Models in economics

Chapter 1
What is Economics ?

Overview
What is economics?
Definition, scarcity, and choice
The world of economics
Micro vs. Macro
Positive vs. Normative
Why and how to study economics
The methods of economics
Math review

Economics, Scarcity, and Choice
Economics
Study of choice under conditions of scarcity
Scarcity
Situation in which the amount of something available is insufficient to satisfy the desire for it

Scarcity and Individual Choice
Unlimited variety of scarcities, based on two basic limitations:
Scarce time
Limited number of hours in each day to satisfy our desires
Scarce spending power
Cannot afford to buy more of the things we want

Scarcity and Individual Choice
Limitations force each of us to make choices
Economists study
Choices
Consequences of those choices
Indirect effects of individual choice on our society

Scarcity and Social Choice
Society faces a scarcity of resources
Categories of resources:
Labor
Capital
Human capital
Capital stock
Land/natural resources
Entrepreneurship

Scarcity and Economics
Problems studied in economics: the scarcity of resources—and the choices it forces us to make
Households – have limited income to allocate among goods and services
Firms – production is limited by costs of production
Government agencies – the budget is limited, so goals must be carefully chosen

Scarcity and Economics
Economists study the decisions made by households, firms, and governments to
Explain how our economic system operates
Forecast the future of our economy,
Suggest ways to make that future even better

Microeconomics
Micro comes from the Greek word mikros, meaning “small”
Studies the behavior of individual households, firms, and governments
Choices they make
Interaction in specific markets
Focuses on individual parts of an economy

Macroeconomics
Macro comes from the Greek word makros, meaning “large”
Studies the behavior of the overall economy
Focuses on big picture and ignores fine details

Positive and Normative Economics
Positive economics: how the economy works
Can be true or false
Can be tested by looking at the facts
Normative economics: what should be
Value judgments, identify problems, and prescribe solutions
Cannot be proved or disproved by the facts alone

Why Economists Disagree
The difference of opinion may be positive in nature
Facts are being disputed
The disagreement can be normative
Facts are not being disputed
When economists have different values, they may arrive to different conclusions
Disagreement - over goals and values

Why Study Economics
To understand the world better
Global events and personal phenomena
To achieve social change
Understand the origins of social problems
Design more effective solutions

Why Study Economics
To help prepare for other careers
A wide range of careers deal with economic issues on many levels
To become an economist
Develop a body of knowledge that could lead you to become an economist in the future

The Methods of Economics
Use economic models to develop economic theories
Economic models are built with words, diagrams, and mathematical statements
Economic models
Abstract representation of reality
Should be as simple as possible to accomplish its purpose

Economic Models: Assumptions and Conclusions
Two types of assumptions:
Simplifying assumptions
Essential features can stand out more clearly
Critical assumptions
Affect the conclusions of a model in important ways
If critical assumptions are wrong, the model will be wrong

The Three Step Process
Economists follow the same three-step process to analyze almost any economic problem:
The first two steps explain how economists build an economic model
The last step explains how they use the model.

Math, Jargon, and Other Concerns…
Economic jargon
Special words that allow economists to more precisely express themselves
Math
High school level algebra and geometry
We will covers some of the basic math concepts that you will need tomorrow

How to Study Economics
Economics must be studied actively, not passively
Active study
Reproduce what you have learned
List the steps in each logical argument
Retrace the cause-and-effect steps
Draw the graphs
Basic principles
relate to what you are learning

Math Review
Tables and graphs
Tables
Straight-line graphs
Curved lines
Linear equations
Lines and curves shift
Shifts vs. movements along a line

Tables and Graphs
TABLE A.1 Advertising and Sales at Len & Harry’s

Straight-line Graphs
FIGURE A.1 A Graph of Advertising and Sales
Advertising
($1,000 per month)
Sales ($1,000 per month)
A
B
C
D
E
F
2
3
6
7
11
12
24
54
51
39
36
27
18

Straight-line Graphs
Slope of a straight line =
Change in vertical variable / Change in horizontal variable
=

Curved Lines
FIGURE A.2 Measuring the Slope of a Curve
1. The slope of this
curve at point B…
2. is the slope of the
straight line tangent
to the curve at point B.
3. Along the tangent line,
when advertising
increases from 0 to 3
units (ΔX = 3)
4. sales increase from 21
to 27 units (ΔY= 6). So
the curve's slope at
point B is =6/3= 2.

Linear Equations
Y = a+bX
a: vertical intercept
b: slope
Exercise: what is the linear equation for advertisement example in Figure A.1?
Y = 18+3X

Linear Equations
Remember : Y= 18+3X
For example, how much expenses are necessary to secure a sale $39,000?
Y = $39 now
$39 = 18 + 3X
X = (39 – 18)/3 = 7

Linear Equations
0
a
b > 0
0
a > 0
FIGURE A.3 Straight Lines with Different Slopes and Vertical Intercepts

Linear Equations
0
a
b = 0
0
a = 0
FIGURE A.3 Straight Lines with Different Slopes and Vertical Intercepts

Linear Equations
0
a
b < 0
0
a < 0
FIGURE A.3 Straight Lines with Different Slopes and Vertical Intercepts

6
36
C''
C'
C
July
September
June
44
Line Shift
FIGURE A.4 Shifts in the Graph of Advertising and Sales

Curves Shift
FIGURE A.5 Shifts of Curved Lines
An increase in Z causes an increase in Y at any value of X
An increase in Z causes a decrease in Y at any value of X
C
C’
C’
C
a)
b)

Shifts vs. Movements Along a Line
Suppose Y is the dependent variable, which is measured on one of the axis. If the independent variable measured on the other axis changes, we move along the line.
But if any other independent variable changes, the entire line shirts.

Practice Question 1

Practice Question 2