Lecture 1
Setting the course
- Introduction to economic logic
- Familiar to those with economic background
- Accessible, but difficult, for those without
- No complicated calculus, but you do need to learn how to interpret figures (i.e.
geometry)
- Different vocabulary
- Basics
- Theory
After this course students are able to:
- Explain concepts and mechanisms of micro- & macroeconomics
- Apply economic concepts and mechanisms to societal challenges and policy fields
- Apply economic concepts and mechanisms to decision making and policy
assessment.
Course program
- Micro-economics (Marks)
- Lecture 1: vocabulary, efficiency & effectiveness, supply & demand.
- Lecture 2: producer behaviour, cost, aggregating individual welfare, market
failure, welfare distribution, governments/institutions.
- Macro-economics (Keulen)
- Lecture 3
- Lecture 4
- Lecture 5
Exam
- 60 multiple choice questions
- Micro-economics: 3 problems, 2 lectures
- Macro-economics: 4 problems, 3 lectures
- Lectures are part (30%) of exam material
- ±25 questions micro-economics & ±35 macro-economics
Lecture 1
- What kind of animal are we talking about?
- Abstract modelling & assumptions
- Vocabulary
- Scarcity & welfare
- Choice & utility
- Allocation, efficiency & effectiveness
- Demand & supply
- What are they and how to construct them
- What if things change?
,What are we talking about?
- Economics is the study of the allocation of scarce resources to meet unlimited human
wants.
- Micro-economics is concerned with decision-making by individual economic
agents such as firms and consumers. Supply & demand at separate markets.
- Macro-economics is concerned with the aggregate performance of the entire
economic system. Individual welfares to reach collective welfare.
- Economic theory relies upon principles to analyze behaviour of economic
agents.
- Example: last couple of years the health care system in the Netherlands has
been reorganized. Previously the national government provided more money
for health care, but due to crises it has reduced the budget drastically. This
has consequences for municipalities to reallocate their resources, but this
also holds for hospitals, care centres, etc. And it influences how people
choose the irrespective health, what to buy at what organization.
Usefulness of economics
- Economics provides an objective mode of analysis, with rigorous models that are
predictive of human behaviour.
- Scientific approach; rigorously tested
- Rational choice; i.e. consistent behaviour
- Economics is a social science, but coming from a different angle; i.e. unlimited wants
versus scarce resources → choices have to be made.
- Many models built by econometrics have been tested over and over.
- Rational behaviour is an underlying principle.
Assumptions in economics
- Economic models are built upon assumptions - simplifications that permit rigorous
analysis of real world events, without irrelevant complications
- The best model (abstraction from reality) is the one that best describes reality
and is the simplest; i.e. Occam’s Razor (leave out what is not relevant)
- Some simplifications (videos on canvas)
- Ceteris paribus (CP): all other things equal: economics is a social
science, experiments can’t be controlled. Ceteris paribus argument
means you assume all other factors remain equal, so you can study
what you want to study. Only 1 factor changes, everything else stays
constant.
- Marginal decision-making principle: marginal means 1 more. So
marginal cost is the cost of 1 more product. Marginal cost usually
increases, marginal benefit usually decreases. Economists look for
marginal cost = marginal benefit (MO=MK).
- Representative agents
Economic models as balancing act
- Method of decreasing abstractions
1
, - Models can easily be made more complex
- Ceteris paribus clause
- Makes it possible to reason partially
- Abstract models teach something about behaviour
Consistency with reality vs usefulness
Economics, especially micro-economics, uses abstract models to understand behaviour.
Once the first steps understood models can be extended and made more complex. →
Ceteris paribus makes it possible to understand e.g. consumer behaviour. Then changes in
behaviour, then producers, and how they meet. Example: if a firm pays less wages it will
gain more profit. End of story under CP. Next step: what is a consequence of lower wages
→ people have less to spend → people will buy less products → prices of products will
decline → firm earns less profit.
There are problems with abstractions, based on assumptions. Too often, the models built
are inconsistent with observed reality - therefore they are faulty and require modification.
When a model is so complex that it cannot be easily communicated or its implications easily
understood - it is less useful.
Adam Smith (1776)
The things which have the greatest value in use have frequently little or no value in
exchange, and on the contrary, those which have the greatest value in exchange have
frequently little or no value in use.
- Water is necessary to survive, but costs hardly anything
- Diamonds are not necessary, but are very expensive
- Tension between wants and needs
Economic perspective
Rational behaviour
2
, Representative agent will behave rational
1. Individuals are goal-oriented
2. Choice behaviour of individuals is consistent
Additional assumptions
- Perfect information: the simple rational choice model above assumes that the
individual has full or perfect information about the alternatives, i.e. the ranking
between 2 alternatives involves no uncertainty.
- Choice under uncertainty: in a richer model that involves uncertainty about the how
choices (actions) lead to eventual outcomes, the individual effectively chooses
between lotteries, where each lottery induces a different probability distribution over
outcomes. The additional assumption of independence of irrelevant alternatives then
leads to expected utility theory.
- Intertemporal choice: when decisions affect choices (such as consumption) at
different points in time, the standard method for evaluating alternatives across time
involves discounting future payoffs.
- Limited cognitive ability: identifying and weighing each alternative against every other
may take time, effort, and mental capacity. Recognizing the cost that these impose or
cognitive limitations of individuals gives rise to theories of bounded rationality.
Rational behaviour is often interpreted as being about self-interest and egoistic behaviour
Objectieve rationaliteit: streven naar maximale welvaart.
Subjectieve rationaliteit: gegeven zijn kennis, middelen, etc. streven naar bevredigende
welvaart.
3
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