Introduction to Economics

Introduction to Economics

• Economics studies how agents make choices with limited resources and how those choices impact society.
• The core concept is choice, not wealth, uniting all economic study.
• Economic agents are any entity (consumers, firms, governments) that makes choices, usually attempting optimal outcomes.
• Scarce resources are goods or services not sufficient to meet everyone's needs.

Branches of Economics

• Positive economics describes actual economic agent behavior—objective, factual analyses of how the economy functions. It predicts and explains without judgment.
  • Examples: Average wages in different sectors, gender income gaps and their determinants.
• Normative economics dictates what economic agents should do—subjective judgments leading to public policy recommendations—examples: best job offers based on preferences and qualifications, policies to close income gaps.

Microeconomics vs. Macroeconomics

• Microeconomics studies individual agents' choices—their interactions affect resource allocation, prices, and the well-being of other agents.
  • Examples: Consumer choices, electricity market designs, firm competitive strategies.
• Macroeconomics examines the economy as a whole—aggregate production, inflation, economic cycles, labor market, and monetary policy.
  • Examples: Impact of labor reforms on unemployment and GDP, effectiveness of government economic stimulus programs.

Principles of Economics

• Optimization: Making the best choice possible based on available information.
  • Possible/feasible: Options accessible to the agent
  • Given Information: Could be incomplete
  • Best: Depends on the agent's preferences.
  • Trade-offs: Sacrificing one thing to gain another.
  • Budget constraint: Limitation on choices due to limited resources.
  • Opportunity cost: Value of the best alternative choice.
  • Cost-benefit analysis: Comparing costs and benefits using a common measure.
• Equilibrium: No individual agent benefits from changing their behavior.
  • Examples: Grocery store lines, housing markets, political party competition.
  • Free-rider problem: Benefits without paying full costs (example: shared house cleaning/lighthouse example)
• Empiricism: Using data to answer economic questions.
  • Correlation vs. causation.
  • Examples: Beach crowding and temperatures; cause and effect (Omitted variables, reverse causality)

Studying Economics

• Scientific Method: A process used to test models.
  • (1) Model building—simplified representation of reality.
  • (2) Hypothesis generation—predictions from the model.
  • (3) Testing the model with data.
  • (4) Refine if the model does not completely reflect reality.
• Models: Simplified representations of reality—helpful to understand complex systems (e.g., metro map).
• Data Analysis: Causation vs. correlation (important to consider omitted variables and reverse causality).
• Good Economic Questions: Relevant, important, addressable via data.
• Graphics/Equations: Tools for summarizing information (linear relationships y = mx + n).
• Optimization (levels): Total benefit minus total cost.
• Optimization (differences): Marginal analysis—calculating changes in net benefit. Limits to optimization: incomplete information.

Markets

• Market: A place of trading goods/services governed by rules/arrangements.
• Market price: Price at which transactions occur.
• Perfectly competitive market: All participants are price takers.