Download Introductory Teaching Notes

ECONOMICS for PUBLIC POLICY ANALYSIS
Introductory Teaching Notes
NATURE AND SCOPE OF ECONOMICS
Economics is the study of the use of scarce resources to satisfy (unlimited) human wants.
Scarcity, in combination with virtually unlimited wants, requires choice -> This is what
microeconomics is about: the study of how economic units make rational choices. Question:
what do we mean by rational?
Constrained optimization: obtaining the best within limits imposed by availability of resources,
e.g. the most benefit from a fixed budget.
Microeconomics is the study of the behaviour of individual decision units of the economy i.e., households and firms - and how their decisions interact to determine the relative prices of
goods and services and of factors of production, and the quantities of these that will be
bought and sold. The ultimate aim is to understand the mechanism by which the total amount
of resources possessed by society is allocated among alternative uses. The central concept in
microeconomics is the market. (Penguin Dictionary of Economics)
Macroeconomics is primarily concerned with the study of relationships among broad economic
aggregates, the most important of which are national income, aggregate savings and consumers’
expenditures (aggregate or total consumption), investment, aggregate employment, the quantity
of money, the average price level, interest rates, and the balance of payments. Macroeconomics
is largely concerned with explaining the determinants of these aggregates, how they change
over time (growth theory, the business cycle), and the role of government expenditure,
taxation and monetary policy in determining the general level of economic activity.
Four key economic problems (and outcomes of the economic system):
1.
What is produced and how? The theory of the firm; price theory.
2.
What is consumed and by whom? The theory of consumption; income distribution
theory.
3.
What resources are used and why? What resources are unemployed? The theory of
factor markets; labour economics.
4.
Why growth occurs and how? How much growth? Economic growth theory.
Economics is a social science: it applies the scientific method to the study of one form of human
behaviour. Thus it uses the tools of scientific enquiry to the extent possible. Reasoning and
observation are used to create theory and models of behaviour. These may be expressed in
mathematical form: equations, graphs, computer simulations, etc.. The theory is both an
explanation and an abstraction (a simplification to the essential elements) of the cause and effect
GSPP 805, Teaching Notes, Lesson 1
© Brian Christie, December 2000, November 2007
-2relations between economic variables (concepts like price and quantity demanded). The theory
then allows both prediction and testing. Good theory stands up to testing with historical data
(explains past observations) and makes good predictions. If an alternative theory predicts and
explains better (statistical tools are used to measure “goodness”), then the original theory is
discarded and the alternative adopted.
The test of goodness of a theory is the accuracy of its predictions, its fit to reality, its “power”.
The competition between theories is like survival of the fittest.
The law of large numbers: The tendency for the peculiarities of individual members of a group
(including the random aspects of their behaviour) to cancel out, which becomes stronger the
larger the size of the group. This means that the group as a whole shows much more uniformity
than any one individual member. It is this phenomenon that allows predictability of large group
behaviour in economics and explains why economists use statistical techniques in many of their
studies.
The difficulty faced in the social sciences compared to the natural sciences - we usually have no
laboratory where we can control and repeat experiments.
******
In addition to mathematical tools, economists also use jargon, terms such as “households,
resources, demand and supply, elasticity, Pareto optimality”. Jargon is defined as “Unintelligible
words, gibberish; mode of speech full of unfamiliar terms or peculiar to a class or profession.”
(OED) This can be compared to legal terms: torts, writs, etc. or medical terms. Why use?
Economy, precision.
******
Opportunity Cost
Cost measures what must be given up in order to achieve or obtain something.
Opportunity cost is the value of the alternatives or other opportunities that have to be foregone
in order to achieve something, e.g. foregone income is part of the opportunity of attending
university. Not always money values. (Non-pecuniary costs and benefits.)
Outlays: the cost measured in terms of the total necessary money expenditures. May be less
than the opportunity cost. If so, from an economist’s view outlays are an inaccurate/ incomplete
measure of the cost of something.
Question for discussion: What is your opportunity cost of the MPA program? How would you
GSPP 805, Teaching Notes, Lesson 1
© Brian Christie, December 2000, November 2007
-3value it in money equivalent terms? How does it compare to the benefits you expect from the
program?
Revealed preference (Samuelson): an analysis of consumer behaviour based only on information
about the choices actually made by the consumer in various price-income situations. This
approach does without the indifference curve analysis and the assumption of measurable utility
that consumer utility theory employs.
******
Markets and the self-organizing economy
A market exists when buyers wishing to exchange money for a good or service are in contact
with sellers wishing to exchange a good or service for money.
Free market economy: an economy in which resources are allowed to be allocated by the
operation of free markets, i.e. markets in which the forces of supply and demand are allowed to
operate unhampered by government regulation or other interference. Question: can any market
be truly “unhampered by government regulation”.
In such markets, the decisions of individual buyers and sellers are coordinated and made
consistent with each other by the movement of (i.e. changes in) prices.
Note that the process of coordination is decentralized. No single central authority collects
information regarding buyers’ and sellers’ decisions or intentions, finds the price level at which
they are consistent, and then transmits information on the necessary sales and purchases and
prices to individual buyers and sellers. (ref., Adam Smith’s “invisible hand”.)
A decentralized system is, other things equal, likely to be more efficient as a coordinating
mechanism, simply because it saves the cost of the two-way flow of information, may operate
more quickly, and make fewer mistakes.
Actual real world markets have inefficiencies: frictions (e.g. transactions costs) and imperfections
(market failure - will look at later in course). Economic efficiency is a particularly important
concept in microeconomics and should be a major concern in determining government policy.
******
Types of Economic Systems Distinguish between:
Command or Centrally Planned Economy: in which decisions about the outputs of production
and the use of resources are made centrally by some administrative process, and
GSPP 805, Teaching Notes, Lesson 1
© Brian Christie, December 2000, November 2007
-4Regulated economy: where government or public bodies impose conditions on the market, e.g.
price ceilings or floors, regulations about market structure (size of firms), etc., to address market
failure (economic inefficiency) or to reflect (presumably more important) social values.
Conditions for free markets to operate include:
·
·
·
social and cultural conditions such as: individual economic freedom to pursue self-interest
in buying and selling goods, services, and factors of production (e.g. labour services);
openness to change and innovation; willingness to accept widespread private property
ownership; information accessibility, etc..
legal framework such as: enforceable contracts, protection of property rights, competition
legislation limiting (ab)use of market power.
expectations play a very important role in the effective and efficient functioning of an
economy: e.g. stability of currency, credibility of the future value of investments <->
uncertainty/high risk can lead to inappropriate, unproductive behaviour.
Transition economics (new field) looks at the process of transition of the former USSR states
and satellites from command to market economies. Lessons from this teach about how market
economies can be assisted to work more efficiently.
Questions for discussion: What roles does government play in assuring the conditions for and
proper functioning of free market economies? What parts of the Canadian economy operate as
free markets and what parts are operated as command sectors?
Government economic policy is pervasive in our economy. Its goals, effectiveness, side effects,
the alternatives, are all subjects for study. Even the choice to do nothing is a policy decision!
GSPP 805, Teaching Notes, Lesson 1
© Brian Christie, December 2000, November 2007