C2

Introduction to Microeconomics: Methodology, Models, and Macro Concerns

Administrative Announcements and Course Logistics

  • Room Allocation Issues: The current lecture hall is insufficiently sized for the number of students enrolled in the English course.

  • Historical Trends: Typically, the French courses are larger, and attendance in most courses tends to decline starting from the second week of the semester.

  • Course Survey: To provide an accurate estimation of in-person attendance for the English track, a survey will be posted on the course Moodle page. Students are requested to complete this by next week, Monday. This data will determine if a formal request for a larger room change is necessary.

Major Contemporary Issues in Economics

  • Inflation: This has emerged as the most significant concern among students this year.

    • Comparison with Previous Years: Even when inflation was already becoming a reality last year, it did not receive as many mentions. This highlights a heightened awareness of decreasing purchasing power.

    • Definitions: Inflation is defined as the general increase in the level of prices.

    • Historical Context: For many years, the economy observed stable inflation rates near zero or even negative rates, known as deflation.

    • Recent Drivers of Inflation:

      • Post-COVID Supply Shock: After lockdowns, economic activity struggled to restart. Shortages of raw materials and intermediate goods (used for producing other goods) raised production costs.

      • Geopolitical Conflict: The war in Ukraine caused a secondary shock by increasing the prices of energy, agricultural products, and raw materials.

  • Income Inequality: A perpetual concern for economists, characterized by two distinct dimensions:

    • Spatial Disparities: Economic activity and population density are highly concentrated. "Black areas" on global maps represent empty regions with low density and low economic activity.

    • Across vs. Within Countries:

      • Historically, GDP per capita (revenue divided by population) increased globally, but differing growth gradients led to a wider gap across countries.

      • Recent evidence suggested this cross-country gap might be shrinking, while inequality within countries is increasing.

    • Measurement: The Gini coefficient is the standard statistical measure used to capture income inequality within a nation.

  • Climate Change: A critical topic studied primarily in Environmental Economics.

    • Circular Relationship: There is a bidirectional link where economic activity causes pollution (CO2CO_2 emissions), leading to temperature increases, while climate change subsequently disrupts economic activity.

    • Historical Origin: The exponential increase in CO2CO_2 concentration in the atmosphere is traced back to the Industrial Revolution.

    • Projections: Even a 1 degree1\text{ degree} increase in overall temperature can drastically affect regional population concentration and exacerbate existing global inequalities.

    • Policy Tools: Pigouvian taxes are government interventions discussed at the end of the semester as a means to reduce emissions.

  • The Return of Protectionism:

    • Historical Context: Tariffs and trade barriers saw a massive decline following the Second World War due to international agreements such as the GATT (General Agreement on Tariffs and Trade) and later the WTO (World Trade Organization).

    • Recent Shifting Trends: The "Trump 1.0" administration initially increased trade barriers. Current projections for a "Trump 2.0" administration suggest a further return to protectionist tendencies observed before WWII.

Defining Economics as a Discipline and a Method

  • Narrow Definition: Economics as a discipline focused on the decision-making processes of individuals and how they interact.

  • Broader Definition: Economics as a method or approach used to analyze any societal issue (e.g., education, health, religion, or sport).

  • Economic Agents: These include consumers, households, firms, industries, and governments.

  • Example Analysis - Electricity Prices:

    • Observed Data: Electricity prices spiked in late 2021 and late 2022.

    • Demand-Side Explanation: A hypothesis that increased usage (e.g., from Artificial Intelligence) drove prices up. While valid for long-term trends, this does not explain specific short-term peaks.

    • Supply-Side Explanation:

      • Peak 1 (2021): Post-lockdown shortages of raw materials and intermediate goods.

      • Peak 2 (2022): The invasion of Ukraine. Germany's dependence on Russian gas supply for electricity production meant it had to find more expensive alternatives quickly.

Microeconomics vs. Macroeconomics

  • Microeconomics:

    • Focuses on the decision process of a representative or typical economic agent.

    • Assumes individual behaviors can be generalized to understand sectors or specific markets.

    • Analyzes how shocks (like price changes) affect household spending or firm production.

  • Macroeconomics:

    • Focuses on aggregate variables.

    • Studies the economy as a whole including aggregate production, total consumption, economic growth (GPDGPD), inflation, and unemployment.

  • Pingo Exercise Analysis:

    • "When the price of oil goes down, its consumption increases" is a micro statement because it focuses on a specific market/sector.

    • "Austerity measures… recession can be avoided if private consumption remains strong" is a macro statement because it involves aggregate measures and government debt.

Positive vs. Normative Analysis

  • Positive Analysis:

    • Describes "what is" and "how the world works."

    • Aimed at identifying regular relationships to gain prediction power (e.g., if variable XX changes, what happens to YY?).

    • Viewed as the scientific side of economics.

  • Normative Analysis:

    • Describes "how the world should be."

    • Involves prescriptions, ideology, political positions, and concepts of justice.

    • Example: "Marijuana should remain illegal" is a normative statement, whereas "Legalizing marijuana will bring its price down" is a positive statement.

Economic Models and Scientific Methodology

  • Scientific Process: Observation →\rightarrow Generalization →\rightarrow Model Building →\rightarrow Empirical Testing.

  • The Model as a Map: Just as a traveler uses different maps (road, geographical, geology) depending on their destination, economists use various models depending on the phenomenon they wish to analyze.

  • Abstraction: A model is a simplified version of reality that ignores irrelevant details to isolate crucial mechanisms.

  • Utility: As the saying goes, "All models are wrong, some are useful." Their purpose is not to replicate every detail of reality but to provide prediction power regarding specific variables.

Correlation vs. Causality

  • Correlation: Captures the fact that two variables move together (e.g., in the same or opposite directions). This is insufficient for prediction.

  • Causality: Identifies the direct impact of one event/variable on another. This is the ultimate goal of economists.

  • Spurious Correlation: A coincidental or non-causal relationship between variables, often caused by an omitted variable.

    • Example: Sales of bikinis and ice cream are positively correlated, but neither causes the other; the omitted variable causing both is "temperature/summer."

    • Other Examples: Global temperature vs. the declining number of pirates; violent crime vs. police presence (where the causal direction is typically inverted).

  • The Risk of Graphical Analysis: Mistaking two lines moving together on a graph for a causal link without statistical or experimental verification.

Establishing Causality through Counterfactuals

  • Counterfactuals: The analysis of what would have happened if a specific change or shock had not occurred.

  • Experimental Methods:

    • Controlled Experiments: Similar to medical trials; two groups (treated and control) are compared to measure the efficacy of a treatment.

    • Difference-in-Difference Analysis: Comparing results between groups that are identical in all dimensions except for the treatment variable.

    • Challenges in Economics: Because economics is a social science, it is difficult to reproduce experiments in a lab-like setting.

    • Natural Experiments & Econometrics: Economists use specific statistical and econometric techniques to identify causality within real-world data where controlled experiments are impossible.