Introduction to Economics

Topic 1: Introduction

• The lectures are structured in the same way: topics start with a puzzle or question, build understanding of economic concepts and models, and end with an explanation of how economists use the topic, including learning outcomes.
• A key symbol in the top right corner of a slide indicates content important for later topics.

A Puzzle: The Industrial Revolution

• Economic history from the year 1000, Britain's GDP per capita rose more rapidly than Japan, Italy, China and India

What is Economics?

• The term "economics" was first used by the Greek philosopher Xenophon (431-354 BCE).
• It originates from the Greek words "oikos," meaning household, and "nomos," meaning rules or norms.
• Adam Smith shifted the focus of economics from the household to the public realm, which is now referred to as "the economy" in the 18th century.
• Canadian economist Jacob Viner defined economics as "Economics is what economists do."
• Gary Becker (1992 Nobel prize winner) described economy as "the art of making the most of life."
• Economics is the study of how people behave and includes alternative definitions.
• Focuses on people in the ordinary business of life (Alfred Marshall, 1890).
• Investigates human behavior as a relationship between given ends and scarce means with alternative uses (Lionel Robbins, 1932).
• Applies models that are relevant to the contemporary world (John Maynard Keynes, 1938).
• Focuses on the study and practice of decision-making (Todd Buchholtz, 1995).
• Studies how humans coordinate their wants and desires, given social customs and political realities (David Colander, 2009).
• The science of choice (Michael Parkin, 2011).
• Studies how society manages its scarce resources (N. Gregory Mankiw, 2018).
• Focuses on the efficient allocation of scarce resources and making resources less scarce (Alvin E. Roth, 2012).
• There are two fields of economics: microeconomics and macroeconomics.
• Microeconomics studies the behavior of individuals, firms, government, or markets.
• Macroeconomics studies the aggregate economy as a whole.
• Macroeconomics is related to microeconomics. Macro-economic phenomena are made up of the decisions of individuals, firms, and governments.
• John Maynard Keynes introduced the key ideas of macroeconomics in the 1930s.
• Ragnar Frisch distinguished between 'microeconomics' and 'macroeconomics.'
• Paul Samuelson (1970 Nobel prize winner) linked microeconomics and macroeconomics as part of the 'neoclassical synthesis.'
• The course covers both microeconomics(Topics 1-8) and macroeconomics (Topics 9-12).

Economics and Data

• Economics uses theories to explain the world, involving the collection and analysis of data, including observations about what humans see.

Extrapolation Error

• Faulty decisions can be easily made from observations due to extrapolation error, like assuming trends will continue indefinitely.

Causation and Correlation

• Observational errors can occur when concluding that a change in one variable causes a change in another.
• This results in the 'faulty causation fallacy,' confusing correlation with causation.
• Causation: a cause-and-effect relationship where a change in one variable produces a change in another, ceteris paribus (all else being equal).
• Correlation: an assessment that two variables have moved together, appearing related, but not necessarily in a cause-and-effect relationship.
• When two variables (A and B) move together, it could be because A causes B, B causes A (reverse causation), a third variable (C) causes both (common cause, or confounding), or the relationship is a spurious correlation, common if both variables are trending over time.

Examples: Causation vs. Correlation

• Relationships between different variables:
• Students who brush their teeth getting high grades in school
• players who play violent video games likely to commit acts of violence
• per capita cheese consumption that leads to people tangled in their bedsheets

Economic Models

• Appropriate models must be used to extrapolate or explain relationships between variables to avoid extrapolation and causation error.
• A model is a deliberate abstraction or simplification of reality.
• Models can be maps, model aircraft, or mathematical or theoretical models.
• An economic model explains how the economy or part of it works.

What is a Good Model?

• A good model should be clear in helping to understand something important
• It must be able to predict accurately and be consistent with evidence available
• A good model will improve communication, and find ways to improve the economy

Some Basic Concepts in Economics

• Economics uses models to explain choices.
• Basic concepts to be kept in mind before describing economic choices:
• Ceteris paribus: an assumption in economic models, meaning "other things being equal”. When looking at a change in a model, everything else doesn't change. Used by Alfred Marshall in the 1800's
• Incentives: economic rewards or punishments that influence the benefits and costs of alternatives.
• Relative price: the price of one good compared to another, used to compare alternatives.
• It is measured as the ratio of two prices, P1/P2.
• Economic rent: a payment or benefit a decision-maker receives above and beyond their next best alternative.
• The idea goes back to David Ricardo in the 1800s.
• Opportunity cost: the cost of not pursuing the opportunity of doing something else.
• It can be measured as its cost in the best alternative foregone.

Opportunity Cost Example

• Example: 6 hours available before an ECONS101 final test, spent either working at $25/hour or studying.
• Opportunity cost for each hour of study and work must be weighed

A Model of Production

• Explains why the Industrial Revolution happened in Britain, using a simple model of production.
• Changes in relative prices created incentives for innovation, leading to the conditions underlying the Industrial Revolution, as explained by Bob Allen.
• Simple model: the amount of labour (L) is measured on the x-axis, the amount of capital (K) on the y-axis.
• Different combinations of inputs (L,K), referred to as "different production technologies", will produce different amounts of output.
• Some technologies will produce the same amount of output.

The Production Decision

• A firm wants to produce amount X with production technologies (labour and capital).
• Combinations that take more inputs are dominated by a better technology
• Assume the firm maximizes its profits (equals their economic rent)
• The best profit technology with the lowest cost will produce X

Iso Cost Lines

• An iso-cost line is one that links all of the combinations of the inputs that have the same total cost
• With a y-interecept of TC/p and a slope of -w/p (the relative rate)
• All iso-cost lines have the same slope (equal to -w/p, equals the relative price of the two inputs)
  • The difference is the total cost (TC)
• When the relative price is high (wages are high) relative to capital, the iso-cost lines will be steep (vice versa)
• The lowest cost production technology will be the one that sits on the lowest iso-cost line

What Happened in the Industrial Revolution?

• The resources in the model are labour and coal, and the output is cloth.
• Two production technologies are available: labour-intensive (A) and coal-intensive (B).
• Prior to the Industrial Revolution, wages were low and coal was expensive.
• Because of this, labour was the lowest cost to produce cloth but changed during the Industrial Revolution as there was an increase in the wages of coal.
• This created an incentive for firms to shift to the coal-intensive production
• Britain was the first to experience this because wages were higher than elsewhere and coal was low.

What Economists do. . .

• This topic covered the basic concepts of economics (incentives, relative prices, economic rent).
• These concepts underlie most economic modelling.
• This model can explain complex transitions in the economy such as the Industrial Revolution

Learning Objectives

• Define economics, and explain the difference between microeconomic and macroeconomics
• Explain extrapolation error and/or the faulty causation fallacy
• Explain what economic models are, and the features of a good economic model
• Explain the simple economic concepts of ceteris paribus, incentives, relative prices, economic rent, and/or opportunity costs
• Use a simple production model to identify the lowest cost production technology
• Explain why the Industrial Revolution happened first in Britain rather than France or China using the simple production model