Introduction to Economics

Economics as a Study of Human Behavior

• The suggested reading is "Principles of Economics" by N.G. Mankiw, chapters 4, 5, and 7.
• The main objectives are to introduce economics, understand different economies, consider economics as a science, learn about economic models, study a model, and understand divisions of economic theory. Economics is a study of human behavior

Economics and Markets

• Economics originates from the Greek word "oikonomia," combining "oikos" (house) and "nomos" (custom/law), signifying household management and administration
• Microeconomics comes from the Greek "mikros" (small); it concerns managing a small house or one's own house
• Macroeconomics comes from the Greek "makros" (large); it pertains to the management of a large house or a nation
• Economics is a result of the conflict between unlimited needs and limited resources
• Economics explores how societies manage scarce resources to produce and distribute goods and services
• Economics addresses what is produced, how, for what purpose, and who makes economic decisions

Market and Planned Economies

• Market economies allocate resources through decentralized decisions of firms and households interacting in markets
• Centrally planned economies allocate resources via a central authority deciding which products to produce, how much of each, which production factors to use, and how to distribute production

The Market Mechanism

• Markets serve as a mechanism where buyers and sellers interact to set prices for exchanging goods and services
• The price system solves consumption, production, and distribution issues
• Market prices reflect the value consumers place on products and the cost of resources used to produce them
• Adam Smith, in "The Wealth of Nations" (1776), observed that households and firms are guided by an "invisible hand" in markets
• The "invisible hand" operates through the price system
• The market interaction of buyers and sellers sets the prices for goods and services
• Prices reflect the value to buyers and the production cost of goods
• Selfish decisions from households and firms that orient the price system maximize economic welfare for society.

Market Interventions and Economic Models

• Governments intervene in market economies to correct and support free interaction, forming a mixed economy
• Interventions address income redistribution, market failures, and macroeconomic policies
• Economists act as scientists, explaining the world, and as consultants, improving it
• Economists develop theories through observation as a first step, followed by collecting data to verify or refute theories, lastly the theories need to be repeatable under same conditions

Economic Theories and Methodology

• Data is harder to use to evaluate theories in economics as opposed to hard sciences such as physics
• Generating data is difficult for economists and therefore they must comply with available data
• Economists substitute laboratory experiments with natural experiments found throughout history, to develop and contrast economic theories
• An economic theory is an organized model used to explain economic phenomena
• An economic model is a simplified depiction of economic reality

Characteristics of an Economic Model

• Economic models should be understandable, manageable, and testable via empirical analysis
• Most economic models include diagrams and equations
• Economic models use economic variables to represent elements of the economy or outcomes of agents' actions
• Economists gather historical data on economic variables to verify or refute economic models and theories

Types of Economic Models

• Endogenous variables: Their values are determined by internal functional relationships within the model (e.g., consumption)
• Exogenous variables: Their values are determined outside the model (e.g., population)
• Flow variables: Variables that are measured over a period of time (e.g., income)
• Stock variables: Variables measured at a specific point in time (e.g., wealth)
• Nominal variables: Expressed in current-year prices or monetary units (e.g., current GDP)
• Real variables: Expressed in constant terms related to a base year, to avoid changes due to the general level of prices (e.g., real GDP)

Types of Analysis

• Positive analysis: Studies economic consequences of policy implementation using economic models and assumptions, without considering desirability for society
• Normative analysis: Studies whether an economic policy should be used, involving scientific understanding and subjective views on economic system characteristics

Circular Flow of Income Model

• Model of the circular-flow diagram is a model that represents transactions in an economy by flows around a circle

Microeconomics and Macroeconomics

• Economics is divided into microeconomics and macroeconomics
• Microeconomics studies how households and firms make decisions and interact in markets
• Microeconomics focuses on individual agents, households, firms, and specific markets
• Examples of Microeconomics questions include how much an individual consumes, how much a company produces, and why things have different pricing
• Macroeconomics studies economic phenomena affecting the whole economy
• Macroeconomics focuses on the structure and performance of national economies and government measures to influence economic outcomes
• Macroeconomics examples are unemployment, changes to the price level, economic growth, and economic policies
• Macroeconomics and microeconomics share economic concepts and methods
• Microeconomics examines economic agents and markets, while macro focuses on aggregate concepts and the whole economy