Download WHAT IS ECONOMICS?

Welcome to Econ 110
Econ 110
Introduction to Economic Theory
Section 2
Professor Tanya Rosenblat
Fall 2007
What is Economics?
Economics is a:
1. Social Science
2. A Business Tool
As a Social Science: Exploration of the consequences of
- Rationality
- Selfishness
- Equilibrium
As a Business Tool: Subject that studies the market forces
that govern the creation and distribution
of value in the marketplace
EXAMPLES
1.
2.
3.
4.
5.
6.
Water/ Diamonds: what determines value?
Why so many new textbook editions?
Renting or Selling: what is better?
Why is popcorn in theaters so expensive?
Which auction maximizes revenue?
To Lead or to Follow: what is better?
PRINCIPLES
1. People face Tradeoffs: No “Free Lunch”
2. The Cost of Something is what you give
up to get it
3. Rational People think at the Margin
4. Rational People react to Incentives
No homework due the first week.
No homework due the weeks of
midterms
Econ 110:
Grade Components
Homework (individual or team)
10%
(8 best out of 10)
Midterms
20% each
(Oct 17 and Nov 14)
Final examination
40%
(December 10 )
More information
on exams will be
provided as the
dates of exams
approach
+ Class Participation
10%
Grading
Final course average is determined according to the following
formula:
[0.1  homework] + [0.2  midterm1] +[0.2  midterm2] +
[0.4  final]+ [0.1  class participation]
• Upward trend in performance will be rewarded. I will weigh final
more if your perform substantially better on the final.
• Students
who do poorly in Econ 110 tend to be those who don’t
come to class and don’t do the reading and problems sets
• Class participation and attendance:
– Not Compulsory, but appreciated. Please let me know if you
cannot attend
• Course readings:
– Stiglitz and Walsh, Economics
– Additional readings distributed through course website
• Problem sets:
– Individual or Group homework assignments to be turned in
(no more than 4 persons)
• Review session: Review sessions weekly on Tue at 7 pm in
PAC 004
Classroom Etiquette: Responsibilities and
Expectations
• My responsibility: I will be on-time for every class (indeed, I will
usually be 5 minutes early)
– My reciprocal expectation: you will try to be in your seats and
ready to go at the beginning of the hour.
• My responsibility: I will remain in the classroom, intensely
focused on your learning, for the duration of the class
– My reciprocal expectation: please do not get up from the class
and then return later
• My responsibility: To surprise you with ideas and insights
– To do this, I need to ask that you not read ahead in the
chapters, especially when we are doing an experiment
Last Warning: What Economics
Offers and Does Not Offer:
• Economics does NOT offer:
– Simple recipes for dealing with every conceivable
problem
• Economics does offer:
– Frameworks of enduring value, that can enable your
intuition, harness your creativity, and help you think
through a broad range of issues
– A honing mechanism that helps you identify the data
that is most relevant for dealing with complex,
ambiguous problems
What is Economics?
• Economics in general is about the allocation of scarce
resources:
• What is produced?
• How is it produced?
• Who produces and gets paid for it? What does it cost?
• Who buys it and why?
• You can’t have it all!  “Tradeoffs” 
“The Dismal Science” Real life
Macro and Micro
• Macro: Aggregate economic behavior and
performance of economy: Inflation, unemployment,
exchange rates, wealth, interest rates, income
distribution
• Micro: Focus on individual economic decisionmakers and behavior and performance of markets for
goods, services, and productive inputs. (price of
gasoline, wages of consultants, innovation in
computer technology)
What is Micro?
• Economic behavior of individual consumers and
producers (firms)
• Interactions between consumers and firms in markets
for goods and services, the role of prices, and the
“laws of supply and demand”
• Behavior and performance (prices, costs, efficiency)
of markets for goods and services, including labor and
capital
• Perfectly competitive markets, monopoly, imperfect
competition
• Analyze effects of public policies: sales taxes, price
controls, antitrust, information and disclosure,
government subsidies, environmental regulations, on
costs, prices, social welfare, consuming and producing
groups
Consumers, Producers, Markets
• In this course we examine consumers, producers and
how they interact in markets
• Consumers choose what goods and services to buy by
maximizing their utility or satisfaction subject to their
scarce income or budget constraint. Consumers are
rational given their information
• Producers (firms) are constrained by technology,
prices for inputs (labor, capital, raw materials),
production from competing firms and what consumers
are willing to pay (demand) for their products
• Firms choose output and prices (supply) to maximize
profits subject to these constraints
Consumers, Producers, Markets
• Consumers (demand) and producers (supply) interact
in markets to trade money for goods and services
• Markets determine prices assigned to goods and
services and to scarce productive inputs (labor,
capital, raw materials)
• Prices play a central role in microeconomics and
determine how scarce resources are allocated: what is
produced, how is it produced, and who gets it. The
central questions of economics.
• Prices are signals that convey information to
consumers and firms and ultimately link millions of
consumers and thousands of firms.
Consumers, Producers, Markets
• Prices tell consumers how much different goods and
services cost and allow them to decide whether to
consume more or less of a good or service (demand)
given how much they value them (utility or
preferences) and their budget constraints
• Prices tell producers how much consumers are willing
to pay for what they produce and how much revenue
they will receive if they producer alternative quantities
(supply)
• Prices for inputs (wages, capital) indicate what it will
cost to produce so firms can decide whether to
produce more or less and how to produce the products
to reduce costs and increase profits (revenues –
costs)
Economic Models
• We try to approach these economic problems
scientifically, but individual human behavior is
complicated, driven by many factors, and cannot be
fully explained by simple precise mathematical
relationships (e.g. E = mc^2 )
• We rely on simple theoretical models to understand
consumer and producer behavior and price formation
in markets of different kinds. A model is any
description of a relationship between two or more
economic variables (e.g. prices and quantities sold)
• These models are based on many assumptions, which
may sometimes seem unrealistic (e.g. consumers have
good information about product prices and qualities
offered by competing firms)
• We then relax these assumptions to see how market
behavior and performance change
Theoretical vs Emprical
• Theoretical economics is the process of building
models to explain economic relationships (when
prices rise consumers buy less – the law of downward
sloping demand)
• Empirical economics is the process of testing models
and measuring the parameters of established economic
relationships (e.g (if the prices of gasoline rises does
consumption fall and by how much? -- elasticity of
demand for gasoline)
• Some economic phenomena are hard to explain
empirically.
• Why do people wait in line for four hours for a
Britney Spears concert and why can scalpers charge 5
times the face value of the tickets?
Perfect vs Imperfect Competition
• One of the key sets of assumptions that must be made
in micro theory is to characterize the nature of
competition in various markets
• We always start with “perfectly competitive” markets.
Perfect competition relies on many assumptions that
may all be satisfied for only a few products (e.g.
wheat). Students find this annoying.
• But perfect competition is a good starting point and
many economic relationships can be understood well
even in markets that don’t satisfy all of the
assumptions
• We will go on to examine alternative markets
structures (e.g. monopoly, cartels) and many other
market imperfections.
Positive vs Normative
• Positive economics focuses on explaining economic
phenomena without making judgments about whether
they are good or bad.
• Why is Wesleyan’s tuition $36,536/year? Why is it
almost identical to Williams’ and Brown’s tuition?
• What happened to oil prices before and after the war
in Iraq started on March 20, 2003?
• Normative economics seeks to evaluate whether
market outcomesare good, bad or could be improved
upon with changes in market structures or with the
application of government policies that affect market
outcomes (e.g. controls on pollution). Normative
economics uses phrases like efficiency, social
welfare, consumer welfare, equity, etc., that reflect
specific normative criteria which may or may not
themselves be controversial
Policy Analysis
Microeconomics is often used to examine the effects of
various government policies:
- minimum wage (“living wage”)
- sales taxes
- antitrust policies (Microsoft)
- farm subsidies (wheat, butter, milk, etc.)
- safety standards (pharmaceuticals)
- pollution regulations (global warming)
- price controls (electricity prices)
- information disclosure (Enron)
- patent and copyright policies
Economics Can Be Fun
• Economics is about real life decisions made by
individuals as consumers and producers. It can be
applied to many phenomena that we encounter in every
day life and care about as citizens. It is of enormous
value in public policy analysis
• By the end of this course you should be able to think and
speak intelligently about issues like the following:
- raising the minimum wage
- alternative approaches to controlling pollution
- government restrictions on Microsoft’s behavior
- behavior of oil prices and effects of price controls
- how to make investment decisions
- how to evaluate insurance policies
- why did Enron’s CEO earn 100 times more than Michael
Roth?
Production Function
• Production refers to the conversion of inputs, the factors of
production, into desired output. A production function for
a particular good or service is often written as follows:
Xi = f(L,K,M,R),
• where Xi is the quantity produced of a particular good or
service and:
• 􀁺 L represents the quantity and ability of labor input
available to the production process.
• 􀁺 K represents capital input, machinery, transportation
equipment, and other types of intermediate goods.
• 􀁺 M represents land, natural resources and raw material
inputs for production, and
• 􀁺 R represents entrepreneurship, organization and risktaking.
Example 1: One Good, Only Labor Input Variable
Example 1: One Good, Only Labor Input Variable
Production function with diminishing marginal
productivity of labor
Two Goods; Labor Supply = 7
MRT (of good 1 for good 2) – How much can output
of good 1 increase if the firm decreases the output of
good 2 by one marginal unit?
• Marginal Rate of Transformation = the slope of the
transformation frontier
• This ratio measures the opportunity cost of using
resources in producing one good in terms of the
alternative use of those resources used in the
production of the other good. Given diminishing
marginal productivity, as resources are allocated
away from good Y towards good X, the
opportunity cost (|MRT|), of producing more of
good X, increases.
Examples
y  a  bx
MRT = |y’| = b
x y c
2
2
y    x  (c  x )
2 1 / 2
2 1 / 2
 x  (c  x )
0