Introduction to Economics
Methodology, Assumptions and Models
Václav Šebek
2014
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1 Course Overview
2 What’s Economics
3 Models
4 Summary
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Course Overview
Outline
1 Course Overview
2 What’s Economics
3 Models
4 Summary
Václav Šebek (FSS MU) Introduction to Economics 3 / 21
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.
Václav Šebek (FSS MU) Introduction to Economics 4 / 21
Course Overview
Requirements
Optional but rewarded active attendance (3 pts each, max 15)
Written exam (December 11) based on readings and lectures (max 50
pts)
Paper due January 18 (max 35 pts) with feedback within a week
Save your papers into IS, Study Materials/Homework Vaults till
midnight
100 pts possible, 60 pts minimum for pass
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Course Overview
Topics
1 The Nord Pool electricity markets
2 Central and Eastern European oil and gas markets
3 Western European oil and gas markets
4 Saudi Arabia oil industry
5 US natural gas market
6 Australian coal industry
7 Sub-Saharan Africa oil and gas industry
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What’s Economics
Outline
1 Course Overview
2 What’s Economics
3 Models
4 Summary
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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) Introduction to Economics 8 / 21
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) Introduction to Economics 9 / 21
What’s Economics
Differences between economists
Why can you hear quite different (often opposite) opinions of
different economists, when they have they are scientists?
Economics has mainstream paradigm mostly agreed 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%)
Václav Šebek (FSS MU) Introduction to Economics 10 / 21
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.
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Models
Outline
1 Course Overview
2 What’s Economics
3 Models
4 Summary
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Models
The Model
Basic and probably the most prolific tool of economics
Simply put: Observation ⇒ Hypothesis (model) ⇒ Testing ⇒
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.
Václav Šebek (FSS MU) Introduction to Economics 13 / 21
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.
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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)
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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.
Václav Šebek (FSS MU) Introduction to Economics 16 / 21
From economics to policy
Positive x normative economic statements:
P - A testable hypothesis about cause and effect, eg: Decrease of
Saudi Arabian oil production causes crude oil price to rise. 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 output to
increase world oil price and make a huge profit of it. Normative
economics, part of economic policy.
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Issues - Economics x Politics
Combination of N and P might by tricky.
Price of oil should be lowered by augmenting Saudi oil producing
capacity.
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.
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Summary
Outline
1 Course Overview
2 What’s Economics
3 Models
4 Summary
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Summary
Mankiw’s Ten Principles of Economics
1 People Face Tradeoffs
2 The Cost of Something Is What You Give Up to Get It
3 Rational People Think at the Margin
4 People Respond to Incentives
5 Trade Can Make Everyone Better Off
6 Markets Are Usually a Good Way to Organize Economic Activity
7 Governments Can Sometimes Improve Market Outcomes
8 A Country’s Standard of Living Depends on Its Ability to Produce
Goods and Services
9 Prices Rise When the Government Prints Too Much Money
10 Society Faces a Short-Run Tradeoff between Inflation and
Unemployment
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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.jstor.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.
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