Topic 1: Economics as a study of human behavior PDF

1 Topic 1. Economics as a study of human behavior  2 Bibliography Mankiw, N.G. Principles of Economics, chapters 4, 5 and 7. Students should read recommended readings. Outline 1. Objectives 2. Economics and markets 3. Economics as...

1 Topic 1. Economics as a study of human behavior  2 Bibliography Mankiw, N.G. Principles of Economics, chapters 4, 5 and 7. Students should read recommended readings. Outline 1. Objectives 2. Economics and markets 3. Economics as a Science 4. The model of the circular-flow of income 5. Microeconomics and Macroeconomics 1. Objectives Introduce the concept of Economics. Understand the difference between market economy and planned economy Consider if Economics is a scientific discipline. Know what an economic model is and what types of variables it uses. Study a first economic model. Know the main parts that economic theory is divided. 2. Economics and markets Economics comes from the ancient Greek word oikonomia, formed by two other words: oikos, “house” and nomos, “custom” or “law“; hence, “management of a household, administration” Micro comes from the ancient Greek, mikros, meaning “small” – Microeconomics is about the management or administration of the small house, the own house Macro comes from the ancient Greek, makros, meaning “large” – Macroeconomics is about the management or administration of the large house, the nation  6 Economics arises because the man faces an unlimited number of needs with scarce resources. Through productive activities, the man tries to fulfil some needs. Economics studies how societies manage scarce resources to produce goods and services and distribute them among individuals. Economics studies how societies manage scarce resources to produce goods and services – WHAT is produced and in what quantity? – HOW are these products produced? – WHAT is their purpose? – WHO is taking these economic decisions? Two options: 1. Market Economy: » Economy that allocates resources through decentralized decisions of many firms and households as they interact in markets for goods and services. 2. Centrally planned economy: » Economy that allocates resources through the decisions of a central authority: o which products to produce o how much of each o which factors of production o how the production is distributed Market: – Mechanism through which buyers and sellers interact to set prices at which exchange goods and services. The price system is the mechanism that is responsible for solving the problems of consumption, production and distribution Market prices reflect the value of a product to consumers and the cost of resources used to produce them Adam Smith (The Wealth of Nations, 1776) observed that households and firms act as if guided in the markets by an "invisible hand." – The invisible hand works through the price system. – The interaction of buyers and sellers determines the prices of goods and services. – Each price reflects the value of the good for buyers and the cost of producing the good. – Multiple selfish decisions of households and firms orienting the price system produces maximizing economic welfare of society. – The market system can achieve efficiency: to get the most out of scarce resources. We focus on the market economy. BUT: the government can and should intervene in the market economy, to correct and support free interaction in the markets. Mixed Economy 1. Redistribution of income 2. Market failures 3. Macroeconomic policies 3. Economic models Economists, among others, play two roles: - Scientists: try to explain the world - Consultants: trying to improve the world Scientific method: 1st Developing theories through observation 2nd Collecting information to verify or refute these theories 3rd Repeatable under the same conditions Scientific method = Research 1st Developing theories through observation 2nd Collecting information to verify or refute these theories  16 3rd Repeatable  17 The use of data to evaluate theories is more difficult in Economics than in other sciences, e.g. physics. Economists have great difficulty generating their own data and, in most cases, must comply with the available data. To find a substitute for laboratory experiments, experiments done on nature throughout history to develop and contrast economic theories. An economic theory is an organized set of ideas about the economy to form a logical whole model: an economic model An economic model is a simplified description of some aspect of economic reality. The art of scientific thought is knowing which assumptions we can use and which not. To determine whether a theory has been developed using feasible assumption and in accordance with reality, these assumptions must be tested empirically Characteristics of an economic model: – Understandable and manageable – With reasonable and realistic assumptions – Testable through empirical analysis Most economic models are composed of diagrams and equations Economic models use economic variables, which are elements that represent some aspect of the economy or define the outcome of the action of agents (production of a good, family income level, price of goods, etc.) Economists collect historical data for economic variables to verify or refute economic models and theories.  22 Different types of variables: - Endogenous variables: its value is determined by internal functional relationships of the model (consumption). - Exogenous variables: its value is determined outside the model (population).  23 - Flow variables : referred to a period of time (income). - Stock variables : referred to a specific moment in time (wealth). - Nominal variables: expressed in current year prices (current GDP), in monetary units. - Real Variables: expressed in constant terms related to a base year to avoid changes in the general level of prices (real GDP). Two types of analysis: – Positive analysis: the study of the economic consequences of implementing an economic policy using an economic model based on certain assumptions. Do not ask if these consequences are desirable for society. – Normative analysis: the study of whether an economic policy should be used or not. This analysis involves not only the scientific understanding of the consequences of the policy but also a subjective view about certain characteristics of the economic system. 4. The model of the circular-flow of income The circular-flow diagram is a model that represents the transactions in an economy by flows around a circle  Wages, rents, interest, profits Factor services Goods Household Firms (production) Government Financial markets Personal consumption Other countries  28 5. Microeconomics and Macroeconomics Economics is traditionally divided into two main subfields: - Microeconomics - Macroeconomics  29 Microeconomics is the study of how households and firms make decisions and the way they interact in each market. Microeconomics focuses on the decisions of individual agents, households and firms, or on specific markets. - how much an individual wants to consume of a particular good, - how much product considers to produce a company - why something has a higher price than other merchandise. Macroeconomics is the study of economic phenomena that affect the whole economy Macroeconomics focuses on the structure and performance of national economies and the measures used by governments to try to influence economic outcomes - Unemployment - Changes in the price level - Economic growth - Economic policies.  31 Macroeconomics and Microeconomics have in common economic concepts and methods. Microeconomics looks at the economic agents (consumers, workers, firms...) and markets. Macroeconomics focuses on aggregate concepts (consumption, investment, production,...), on the whole economy.  32 End of topic 1 For any questions you can always come during my office hours. Contact me in advance via aula virtual email to make an appointment at a specific time and to avoid delays