Chapter 1

1.1 General Introduction

Econosystem –

An economic system, comprised of not only many elements, but also the relationships between them

Ex. Forest/trees analogy

Understanding and Learning

To understand- to “get it”

To learn- to “own it”

Definitions

Clarity is important

Common words may have very precise meanings within the context of this subject

Economics is a tool

for analyzing a complex world

Extremely useful, but not in isolation

“Necessary but not sufficient”

Limits of economics

Theories have flaws, weaknesses

Theories are evolving over time

1.2 The Subject of Economics

The Road Not Taken

Robert Frost Poem

On scarcity

Resources, money, time are all scarce

Because of scarcity, we must make choices

We face a challenge of choice

Scarce money

Spend on one thing, give up something else

Opportunity cost- best foregone opportunity you give up when you make a choice

It is the cost of choosing

Ex. Could have babysat - earned $15

Went to movies - spent $10

Opportunity cost-

$25

Scarce Time

Even if you had all the money in the world,

scarcity is still an issue

Time is scarce for all of us

Society also faces choices as a whole

earth’s resources are finite

number of people are growing

each nation, and ultimately humankind, face a similar challenge of choice

1.3 Preview of the story

We will first look at individual choice, then

interdependent choice

We will see how markets can, under the right conditions, effectively coordinate choices

Markets are amoral; they do not create or destroy justice

Microeconomics

Greek root- mikros- little or small

Individual choices, individual markets

Macroeconomics

Greek root- makros – large

Societal level – unemployment, inflation, etc.

By the end of the story,

you should see the connections between the two perspectives

1.4 Method of Telling the Story

Neoclassical Theory

Mainstream economics-

Currently the best representation of how the world works

Joseph Schumpeter

Model building begins with a vision –

a “preanalytic cognitive act”

Comes from observation of the world and from other theories that came before yours

After vision comes analysis

“Formalizing your vision”

Defining terms and arranging them to tell your story

Assumptions

The world is so complicated, you have to assume certain things to be true

That way, you can focus on just one part of something, not the whole universe

Most fundamental assumption-

There is order to the world

When a model is complete enough

the scientist presents it to others

Journals, conferences, etc.

It is then critiqued as others look for flaws

2 basic sources of flaws

Ideological bias

Lack of care in construction

Ideology

Our mind’s eye distorts what we see

We see reality through biased eyes

These biases can weaken our model

Other sources of problems

Vague definitions

Malleable definitions

Problems in testing the data

Assumptions are an abstraction from reality

Strong assumptions – assume a lot – big step from reality

Ex. Everyone will get an A in this courseWeak assumptions – considered more

realisticEx. Someone will get an A in this courseThe weaker the assumptions, the stronger

the model’s foundation

Relaxing assumptions-

To move from stronger to weaker assumptions

Models become more realistic, but also more complex

You also need more vocabulary to explain what is happening

Ceteris Paribus-

All other things being equal

Maintained assumptions

Will play a big role in how useful the model is

They are the foundation on which the whole superstructure of the model is built

As we build this model, you should reflect on how strong or weak you think they are