Ten Principles of Economics and How Economists Think ...home.cerge-ei.cz/pstankov/teaching/aubg/micro/f15/Lecture01... · Ten Principles of Economics and How Economists Think PrinciplesofMicroLecture1

Ten Principles of Economics and How Economists ThinkPrinciples of Micro Lecture 1

Petar Stankov

[email protected]

Sept. 2015

P.Stankov (UNWE, AUBG) Lecture 01 Sept. 2015 1 / 18

Unlimited Wants Vs. Limited Resources

Can you have everything you want?

Scarcity: limited resources⇒ the need to make choices.

Economics: the intuitive way to see what economists doA study of the reasons people, firms and governments make their choiceswith the limited resources they have and of the consequences of thosechoices.



Can you have everything you want?Scarcity: limited resources

⇒ the need to make choices.




Can you have everything you want?Scarcity: limited resources

⇒ the need to make choices.



What is Economics?

Economics: the textbook wayA study of the production, exchange and consumption of goods andservices, and of the distribution of income received from production andexchange. More generally, Economics is the study of how society managesits scarce resources.

Economics: the professional wayA study of the economy by using economic models.

theoretical models: use maths or intuition to predict patterns ofbehavior –> build hypothesesempirical models: test these hypotheses by using data


Parts of Economics

MicroeconomicsPart of Economics studying individual actions: consumers, firms, industries:

how prices affect the quantities demanded

how factor prices affect demand of inputs for production

MacroeconomicsPart of Economics studying aggregate behavior of consumers, firms and the government,and aggregate dynamics of economic variables:

how much the entire economy produces, consumes, invests, exports

how the overall price level changes

how many people are unemployed

EconometricsPart of Economics which uses maths and statistics to test hypotheses derived in Micro-and Macroeconomics


MicroeconomicsExamples

Rational behavior of the individual:Coming to class?Applying to a university?Disco?Dumping a partner?Quit smoking?

Rational behavior of the firm:Do I raise my prices?Do I produce more?Do I hire more people and machines?How do taxes affect my decisions?


MacroeconomicsExamples

GDP = Gross Domestic ProductEmployment in the private sectorIs there a link?


EconometricsExamples

How does coming to class affect my grade?How much more I will earn if I stay in school for another year?If the government did not introduce this measure, where would theeconomy be now?What is the effect from a given policy?If I spend 100K on advertising, will it bring me more than 100K inrevenues?If I quit smoking at 25, will I live significantly longer than if I quit at35?


Approaches in Economics

Positive approach –> Positive EconomicsDescribes the events as they are:

If I get a 10% pay raise, then I will increase my consumption by morethan 10%.If the government lowers taxes, then people will consume more.

Normative approach –> Normative EconomicsPrescribes actions:

If you want to increase his consumption by more than 10%, you shouldgive him a 10% raise.

If the government wants to make people consume more, it shouldlowers taxes.


Approaches in Economics

Positive approach –> Positive EconomicsDescribes the events as they are:

If I get a 10% pay raise, then I will increase my consumption by morethan 10%.If the government lowers taxes, then people will consume more.

Normative approach –> Normative EconomicsPrescribes actions:

If you want to increase his consumption by more than 10%, you shouldgive him a 10% raise.If the government wants to make people consume more, it shouldlowers taxes.


Ten Principles of EconomicsHow people make decisions?

1 People face trade-offs: Food Vs. clothing; Leisure vs. Work (Facebookvs. studying)

2 The cost of something is what you give up to get it: How many newfriends will I never make (at the disco) by spending an hour ofstudying? –> opportunity costs

3 Rational people think at the margin (taking into account small,marginal, changes): Does it make sense to spend an additional hour ofbiking/swimming?

4 People respond to incentives: if 1 hr. of studying increases my grade by5 pts., then I will spend more time studying (especially before exams)


Ten Principles of EconomicsHow people interact?

5 Trade makes everyone better-off: you specialize in what you do best–> you make more per hour –> you produce cheaper –> competewith others.

6 Markets are usually a good way to organize economic activity: becauseof prices –> a guide for action/inaction. When everyone does what isbest for themselves, the society improves welfare (as a whole).

7 Governments can sometimes improve economic outcomes: sometimesmarkets fail and government action is needed. Typical market failures:

negative externality: what’s best for you harms othersmarket power: e.g., monopoly


Ten Principles of EconomicsHow the economy as a whole works?

8 The standard of living depends on a country’s productivity: how muchthe average person produces per hour?

9 Prices rise when the government/central bank prints too much money:inflation

10 Society faces a short-run trade-off between inflation andunemployment: I ↑ ⇔ U ↓


How Economics Works?What are the models economists use?

When modeling the world, economists:1 use abstraction from the real world: we refrain from irrelevant stuff to

be able to better predict human action based on the relevantinformation. Example: your grade does not depend on the color ofyour shoes

2 make assumptions about agents: agents care about one or two mostimportant things. Example: consumers care about consumption andleisure; firms care about profits

3 design experiments: how consumers spend income4 work with large data: e.g. “big data” ⇒ abstraction, assumptions,

experiments and data help us understand the world better.Two basic models:

The Circular Flow ModelThe Production Possibilities Frontier (PPF)


The Circular Flow ModelA graphical illustration


The Circular Flow ModelWho and What to Whom and Where?

Who and What?1 Households: buy and consume products, own production factors2 Firms: produce and sell products, hire production factors

To/From Whom and Where?1 The goods markets: HH buy, F sell2 The factor markets: HH sell, F buy

What are the production factors:1 Inputs into the production process to make final products possible.2 Examples?


The Production Possibility FrontierA graphical illustration


The PPFImportance

It shows you:1 Trade-offs in an economy, household or an individual2 Opportunity costs3 Efficiency4 Growth and increase in productivity


The PPFImportance

It shows you:1 Trade-offs in an economy, household or an individual2 Opportunity costs3 Efficiency4 Growth and increase in productivity


Where do economists work?Wide career choices

After an economists graduates:1 academia: teachers, researchers2 business: manufacturing, and consultancies3 government: policy makers4 central banks: research departments5 non-government organizations: policy advice and lobbying6 international organizations: research7 private companies: entrepreneurs

More career options in this AEA video: https://vimeo.com/135871291


Further reading

Reading:M-T, Chapters 1,2: pp.1-40.

Do no miss:economist.com; wsj.com; the economic news on TV


Documents

Ten Principles of Economics and How Economists Think ...home.cerge-ei.cz/pstankov/teaching/aubg/micro/f15/Lecture01... · Ten Principles of Economics and How Economists Think PrinciplesofMicroLecture1