EC4101 Topic 1b Tools of Economic Analysis PDF

EC4101 Topic 1b: Tools of economic analysis Thinking like an economist Economics trains you to.... Think in terms of alternatives Evaluate the cost of individual and social choices Examine and understand how certain events and issues are related The economic way of thinking… I...

EC4101 Topic 1b: Tools of economic analysis Thinking like an economist Economics trains you to.... Think in terms of alternatives Evaluate the cost of individual and social choices Examine and understand how certain events and issues are related The economic way of thinking… Involves thinking analytically and objectively Makes use of the scientific method (observation, theory, and more observation!) Economic models Economists use abstract models to help explain how a complex, real world operates Essentially, economic models are simplified representations of a particular feature of the world that we want to better understand Economic models allow us to generate hypotheses that can be tested against the facts by collecting and analysing data Importance of data Any applied economic analysis is only as good as the data it is based on Choice of what variables to include in a model and the quality of the data gathered for chosen variables is therefore critical to any analysis We distinguish between time-series data, cross-section data and panel data Time-series data A time series is a sequence of measurements of the same variable at different points in time Can be presented in tabular or graphical format but charts or diagrams must be interpreted with care Very easy to mislead someone with simple change in presentation of data High frequency data can also contain too much detail when presented in a chart so the use of averages over a month/quarter/year can sometimes be a better way to present data  DKK to EUR Exchange Rate, 1999 – 2023 (daily market rate) 7.48 7.47 7.46 7.45 7.44 7.43 7.42 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023  7.42 7.43 7.44 7.45 7.46 7.47 7.48 1999Jan 1999Jun 1999Nov 2000Apr 2000Sep 2001Feb 2001Jul 2001Dec 2002May 2002Oct 2003Mar 2003Aug 2004Jan 2004Jun 2004Nov 2005Apr 2005Sep 2006Feb 2006Jul 2006Dec 2007May 2007Oct 2008Mar 2008Aug 2009Jan 2009Jun 2009Nov 2010Apr 2010Sep 2011Feb 2011Jul 2011Dec 2012May 2012Oct 2013Mar 2013Aug 2014Jan 2014Jun 2014Nov 2015Apr 2015Sep 2016Feb 2016Jul 2016Dec 2017May 2017Oct 2018Mar 2018Aug 2019Jan 2019Jun 2019Nov 2020Apr 2020Sep 2021Feb 2021Jul DKK to EUR Exchange Rate, 1999 – 2023 (monthly average) 2021Dec 2022May 2022Oct 2023Mar 2023Aug  DKK to EUR Exchange Rate, 1999 – 2023 (quarterly average) 7.48 7.47 7.46 7.45 7.44 7.43 7.42  DKK to EUR Exchange Rate, 1999 – 2023 (annual average) 7.48 7.47 7.46 7.45 7.44 7.43 7.42 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023  DKK to EUR Exchange Rate, 1999 – 2023 (daily market rate) 7.48 7.47 7.46 7.45 7.44 7.43 7.42 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 DKK to EUR Exchange Rate, 1999 – 2023 (daily market rate) 7.65 7.6 7.55 7.5 7.45 7.4 7.35 7.3 7.25 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Spot rate Central rate Upper band Lower band Cross-section and panel data Cross-section data records the way an economic variable differs across different individuals or groups of individuals at a point in time Panel data records observations over multiple time periods for the same individuals or groups of individuals Important: A lot of cross-sectional or panel economic data needs to be adjusted to ensure a like-for-like comparison is being made  Minimum wages, July 2013 v. July 2023 (EUR per month) 2,500 2,000 1,500 1,000 500 0 BG RO LV HU HR SK EE CZ PL MT LT PT EL CY SI ES FR IE BE NL DE LU Minimim Wages (July 2013) Minimum Wages (July 2023) Economic models Economists use abstract models to help explain how a complex, real world operates Economists make assumptions in order to make the world easier to understand The art in scientific thinking is deciding which assumptions to make Economists use different assumptions to answer different questions Economic models allow us to generate hypotheses that can be tested against the facts by collecting and analysing data Econometrics Econometrics is used by economists to fit average relationships between two or more variables simultaneously while controlling for as many factors as possible In principle, this allows us to get round the ‘other things equal’ problem (assuming the correct explanatory and control variables are included) Once relationships have been established, they are useful as a test of our hypotheses they can be used to make predictions about the likely impact of a change in one variable (e.g. price) on another (e.g. demand)  Importance of correlation versus causation! Correlation versus causation on EC4101 Does more engagement with online resources and learning activities on Connect lead to better exam performance? How might we answer this question? We could compare online engagement scores from Connect with overall exam results… See XY scatter plot on next slide  Exam results versus online engagement 10 9 Connect Online Engagement Indicator (1-10) 8 7 y = 0.0386x + 5.6454 R² = 0.3015 6 5 4 3 2 1 0 0 10 20 30 40 50 60 70 80 90 100 Overall Exam Result (%) Correlation versus causation on EC4101 So does more online engagement cause better exam performance? Problem with previous XY scatter plot is that other variables that impact performance are omitted, e.g. Higher ability students tend to perform better Does not take into account offline study Does not take into account lecture/tutorial attendance, etc. A better model would control for certain characteristics Some basic economic models Economists use models to simplify reality in order to improve our understanding of the world Economic models Paul Krugman on economic models: I guess the problem is that too many economists have the wrong attitude toward models. They’re not Truth; they’re intuition pumps, gadgets you use to clarify your story. You go badly wrong when you take them too seriously, and either forget that they’re just models, or reject them because the world isn’t that simple. Two of the most basic economic models are: The Production Possibilities Frontier The Circular Flow Model The Production Possibilities Frontier The production possibilities frontier is a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology Begg et al., Chapter 1, Section 1.3 (pages 10-12)  The Production Possibilities Frontier The Production Possibilities Frontier Quantity of Computers Produced 3,000 D C 2,200 2,000 A Production possibilities frontier 1,000 B 0 300 600 700 1,000 Quantity of Cars Produced The Production Possibilities Frontier (PPF) Concepts Illustrated by the PPF Efficiency Trade-offs Opportunity Cost Economic Growth  Figure 3 A Shift in the Production Possibilities Frontier A shift in the PPF Quantity of Computers Produced 4,000 3,000 2,100 E 2,000 A 0 700 750 1,000 Quantity of Cars Produced Copyright © 2011 South-Western The Circular-Flow Model The circular-flow model is a visual model of the economy that shows how money flows through markets among households and firms While the model is overly simplistic, it still gives a good general representation of how the main economic agents in an economy are connected The Circular-Flow Diagram Spending Income Goods Factors and services Trade in physical …and the things such as money that pays goods, services, for these labor, and raw physical things materials flows flows in the in one opposite direction… direction. Goods and services Factors Revenue Wages, rent, profit  An Expanded Circular-Flow Diagram Government purchases of goods and services Government borrowing Consumer Taxes Government transfers Private spending savings Income Financial markets Factor markets Wages, profit, Revenue interest, rent Borrowing and stock issues by firms Investment spending Foreign Exports borrowing and sales of stock Imports Foreign lending and purchases of stock The economist as a policy advisor When economists are trying to explain the world, they are scientists When economists are trying to change the world, they are policy advisors Positive versus normative analysis Positive statements are statements that attempt to describe the world as it is Called descriptive analysis Normative statements are statements about how the world should be Called prescriptive analysis Why economists disagree… They may disagree about the validity of alternative positive theories about how the world works They may have different values and, therefore, different normative views about what policy should try to accomplish