The Scope of Economics

The Scope of Economics

• Economics studies how agents make choices with limited resources and how these choices impact society.
• The unifying aspect of economics is choice, not money or wealth.
• Economic agents include individuals or groups, like consumers, households, firms, and governments, who make decisions, typically aiming for optimal outcomes.
• Scarce resources are goods that are insufficient to meet everyone's desires.
• Positive economics provides descriptions of economic agent behavior using objective analysis and facts, focusing on economic phenomena without value judgments.
• Example of positive economics: determining the average wage in different sectors or analyzing the gender income gap in Spain including determinants like labor market composition, discrimination, and temporality/part-time work.
• Normative economics prescribes what economic agents should do, involving subjective decisions often resulting in public policies.
• Example of normative economics: deciding the most suitable job for a worker based on qualifications or whether to implement public policies to reduce the gender pay gap, and assessing which policy approach is most effective.
• Microeconomics studies the choices of individuals, households, firms, and governments, and how these choices affect prices, resource allocation, and overall welfare.
• Microeconomic analysis focuses on isolated segments of the economy, such as consumer choice, electricity market design, and firm behavior.
• Macroeconomics studies the economy as a whole, examining aggregate production, inflation, economic cycles, labor market dynamics, and monetary policy.
• Macroeconomic examples include assessing the impact of labor reforms on unemployment and GDP, and evaluating economic programs.
• Both micro and macro perspectives can be applied to analyze specific issues.

Three Principles of Economics

Optimization

• Optimization is making the best choice with the information available.
• Feasible options are those accessible to the agent.
• Agents may lack complete information, and changes in information can alter the optimal choice.
• The "best" choice is determined by the decision-maker's preferences.
• Trade-offs involve giving up something when making a decision.
• Budget constraints force choices due to limited resources.
• Opportunity cost is the value of the next best alternative use of a resource, usually expressed monetarily.
• Cost-benefit analysis is an optimization technique that compares benefits and costs in a standard unit to determine the best option.
• Example cost benefit analysis: deciding to buy a book for 20€ at store A or driving 100km to buy it at store B for 10€
• Another cost benefit analysis: deciding to buy a laptop for 1000€ in store A or drive 100km and buy it for 990€ in store B
• Another cost benefit analysis: deciding whether spending your afternoon on social media is the best use of your time

Equilibrium

• Equilibrium is a state where no individual can improve their situation by changing their behavior.
• Examples include queues in grocery stores, the housing market, and competing political parties.
• Decisions are made with available information to achieve optimal results.
• Free-rider problems arise when agents benefit from a choice without bearing all costs.
• Example of free-rider problem: In a shared house, when one housemate watches TV instead of cleaning dishes
• Second example: John building a lighthouse and sailors still beneffiting even if they don't contribute to it's upkeep

Empiricism

• Empiricism uses data analysis to answer interesting questions.
• Correlation, as seen with crowded beaches and hot temperatures, is different from causation.

Is Economics Good for You?

• Attending an economics course involves a cost-benefit analysis.
• The benefit is understanding the application of economic thinking in daily life.
• The cost includes tuition, stress, and opportunity cost.

The Scientific Method

• Employing the scientific method in economics involves specifying a simplified model of reality, generating testable hypotheses, and rigorously testing these models against data to refine them.
• If a model fails to accurately explain observed data, the process restarts.

What Is A Model?

• Models can be simple representations, like emojis, which are simple models that show expressions.
• All models have simplifications.
• Example: A “flat Earth” is not a helpful model for flying to NY.

Working with Data: Causation vs Correlation

• Causation occurs when one factor directly affects another.
• Correlation indicates a relationship exists:
  • Positive correlation: both factors change in the same direction.
  • Negative correlation: factors change in opposite directions.
• Causation differs from correlation due to:
  • Omitted variables: Ignoring factors that contribute to cause and effect can skew correlations.
  • Example of something that can be an omitted variable: An increase in sales resulting from the use of red ads
  • Reverse causality: The presumed cause and effect are reversed (e.g., ibuprofen consumption and pain).
• Experiments:
  • Controlled experiments: Researchers assign subjects randomly to treatment or control groups.
  • Natural experiments: Subjects fall into treatment or control groups naturally.
• Useful scientific economic questions are relevant, important and contribute to social welfare.
• Economic questions can be answered empirically.

Optimization

• Optimization in levels: total benefit – total cost (net benefit)
• Optimization in differences: Change in the net benefit of one option compared to another
• Optimization has limits: It may be affected by limited information, the cost of collecting information, inexperience, and trade-offs.
• Commuting costs to consider when choosing an apartment include public transportation availability, gasoline, parking, car wear and tear, and opportunity cost.
• Optimization includes:
  • Expressing all costs and benefits in the same unit
  • Calculating total net benefit (benefits – costs) for each option
  • Choosing the option with the highest net benefit
• Optimization in Differences/Marginal Analysis:
  • Express all costs and benefits in the same unit.
  • Determine how costs and benefits change when shifting from one option to another.
  • Choose the option that improves your situation and avoids those that worsen it.
  • Marginal cost is the added cost of choosing one alternative over another.
• Uses of graphics:
  • Visually summarize numeric information
  • Useful to represent models
  • Equation of a line: y=mx +n
    • m is the slope
    • n is the y-intercept

Markets

• A market consists of economic agents trading goods or services, governed by specific rules and arrangements.
• Economic agents include consumers, firms, governments, and landlords.
• Rules and arrangements include social norms, institutions, and infrastructures.
• The market price is the price at which transactions between buyers and sellers occur.
• Perfectly competitive markets:
  • Sellers offer identical goods or services.
  • Participants are price-takers, with no individual buyer or seller influencing market price.
  • The market establishes prices for goods and services.

How do buyers behave?

• Consumers aim to maximize satisfaction.
• Demand represents the relationship between quantity demanded and price, assuming all other factors remain constant, capturing consumer behavior at various price points.
• Quantity demanded is the specific amount buyers are willing to purchase at a particular price.
• A demand schedule is a table showing quantity demanded at different prices.
• A demand curve is a graph plotting the quantity demanded at various prices.
• The law of demand describes an inverse relationship between price and quantity demanded, all else being equal (ceteris paribus).
• Changes in quantity demanded and changes in demand are distinct:
  • Changes in quantity demanded reflect shifts in consumer willingness to buy due to price fluctuations, other factors held constant.
  • Changes in demand involve shifts in underlying factors, affecting how much of a product people want at a specific price.
• The market demand curve represents the sum of individual demand curves, illustrating the total quantity demanded at each market price.

Cause of Shifts on the Demand Curve

• Tastes and preferences
• Income and wealth, which includes:
  • Normal goods
  • Inferior goods
• Availability and prices of related goods:
  • Substitute goods
  • Complement goods
• Number and scale of buyers
• Buyers’ expectations about the future
• Tastes and preferences examples: fashion, trends
• Income and wealth examples: Seafood or taxis are examples of normal goods, potatoes or bus are examples of inferior goods
• Availability and prices of related goods: Complements like gin and tonic, Substitutes like gin and vodka, coffee and tea
• Buyers’ expectations about the future: Expecting unemployment to rise and their jobs are insecure typically makes people save money

How do sellers behave?

• Producers vary in their willingness to accept certain prices for their goods or services.
• Quantity supplied represents the amount of a good sellers are willing to offer at a specific price point.
• The supply schedule is a table detailing the quantities supplied at various prices.
• The supply curve graphically represents the quantities supplied at each price.
• The quantity provided increases along with the price
• Shifts in the Supply Curve can happen due to:
  • Input prices
  • Technology
  • Number and scale of sellers
  • Number of sellers

Equilibrium

• Competitive equilibrium occurs when the market agrees on a price, known as the competitive equilibrium price, and the quantity exchanged, or competitive equilibrium quantity.
• Excess demand happens when consumers desire more than suppliers offer at a given price, leading to a shortage.
• Excess supply arises when suppliers provide more than consumers want at a certain price, resulting in a surplus.
• Excess demand is when there is a shortage
• Excess supply is when there is a surplus
• In a competitive equilibrium, the price is determined by the intersection of supply and demand curves, creating market equilibrium.
• In a competitive equilibrium the price is where supply and demand intersect:

Types of changes in the supply and demand

• The Demand and Supply curves shift right

• See image on page 10

• The Demand curve shifts right, and the supply curve shifts left

• See image on page 10

• The demand curve shifts left, and the supply curve shifts right

• See image on page 10

• The demand curve shifts left, and the supply curve shifts left

• See image on page 10

• Price ceiling: When prices are set below the competitive price we end up with excess demand

The Buyer's Problem

• The goal is to understand how each decision is on the side of the consumers
• Decision factors include:
  • What do you like? Factors include:
    • Taste and preferences
  • How much does it cost? These include:
  • Prices (monetary cost)
  • How much money/resources do you have?
    • Budget set / Budget constraint
• Desirable thing include:
  • the more of a good thing, the better
  • what we buy reveals our taste and preferences Assumptions made about preferences include:
  • If A has more goods than B, you prefer A (non-satiation)
  • You have a preference for any two choices (completeness)
    • If you prefer A to B, and B to C, you prefer A to C Preferences are internally consistent (transitivity)
• Prices serve as the incentives in making purchase decisions
• Prices allow to formally define the relative cost of goods
• Buyers are price-takers who assume constant prices
• A budget set is the set of all bundles of goods and services purchasable by a consumer.
• A budget constraint represents the goods that a consumer can buy after exhausting their budget
• 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€
• Buyer’s Equilibrium Condition: 𝑀𝐵𝑠/𝑃𝑠= 𝑀𝐵𝑗/𝑃𝑗 “Equal bang for your buck”
• If marginal benefits are not equal, then you can do better, be happier, by shifting consumption toward the good that has higher marginal benefits per dollar spent
• When we have more than two goods: 𝑀𝐵𝑠/𝑃𝑠=𝑀𝐵𝑗/𝑃𝑗= 𝑀𝐵𝑘/𝑃𝑘
• You choose prices and budget and if things don't fit nicely, choose the closest integer options before running of money
• The slope of the constraint is negative because as one good increases, the other good decreases, and it comes from dividing Pgood1/Pgood2
• An increase in price means a change in ammount you could by and the slope as well

Consumer surplus

• Consumer surplus: The difference between what you are willing to pay and what you have to pay, the market price
• With Qd=(125-P)/1,25, P*=Equilibrium Price, Q*=Equilibrium Quantity and 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

• Measures of elasticity:

  • Price elasticity of demand
  • Cross-price elasticity of demand
  • Income elasticity of demand

• Price elasticity of demand: How much does quantity demanded change when the good’s price changes?

• Example: Decrease of demand of 33% but increase in price of 50%. Abs(-0,33/0,5)=0.66

• Cases:

  • Ed>1: Elastic
  • Ed<1: Inelastic
  • Ed=1: Unit Elastic
  • Ed=∞ : Perfectly elastic
  • Ed=0: Perfectly inelastic

Indifference curve

• They represent combinations of goods that give to consumers the same utility.
• In the case of jeans vs sweaters, when the price of jeans decreases:
  • Substitution: Jeans become relatively cheaper with respect to sweaters
  • Income effect: You are richer, so you can buy more
  • Final effect depends on the specific preferences

Topic 4

• Focuses on sellers in a perfectly competitive market

The Seller's Problem

From the Seller's Problem to the Supply Curve

Producer Surplus

Perfect Competition and the Invisible Hand