world.

  • Models generate hypotheses that can be tested against the facts by collecting and analyzing evidence/data.

Data and Data Types

  • The quality and choice of data determine the reliability of applied analysis.

  • Key data types: time-series data, cross-section data, and panel data.

Time-series Data

  • Definition: measurements of the same variable at different points over time.

  • Presentation can be tabular or graphical but charts must be interpreted carefully.

  • High-frequency data can be too detailed, using averages (monthly/quarterly/yearly) is better to present data

  • Patterns: Over time, patterns like trends or seasonality may emerge

Cross-Section Data

  • Definition: Records the way economic variable differs across different individuals or groups of individuals at a point in time

  • Important: data must be adjusted to ensure like-for-like comparisons.

Panel Data

  • Definition: Records observations over multiple time periods for the same individuals or groups of individuals. Models help generate hypotheses tested with data.

Economic Models and Assumptions

  • Economists use abstract models to simplify how the real world works and improve understanding.

  • Assumptions are chosen to make the world understandable the art is deciding which assumptions to make.

  • Different questions require different assumptions.

  • Economic models allow us to generate hypotheses that can be tested

    against the facts by collecting and analysing data

Econometrics

  • Econometrics fits average relationships between two or more variables while controlling as many factors as possible.

  • This helps address the 'other things equal' problem when correct controls are included.

  • Uses: test hypotheses and predict the impact of changes in one variable on another (e.g., price variable on demand variable).

Basic Economic Models

  • Economists use models to simplify reality in order to improve our

    understanding of the world

  • Two foundational models: the Production Possibilities Frontier (PPF) and the Circular Flow Model

The Production Possibilities Frontier (PPF)

  • Definition: a graph showing the combinations of output that the economy can produce given available factors of production and the available production technology.

  • Key concepts: efficiency, trade-offs, opportunity cost, and economic growth.

PPF Concepts Illustrated

  • Efficiency: on the frontier; inefficiency: inside the frontier.

  • Trade-offs: choosing more of one good requires giving up some of another.

  • Opportunity Cost: the slope of the PPF represents the cost of one more unit of a good in terms of the other good.

  • Economic Growth: outward shift of the frontier.

PPF Shifts

  • A shift in the PPF occurs when resources, technology, or preferences change.

  • Example: a shift from point A to A' reflects growth or improved production capabilities.

The Circular-Flow Model

  • Visual model of the economy showing money flows between households and firms.

  • Although simplified, it shows how households and firms are interdependent through markets for goods/services and for factors of production.

Expanded Circular-Flow Diagram

  • Adds financial markets, government, and foreign sector.

  • Components include: government purchases, taxes, transfers, borrowing, private savings, investment, exports, imports.

The Economist as a Policy Advisor

  • When explaining the world: scientists.

  • When trying to change the world: policy advisors.

Positive vs Normative Analysis

  • Positive (descriptive): statements about how the world is.

  • Normative (prescriptive): statements about how the world should be.

Is the following normative or positive?

  • Example: "Minimum wages in Ireland are too high." (normative/positive distinction depends on framing; typically normative.)

Why Economists Disagree

  • Disagreements can stem from different positive theories about how the world works.

  • Different normative values lead to different policy prescriptions about what should be done.