Introduction to Economics Methodology, Assumptions and Models Václav Šebek 2015 Václav Šebek (FSS MU) Introduction to Economics 1/22 O Co urse Overview Q What's tconomics Q Models Q Economic Policy Q Summary < □ ► < rfP1 ► < 1 ► < 1 ► 1 •O 0,0 Introduction to Economics 2/22 Course Overview Outline O Co urse Overview 0 What's tconomics 0 Models Q Economic Policy Q Summary Václav Sebek (FSS MU) <□► < [f? ► < ► < -Ž ► -Š 'O Q, O Introduction to Economics 3/22 Course Overview Objectives Introduce you to the basics of economic analysis How economists think, which tools do they use and how they mean what they say Basics of mainstream neoclassical synthesis1 The course is based mainly on Mankiw [2007] with Varian [2010] extending some topics. Your questions and comments welcomed! Course is held in lecture/discussion mode. 1For further reading on history of economic thought see eg Schumpeter [2000], for heterodox economics see contemp debate. Introduction to Economics 4/22 Václav Sebek (FSS MU) Course Overview Requirements • Optional but rewarded attendance (3 pts each, max 15) • Written exam (during first two weeks in December) based on readings and lectures (max 50 pts) • Paper due January 17 (max 35 pts) with feedback within a week • Save your papers into IS, Vaults till midnight • Altogether 100 pts possible, 60 pts minimum for pass Václav Šebek (FSS MU) Introduction to Economics 5/22 Course Overview Topics O Electricity markets in V4 countries O Oil commodity trading in Europe O Natural gas commodity trading in Europe O Energy trends in emerging markets O US prospects for natural gas export Q Coal mining and coal trade in the Czech Republic O Pumped-storage hydrolectic power in the central European countries Václav Sebek (FSS MU) <□► < [f? ► < ► < -Ž ► -Š 'O Q, O Introduction to Economics 6/22 What's Economics Outline Q Course Overview Q What's tconomics O Models Q Economic Policy Q Summary Václav Sebek (FSS MU) < □ ► < t3? ► < ► < -ž ► -š •O Q, O Introduction to Economics 7/22 What's Economics Definition • Economics is the study of how society manages its scarce resources. • Note: Economics is the science, Economist is practitioner and Economy is sum of people, products and relations. • Economics assumes that: • There is scarcity of resources • People behave in a rational way pursuing their own interests and utility • Economy reaches equilibrium Václav Šebek (FSS MU) <□► < [f? ► < -E ► < -Ž ► Š 'O Q, O Introduction to Economics 8/22 What's Economics Micro x Macro • They address various levels of analysis and ask different questions. They are intertwined, interconnected but also distinct and peculiar. • Microeconomics focuses on households' and firms' decisions and their interactions on the market. • Macroeconomics addresses the economy-wide phenomena such as product (GDP), unemployment, inflation, balance of payments (ei foreign trade). • Micro is much more consensual than macro (among economists, see below) Václav Šebek (FSS MU) <□► < [f? ► < -E ► < -Ž ► Š 'O Q, O Introduction to Economics 9/22 What's Economics Differences between economists • Why can you hear quite different (often opposite) opinions of different economists, when they are scientists? • Economics has mainstream paradigm mostly agreed on by economists (not so by those pretending to be economists) • Example Alston et al. [1992]: • Ceiling the estate lease decreases quantity and quality of housing available (93%) • Floating exchange rates facilitate effective international monetary setting (90%) • Minimal wage increases unemployment of youth and unskilled (79%) • Taxation of environmental pollution is more effective than limiting physical emissions (79%) Introduction to Economics 10 / 22 What's Economics Basic terms Scarcity - or No Free Lunch. A thing is scarce when people want more than available. • Not necessarily equal to preciousness! Utility - the pleasure, happiness, or satisfaction obtained from consuming a good or service their satisfaction. Opportunity costs - trade-off - to get more of one thing society forgoes the opportunity of getting the next best thing. Equilibrium - state of economy when no variable changes unless influenced from outside. (Pareto or Nash) Variable - measurable category worth observing. May be stock or flow, dependent or independent. Václav Šebek (FSS MU) Introduction to Economics 11 / 22 Models Outline 0 Course Overview 0 What's tconomics Q Models Q Economic Policy Q Summary Václav Sebek (FSS MU) Introduction to Economics 12 / 22 Models The Model • Basic and probably the most prolific tool of economics • Simply put: Observation =4> Hypothesis (model) =4> Testing =4> Evaluation (acceptance, rejection, or modification of the hypothesis/model) • To explain how individuals and firms allocate resources and how market prices are determined (and many more), economists use a model: a description of the relationship between two or more economic variables. • Technically, models may be of many different kinds (eg either deterministic or stochstic) and based on various platforms (econometrics, general equilibrium, agent based...) Introduction to Economics 13 / 22 Models Assumptions Ceteris paribus or "other things equal" assumption - when working with models, one variable changes while all other stay still. Generalization - Models abstract from reality, miss many features of real world so they can focus on those important. Models both describe and predict. A good model makes sharp, clear predictions that are consistent with reality. Some very simple models make sharp predictions that are incorrect, and other more complex models make ambiguous predictions—any outcome is possible—which are untestable. Václav Šebek (FSS MU) Introduction to Economics 14 / 22 Models Examples Most of the topics in this course will be explained with models, so that's what you'll see. Supply and Demand - knowing one's willingness to pay and others costs reveals the price Prisoners dilemma - knowing various outcomes reveals the strategy (or behavior) Benchmarking Václav Šebek (FSS MU) Introduction to Economics 15 / 22 Models Issues Everything should be made as simple as possible, but not simpler. -Albert Einstein Composition problem - Even if we know behavior every single element, even their sum, the system as a whole might work otherwise. Omitting variables, observing false causality, confusing correlation with causality • eg. wee see A =^ B while it's B =^ A or C {A, B} etc. Garbage in garbage out Václav Šebek (FSS MU) <□► < [f? ► < -E ► < -Ž ► -Š 'O Q, O Introduction to Economics 16 / 22 Economic Policy Outline 0 Course Overview 0 What's tconomics O Models Q Economic Policy Q Summary Václav Sebek (FSS MU) <□► < rS? ► < ► < -ž ► -š •O Q, O Introduction to Economics 17 / 22 Economic Policy From economics to policy Positive x normative economic statements: P - A testable hypothesis about cause and effect, eg: Recent decrease of crude oil is accompanied by Saudi Arabian' budget deficit. Positive economics thus deals with factual statements. N - A value judgment or a conclusion as to whether something is good or bad, eg: Saudi government should decrease its oil export dependency to make its public budgets more robust. Normative economics, part of economic policy. Václav Šebek (FSS MU) Introduction to Economics 18 / 22 Economic Policy Issues - Economics x Politics • Combination of N and P might by tricky. • Recent decrease of crude oil is caused by Saudi Arabian' budget deficit. • Good intentions pave the road to hell - Czech proverb (and indeed positive statement) • It is nice to have good intentions embodied in normative statements of high moral profile (eg Poverty should be eradicated] Oil should be cheap and widely available). However, quite a lot of economic prescriptions based solely on normative (and often intuitive) assumptions lead to disasters or at least adverse effects. (Setting minimum wage or maximum price...) • The more precise and positive based objectives the better outcomes. Introduction to Economics 19 / 22 Summary Outline Q Course Overview O What's tconomics O Models Q Economic Policy Q Summary Václav Sebek (FSS MU) < □ ► < [f? ► < ► < -Ž ► Š 'O Q, O Introduction to Economics 20 / 22 Summary Mankiw's Ten Principles of Economics O People Face Tradeoffs Q The Cost of Something Is What You Give Up to Get It O Rational People Think at the Margin O People Respond to Incentives O Trade Can Make Everyone Better Off O Markets Are Usually a Good Way to Organize Economic Activity O Governments Can Sometimes Improve Market Outcomes 0 A Country's Standard of Living Depends on Its Ability to Produce Goods and Services O Prices Rise When the Government Prints Too Much Money Q Society Faces a Short-Run Tradeoff between Inflation and Unemployment Introduction to Economics 21 / 22 Summary References Richard M. Alston, J. R. Kearl, and Michael B. Vaughan. Is there a consensus among economists in the 1990's? The American Economic Review, 82(2):pp. 203-209, 1992. ISSN 00028282. URL http://www.j stor.org/stable/2117401. N. Gregory Mankiw. Principles of Economics. Mason: Thomson Higher Education, 2007. Joseph Schumpeter. History of Economic Analysis. Mason: Thomson Higher Education, 2000. Hal R. Varian. Intermediate Microeconomics. A Modern Approach. W. W. Norton & Company, 2010. Václav Šebek (FSS MU) Introduction to Economics 22 / 22