The Scope of Economics

The Scope of Economics

• Studies how agents make choices involving scarce resources and how these choices affect society

Choice as the Unifying Feature

• Choice, rather than money or wealth, is what economists study

Economic Agents

• Any group or individual that makes choices, such as consumers, households, firms, or governments
• They aim to choose optimally

Scarce Resources

• Goods are considered scarce when there are not enough to satisfy everyone's wants

Positive Economics

• Describes what economic agents actually do through objective analysis and facts about how the economy functions
• Focuses on explaining and predicting economic phenomena without making value judgments

Examples of Positive Economics

• Determining the mean wage in different sectors of the economy
• Investigating the presence and determinants of a gender income gap in Spain, including labor market composition and discrimination

Normative Economics

• Involves a decision-maker determining what economic agents should do

Examples of Normative Economics

• Suggesting the best job offer for a worker based on qualifications and preferences
• Recommending public policies to reduce the gender pay gap and assessing their effectiveness

Normative Economics and Public Policy

• Normative analysis informs public policies, addressing subjective questions

Microeconomics

• Studies the choices of individuals, households, firms, and governments, and how these choices affect prices, resource allocation, and well-being
• In microeconomics, an isolated piece of the whole economy is examined

Examples of Microeconomics

• Consumer choice
• Electricity markets
• Competitive behavior of firms

Macroeconomics

• Studies the economy as a whole

Macroeconomics Focus

• Studies aggregate production, inflation, economic cycles, labor market performance, and monetary policy
• Assesses the impact of labor reform on unemployment and GDP, as well as the adequacy of public economic programs

Micro vs Macro Questions

• Both micro and macro perspectives can be applied to the same topic

The First Principle of Economics: Optimization

• Involves making the best choice possible with the information available

Factors Affecting Optimization

• Possible/feasible options: The choices available to an agent
• Given information: Agents may lack full information, and changes in information can alter the optimal choice
• Best option: Determined by the agent's preferences

Concepts Related to Optimization

• Trade-offs: Giving up something to obtain something else
• Budget constraint: Being forced to choose due to limited resources
• Opportunity cost: The value of the best alternative use of a resource, often expressed monetarily
• Cost-benefit analysis: Comparing benefits and costs in a common unit to identify the optimal choice

Examples of Optimization

• Deciding whether to buy a book for 20€ in store A or drive 100km to buy it in store B for 10€ involves considering trade-offs, budget constraints, and cost-benefit analysis
• Evaluating the opportunity cost of spending an afternoon on Instagram or TikTok

The Second Principle of Economics: Equilibrium

• Describes a situation where no one would benefit by changing their own behavior

Examples of Equilibrium

• Queues at grocery stores, housing markets, and political parties competing for votes

Equilibrium and Information

• Decisions are made optimally with available information

Free-Rider Problem

• Occurs when an agent benefits from a choice without bearing all the costs

Examples of the Free-Rider Problem

• One flatmate watching TV instead of cleaning in a shared house, raising the question of whether this situation is an equilibrium and how it changes with the number of flatmates
• The construction of a lighthouse benefiting sailors who do not contribute to its upkeep

The Third Principle of Economics: Empiricism

• Uses data analysis to answer interesting questions
• Correlation is different from causation

Example of Empiricism

• Observing a correlation between crowded beaches and hot temperatures and using that information to manage beach crowds

Is Economics Good for You?

• Attending an economics course involves a cost-benefit analysis

Benefits of Studying Economics

• Understanding and applying economic thinking in everyday life

Costs of Studying Economics

• Tuition, stress, and opportunity cost

The Scientific Method

• Involves specifying a model as a simplified description of reality and testing it using data to see how closely it matches observations

Model Evaluation and Iteration

• If the model does not accurately explain the data, it is revised, and the process starts again

Models

• Emojis are models that show expressions

Causation vs. Correlation

• Causation: When one thing directly affects another
• Correlation:
  • Positive: Both change in the same direction
  • Negative: They change in opposite directions
• Omitted variables: Ignoring something that contributes to the cause and effect leads to a correlation that doesn't make sense

Examples of Causation vs Correlation

• Reverse casualty: Cause is ibuprofen consumption, and the effect is pain, but people consume ibuprofen because of pain
• Red adds lead to sales rise

Experiments

• Controlled: Subjects are randomly put into treatment (something happens) and control (nothing happens) groups by researchers
• Natural: Subjects end up in treatment or control groups due to something that is not purposefully determined by the researcher

Optimization in Economics

• Good economic questions should be relevant and important, contributing to social welfare

Graphics in Economics

• Graphics should be able to answer questions empricially.
• Graphics are useful for visually summarizing numeric information and representing models

Equation of a Line

• Equation of a line: y=mx +n, where m is the slope and n is the y-intercept

Optimization

• Optimization in levels: total benefit – total cost (net benefit)
• Optimization in differences: Change in the net benefit of one option compared to another

Limits to Optimization

• Limits:
  • Limited information
  • Collecting information can be complicated or costly
  • Inexperience
  • Trade-off, there is something you refuse to obtain to use other
• Reasons in the cost of commuting in choosing an apartment:
  • Availability in public transportation
  • Gasoline
  • Parking
  • Wear and tear on car
  • Opportunity cost of time

Optimization Explained

• Express all costs and benefits in the same unit
• Calculate total net benefit (benefits – costs) for each option
• Choose the option with the highest net benefit

Optimization in Differences: Marginal Analysis

• Express all costs and benefits in the same unit
• Calculate how the costs and benefits change as you move from option to another
• Choose the option that makes you better off by moving toward it, and worse off by moving away from it.
• Marginal cost is the additional cost incurred when choosing to make one decision over another

Markets

• A market consists of economic agents trading goods or services under specific rules and arrangements

Components of a Market

• Economic agents: Consumers, firms, governments, landlords, and others
• Rules and arrangements: Social rules, institutions, and infrastructures

Market Price

• The price at which buyers and sellers conduct transactions

Perfectly Competitive Market

• Characterized by all sellers offering identical goods or services, and participants acting as price-takers
• No single buyer or seller can influence the market price
• The market itself determines goods' and services' prices

Consumer Behavior Objective

• Consumers aim to maximize satisfaction

Demand

• The relationship between quantity demanded and price, assuming all else is equal
  • It reflects how consumers in a market behave at different prices
  • Demand does not refer to a specific quantity, but a relationship

Quantity Demanded

• The amount of a good that buyers are willing to purchase at a specific price

Demand Schedule

• A table outlining the quantity demanded at different prices, holding other factors constant

Demand Curve

• A graph plotting the quantity demanded at different prices, all else equal

Law of Demand

• The law of demand dictates that as the price increases, the quantity demanded decreases, and vice versa, assuming all other factors remain constant (ceteris paribus)

Changes in Quantity Demanded vs. Changes in Demand

• Changes in the "quantity demanded" reflect how much we are willing to consume when the price changes and everything else remains constant
• Changes in "demand" reflect shifts in the fundamentals affecting how much people will demand at a given price, regardless of price changes

Market Demand Curve

• A graph plotting the relationship between the total quantity demanded and the market price, holding all else equal, representing the sum of individual demand curves

Shifts on the Demand Curve

• Tastes and preferences
• Income and wealth (normal and inferior goods)
• Availability and prices of related goods (substitute and complement goods)
• Number and scale of buyers
• Buyers' expectations about the future

Tastes and Preferences

• Examples include fashion and trends

Income and Wealth

• Examples of normal goods include seafood or taxis
• Examples of inferior goods include potatoes or bus rides

Availability and prices of related goods:

• Complements like gin and tonic.
• Substitutes like gin and vodka, coffee and tea

Expectations

• When people expect unemployment and insecure jobs, they save money and stop buying luxury things

Downward Sloping Demand Curve

• Producers and consumers will use more oil for production or travel if the price is lower
• Some buyers will use oil instead of other sources of energy if the price is low enough
• If the government sets the price, the price and demand doesn't move

Sellers Behavior

• Quantitiy supplied: The amount of a good that sellers are willing to sell at a certain price
• Supply schedule: A table that reports the quantity supplied at different prices
• Supply curve: A graph that plots the quantity supplied at different prices

Shifts of the Supply Curve:

• Input prices
• Technology
• Number and scale of sellers
• Sellers

Competitive Equilibrium

• Achieved when the market agrees on a price, competitive equilibrium price, and the quantity exchanged, competitive equilibrium quantity

Excess Demand

• Occurs when consumers demand more than suppliers provide at a given price, resulting in a shortage

Excess Supply

• Occurs when suppliers provide more than consumers want at a given price, resulting in a surplus

Competitive Equilibrium and Price

• The price in a competitive equilibrium is determined by the intersection of supply and demand, benefiting both producers and consumers

Equilibrium Definition

• Producers with costs lower than the competitive price aim to sell, while those with higher costs cannot sell below their cost
• Consumers with a higher willingness to pay than the competitive price do not gain by offering more, and those with a lower willingness do not buy
• It is an equilibrium

Supply and Demand

• If the price is higher than the competitive price, there is excess supply, and producers may lower prices to attract more customers
• If the price is lower than the competitive price, there is excess demand, and willing customers should raise prices

Demand and Supply Shifts

• The Demand and Supply curves can shift right, shift left, and both

Price Ceiling

• Results in excess demand

The Buyer's Problem

• Understanding how the consumer decides on purchasing goods/services
  • What do you like?
    • Taste and preferences.
  • How much does it cost?
    • Prices.
  • How much money/resources do you have?
    • Budget set / Budget constraint.

Consumer Preferences Assumptions

• The more, the better (non-satiation): If in A you have more goods than in B, you prefer A
• For any two choices you have a preference (completeness)
• Preferences are internally consistent (transitivity): If you prefer A to B, and B to C, you prefer A to C

About Goods and Services

• Prices are the incentives that we face when making purchase decisions
• Prices allow to formally define the relative cost of goods
• We will assume that they are constant and given (buyers are price-takers)

Budget Consideration

• Budget set: Budget set is the set of all possible bundles of goods and services that can be purchased with a consumer's income
• Budget constraint: The budget constraint represents the goods or activities that a consumer can choose which exhausts the entire budget

Budget Expectations

• No saving or borrowing.
• Whole units of goods/services but a continuous budget constraint

Marginal Benefit

• As the quantity bought of the same type of goods increases, the marginal benefit decreases, that is because the consumer gets exhausted and enjoys less every extra good bought after the first one. Example: With 300€

Consumer Equilibrium

• Buyer's Equilibrium Condition: MBs/Ps= MBj/Pj "Equal bang for your buck”
• More than two goods: MBs/Ps=MBj/Pj= MBk/Pk
• The slope of the constraint is negative because as one good increases, the other good decreases, and it comes from dividing Pgood1/Pgood2
• If the price of one good changes, you could buy a different amount and the slope would change
• If the price decreases, the quantity demanded increases.

Consumer Surplus

• Consumer surplus: The difference between what you are willing to pay and what you have to pay, the market price
• Demand function: Qd=(125-P)/1,25 P*=Equilibrium Price. Q*=Equilibrium Quantity Consumer surplus=(60*75)/2=$2250 million

Demand Elasticities

• The demand elasticity is a measure of how sensitive one variable is to changes in another. Price elasticity of demand: How much does quantity demanded change when the good's price changes?
  • (Percentage change in quantity demanded) / (Percentage change in price)
• If demand is inelastic, when price increases, quantity decreases a little - If demand is elastic, when price decreases, quantity decreases in a higher amount - In general, price elasticity varies among the demand curve.

Cross-price Elasticity

• how much does quantity demanded change when the other good’s price changes?
  • Percentage change in quantity demanded/ Percentage change in price of other good

Elasticity Formula Percentage

• ((Percentage change in quantity demanded) / (Percentage change in price of other good))
• Income elasticity of demand: (Percentage change in quantity demanded) / (Percentage change in income)

Indifference Curve

• represent preferences graphically.

Income and Substitutions

• In the case of jeans vs sweaters, when the price of jeans decreases:
  • Substitution: Jeans become relatively cheaper with respect to sweaters->Buy more jeans but less sweaters
  • Income effect: You are richer, so you can buy more
• Final effect depends on the specific preferences

Sellers in a Perfectly Competitive Market

• They are price takers: No one is big enough to influence the market price
• Sellers produce identical goods/services
• Sellers can't influence market price by selling a differentiated product
• All sellers are identical, and sellers can’t charge a higher price because there would be cheaper options
• There is free entry and exit in the market: Sellers can respond to potential profits in a market by entering, or leaving non profitable markets

Creating a Product

• To transform materials into products
  • Production functions show the HIGHEST output that a firm can produce for a given combination of inputs
  • Production functions describe what is technically feasible when firms operate efficiently
  • Variable inputs for production are inputs that change if the level of outputs changes
  • Fixed inputs in production cannot be changed independently of the amount of output production

Time Horizon

• Short run for the inputs cannot be changed
• Long run for inputs can be changed Marginal product measures the extra output from a worker

Productivity

• Specialization: Workers are more efficient when they specialize in production and collaborate
• The Law of diminishing marginal returns: At some point, each additional worker contributes less output on the margin than the worker before
• Marginal product of labor can be negative

Production Costs

• Accounting costs: Actual expenses plus depreciation charges for capital equipment
• Economic costs: Costs of utilizing economic resources in production
• Opportunity cost: Costs associated with opportunities that are forgone when a firm's resources are not put to their best alternative use

Explicit vs Implicit Costs

• Accounting costs (Explicit costs): Wages, costs of raw materials, etc
• Economic costs (Explicit + Implicit costs): Accounting cost opportunity costs

Types of Costs

• Variable costs (VC): Variable costs change with the level of output changes
• Fixed costs (FC):Do not change as output changes

Total Costs Formula

• Total cost (TC)= Variable Costs + Fixed Costs
• Average variable cost (AVC)= Variable Cost/Output
• Average fixed cost (AFC)= Fixed Cost/Output marginal Cost (MC): How the total cost changes, when you want to grow
• To calculate the marginal variable cost, divide the change in cost by the change in production

Revenue and Profit

• (Total revenues)= Price per unit x number of units sold. ( marginal revenue) is the price per unit sold Profit = Total Revenue – Total Cost. Formula:
• Profit = (P-ATC) x Q the MC curve = Supply curve

Firm Expectations

• In the short run, fixed costs are sunk. If the price falls below the (AVC), the firm will shutdown and stop producing
• If the price is above the (AVC) but is below the (ATC), they should continue producing as fixed cost in the long run can change, and they have to make the losses the lowest possible

Producer Surplus

• Total Value/Benefit - Sum of Marginal Costs of Production, also graphically described as the area above the supply curve and below price
• Formula: Producer Surplus = (Base*Height)/2
  • The base is the quantity
  • The height is the variation between the marginal cost at Q(0) and the price

Elasticity of Supply

• How responsive is the quantity supplied to changes in the marlet price
  • (Percentage change in quantity supplied) / (Percentage change in price)

Other

• the point at which the market comes to an agreement about what the price will be, and how much will be exchanged
• Perfect Competition and the Invisible Hand