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ECONOMIC PRINCIPLES IN A GLOBAL ERAWeek 1:
Goal :
Being able to understand and analyze economic news and read journals like the Economist.
Distinguish sound analysis from BS
CHAPTER 1 : THE PRINCIPLES AND PRACTICES OF ECONOMICS
Key ideas :
- Economics is the study of people’s choices
- First principle People try to optimize
= they try to choose the best available option. Taken in account others decisions.
- Second principle economic systems tend to be in an equilibrium
= a situation which nobody would benefit by changing his or her own behavior.
- Third principle empiricism
= analysis that uses data. Economists use data to test theories and to determine what is causing
things to happen in the real world
Example phone
When an economic system is an equilibrium it doesn’t mean its desirable. For example sweatshops
and child labor. Except, if they don’t do it their situation would be worse.
What are the costs of using Facebook or Instagram ? for example time. You don’t do anything else.
The scope of economics
= economics studies how agents make choices among scarce resources and how those choices affect
society
Scares resources = Resources for which the quantity that people want exceeds the quantity that is
freely available
Economic agent
= any group or individual that makes choices, such as consumers, firms, parents, politicians, etc.
Economics covers almost every part of society
Macroeconomics = the study of the whole economy
Micro economics = the study of individuals, firms, government
Optimization trade-offs and budget constraints
>Optimization cost-benefit analysis = every body puts their costs and benefits on a scale to check
what their optimum decision is.
If you look at the government..
What is their optimal level of crime ?
Is it 0 or greater than 0. greater than zero because if it is precisely zero it would be too costly to
create that.
Equilibrium
= a situation when no one benefits by changing his/her behavior
If some people are not optimization. The whole will still look like as if everybody is optimizing.
Free rider problem = exist when an individual or group is able to enjoy the benefits of a situation
without incurring the costs
Empiricism
Correlation ≠ Causation
Costs
Opportunity costs = costs that you make by not doing something else. If you do one thing you can’t
do something else at the same time. You want to reduce this.
, Example : In covid times, education is less fun because you can’t go to class and meet people.
But the opportunity costs are also lower because you can’t go to a bar or to another place to
meet people.
Commute time = reistijd
CHAPTER 2: ECONOMIC METHODS AND ECONOMIC QUESTIONS
Key ideas
A model is a simplified description of reality
Economists use data to evaluate the accuracy of models and understand how the world works
Correlation is not the same thing as causality
Experiments help economist to measure cause and effects
Economic research focuses on questions that are important to society and can be answered
with models and data
Model = a simplified description of reality
The scientific method (empiricism) is composed of two steps:
1. Developing models that explain some part of the world
2. Testing those models using data to see how closely the model matches what we actually
observe
Jorge Luis Borges on Science
A story about a map maker who thought his map was not detailed enough and started to draw
the houses, the rooms and allot of details. He realized that it’s not a perfect map at al.
The idea of a map/model is that you get rid of the noise and get only the crucial parts of the
reality.
>An unrealistic model can be sometimes better to use because it answers to a particularly question for
example a normal map vs a public transportation map . It’s much more useful while the roads are not
exactly on that place and that straight etc.
The scientific method : an economic model
>Evidenced-Based Example:
Education Assumption – one more year of education results in a 10% increase in future earnings
If you would earn $16.50 with 13 years of education, with one more year (second college year) of
education, you would earn
$16.50 * 1.10 = $18.15
Third year: 18.15 * 1.1 = $19.97
Fourth year: 19.97 * 1.1 = $21.97
So hypothesis is : getting a college degree increase wages from $15 to $21.97, or 46.5%
($21.97 - $15)/$15 = 0.4647
Two important features of models :
1. They are not exact. Not everyone will see their wages increase by 10% with every additional
year of education
2. They generate prediction that can be tested with data
Causation = when one thing directly affects another
Correlation = when two things are related
Positive when two things go the same way
Negative when they go the opposite way
Omitted variable = if we ignore something that contributes to cause and effect, then that something is
an omitted variable. A correlation might not make sense until the omitted variable is added.
Reverse causality = reverse causality is when there is cause and effect, but is goes in the opposite
direction as hat we thought
,How can we tell the difference between causation and correlation? experiments
-Controlled experiment = subjects are randomly put in treatment and control groups by the
researcher
-Natural experiment = subjects end up in treatment or control groups due to something that is not
purposefully determined by the researcher
Two properties of a good economic question:
1. Relevant and important
Economic research contributes to social welfare
2. Can be answered
Economic questions can be answered empirically
CHAPTER 3: DOING THE BEST YOU CAN
Optimization in levels:
1. Express all costs and benefits in the same unit (like $)
2. Calculate total net benefit (benefits – costs) for each option
3. Choose the option with the highest net benefit
Principle of optimization at the margin
= if an option is the best choice, you will be made better off as you move toward it, and worse off as
you move away from it.
Optimization in differences:
1. Express all costs and benefits in the same unit
2. Calculate how the costs and benefits change as you move from the one option to another
3. Apply the principle of optimization at the margin – choose the option that makes you better
off by moving toward it, and worse of by moving away from it
A budget constraint = an economic tool that quantifies the trade-off between the consumption of two
goods
CHAPTER 4: DEMAND, SUPPLY, AND EQUILIBRIUM
Key ideas
In a perfectly competitive market.
(1) sellers all sell an identical good or service, and
(2) any individual buyer or any individual seller isn’t powerful enough on his or her own to
affect the market price of that good or service
The demand curve plots the relationship between the market price and the quantity of the good
demanded by buyers
The supply curve plots the relationship between the market price and the quantity of a good
supplied by sellers
The competitive equilibrium price equates the quantity demanded and the quantity supplied
When prices are not free to fluctuate, markets fail to equate quantity demanded and quantity
supplied
Market price = the price at which buyers and sellers conduct transactions
In a perfectly competitive market every buyer pays and every seller charges the same market
price, no buyer or seller is big enough to influence that market price, and all sellers sell an identical
good or service.
Market demand curve = the sum of the individual demand curves of all potential buyers. The market
demand curve plots the relationship between the total quantity demanded and the market price,
holding all else equal
Shifts of the Demand Curve occur when one of the following changes:
1. tastes and preferences
2. income and wealth
3. availability and prices of related goods
, 4. number and scale of buyers
5. buyers’ expectations about the future
When price changes you just move along the demand curve
Market supply curve = plots the relationship between the total quantity supplied and the market price,
holding all else equal
Competitive equilibrium = the point at which the market comes to an agreement about what price
will be the competitive equilibrium price and what the competitive equilibrium quantity is at that price
Excess demand = occurs when consumers want more than suppliers provide at a given price. This
situation results in shortage
Excess supply = occurs when suppliers provide more than consumers want a at a given price. This
situation result in a surplus
Why are brown eggs more expensive than white eggs?
>because there are lesser chicken that make brown eggs so there are less brown eggs. This makes it a
supply thing.
Why do the prices of roses increase right before valentine’s day?
>the demand goes up. But roses are not easy to store so the supply cannot go up
But why isn’t the price of beer rising just before the champions league?
>the demand of beer is going up, except the beer company knows this so the supply also goes up.
?Tutorial 1:
Marginal optimization
Everyone want to optimize their gain.
Do you benefit from this change or not?
Gain = benefit – costs
In economics costs are also opportunity costs
Demonising marginal benefit = the benefit per scoop of ice cream is getting less and less
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