Introduction to Economics
Vladimír Hajko
2016
Vladimír Hajko (FSS MU) Introduction to Economics 1 / 37
1 Course Overview
Course overview
2 Methodology, Assumptions and Models
What is Economics?
3 Models
Economic models
Economic Policy
4 Supply & Demand
Market Supply & Market Demand
Elasticity
Vladimír Hajko (FSS MU) Introduction to Economics 2 / 37
Course Overview
Outline
1 Course Overview
Course overview
2 Methodology, Assumptions and Models
What is Economics?
3 Models
Economic models
Economic Policy
4 Supply & Demand
Market Supply & Market Demand
Elasticity
Vladimír Hajko (FSS MU) Introduction to Economics 3 / 37
Course Overview Course overview
Objectives
Introduction to the basics of economics
Basic terms, concepts, and tools
Basics of mainstream neoclassical synthesis
The course is based mainly on Mankiw [2007] with Varian [2010]
extending some topics - but do not hesitate to use other sources
Feel free to share questions and comments. Course is held in
lecture/discussion mode.
Vladimír Hajko (FSS MU) Introduction to Economics 4 / 37
Course Overview Course overview
Requirements
Attendance - optional - but active attendance rewarded (3 pts each,
max 15)
Written exam (in December or Januray - date TBA) based on
readings and lectures (max 100 pts)
min. 60 pts to pass
Vladimír Hajko (FSS MU) Introduction to Economics 5 / 37
Course Overview Course overview
Course outline
1 Introduction to Economics - Methodology, Assumptions and Models
+ Supply & Demand
1 Chapters 1-2
2 Chapters 4-6
2 Consumers, Producers and Efficiency of Markets + Externalities and
Public goods
1 Chapter 7
2 Chapters 10-11
3 Theory of Consumer Choice + Theory of Firms
1 Chapter 21
2 Chapter 13
4 Market Structures
1 Chapters 14-17
5 Macroeconomics
1 Chapters 22-24 and 27-28
Vladimír Hajko (FSS MU) Introduction to Economics 6 / 37
Methodology, Assumptions and Models
Outline
1 Course Overview
Course overview
2 Methodology, Assumptions and Models
What is Economics?
3 Models
Economic models
Economic Policy
4 Supply & Demand
Market Supply & Market Demand
Elasticity
Vladimír Hajko (FSS MU) Introduction to Economics 7 / 37
Methodology, Assumptions and Models What is Economics?
Definition
Economics is the study of how people make decisions to reach their
goals
which in turn explains how society allocates its scarce resources
Note: Economics is the science, Economist is practitioner and
Economy is the sum of people, products and relations in a certain area
Economics assumes that:
Resources are scarse
People behave in a rational way, pursuing their own interests and utility
Economy reaches equilibrium
Economics is not a religion! Economists disagree with each other
assumptions and models...
traditional view: rational behavior - does it hold? Continuous
functions..., indifference..., market failures... etc.
Vladimír Hajko (FSS MU) Introduction to Economics 8 / 37
Methodology, Assumptions and Models What is Economics?
Microeconomics vs. Macroeconomics
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 (i.e.
foreign trade)
There is more consensus in microeconomics than in macroeconomics
(among economists, see below)
Both develop theories that are used for predictions
Vladimír Hajko (FSS MU) Introduction to Economics 9 / 37
Methodology, Assumptions and Models What is Economics?
Differences between economists
“Economics is the only field where two people can win the Nobel
Prize for saying the exact opposite thing”
Hayek vs. Myrdal (1974), Shiller vs. Fama (2013)
Economics has mainstream paradigm mostly agreed on by economists
- but no theory is without drawbacks (assumptions of the models)
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%)
Vladimír Hajko (FSS MU) Introduction to Economics 10 / 37
Methodology, Assumptions and Models What is Economics?
Basic terms
Scarcity - or No Free Lunch. A thing is scarce when it has a limited
supply (and people want to consume it)
Utility - the pleasure, happiness, or satisfaction obtained from the
consumption of a good or service
Opportunity costs - trade-off - if you get something, you give up the
opportunity to get the next best thing (if attend a lecture, you give
up the opportunity to watch a movie or go for a drink etc.)
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
Vladimír Hajko (FSS MU) Introduction to Economics 11 / 37
Models
Outline
1 Course Overview
Course overview
2 Methodology, Assumptions and Models
What is Economics?
3 Models
Economic models
Economic Policy
4 Supply & Demand
Market Supply & Market Demand
Elasticity
Vladimír Hajko (FSS MU) Introduction to Economics 12 / 37
Models Economic models
Economic Models
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
Technically, models may be of many different kinds (e.g. deterministic
or stochastic) and based on various platforms (econometrics, general
equilibrium, agent based, ...)
Vladimír Hajko (FSS MU) Introduction to Economics 13 / 37
Models Economic models
Assumptions
Ceteris paribus or “other things equal” assumption - when working
with models, only one thing is allowed to change, everything else
remains the same
Generalization - Models abstract from reality, miss many features of
real world so they can focus on those important.
Models both describe (explain) and predict. A good model makes
sharp, clear predictions that are consistent with reality.
Good model does not need to be complex. But simple models
describe simple behavior.
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
Vladimír Hajko (FSS MU) Introduction to Economics 14 / 37
Models Economic models
Issues
Everything should be made as simple as possible, but not simpler.
—Albert Einstein
Composition problem - Even if we know behavior of 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
Economics is a social science
Largest dispute in Economics - Methodenstreit (1880s!) - philosophy
and epistemology - today, economics largely using methods of natural
science (which may also be the root of many problems)
Vladimír Hajko (FSS MU) Introduction to Economics 15 / 37
Models 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 (and politics)
Vladimír Hajko (FSS MU) Introduction to Economics 16 / 37
Models 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.
Vladimír Hajko (FSS MU) Introduction to Economics 17 / 37
Models Economic Policy
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
Do not take for granted - this is not a sacred religious text... Some are
normative ((6 leading to) 7, 10) utility functions are strictly subjective we
will talk about this later...
Vladimír Hajko (FSS MU) Introduction to Economics 18 / 37
Supply & Demand
Outline
1 Course Overview
Course overview
2 Methodology, Assumptions and Models
What is Economics?
3 Models
Economic models
Economic Policy
4 Supply & Demand
Market Supply & Market Demand
Elasticity
Vladimír Hajko (FSS MU) Introduction to Economics 19 / 37
Supply & Demand Market Supply & Market Demand
Basic Terms
Good(s) - a thing satisfying a need. A thing scarce in its availability
(remember previous lecture) - which means there is a price of it
Market - Group of buyers and sellers of particular good, exchanging
it for a certain negotiated price
Competition A
process, clash of buyers to buy or sellers to sell (offering lowest price
to catch a customer)
More importantly: a particular structure of a market (i.e. a competitive
market, monopoly, oligopoly etc.)
Quantity (Q) - the amount of good (quantity demanded, quantity
supplied, quantity produced etc.)
Price (P) - represents relative scarcity of a good (usually compared
with money or other good) as an interaction of supply and demand
Vladimír Hajko (FSS MU) Introduction to Economics 20 / 37
Supply & Demand Market Supply & Market Demand
Quantity demanded
Demanded Q of a good is an amount of good one buys at certain
price.
Q demanded thus cannot be found without relation to price
Set of all possible amounts demanded at all possible prices is the
demand (quantity demanded as function of the good’s price:
QD = f (P))
Price 1 2 3 4 5 6 7 8 9
Q 17 15 13 11 9 7 5 3 1
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Supply & Demand Market Supply & Market Demand
Demand
Vladimír Hajko (FSS MU) Introduction to Economics 22 / 37
Supply & Demand Market Supply & Market Demand
Quantity supplied
Supplied Q of a good is an amount of good one offers (sells) at
certain price.
Q supplied thus cannot be found without relation to price!
Set of all possible amounts sold at all possible prices is the supply
(quantity demanded as function of the good’s price: QS = f (P))
Price 1 2 3 4 5 6 7 8 9
Q 1 3 5 7 9 11 13 15 17
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Supply & Demand Market Supply & Market Demand
Supply
Vladimír Hajko (FSS MU) Introduction to Economics 24 / 37
Supply & Demand Market Supply & Market Demand
Some Remarks
Market supply is simply the sum of all personal supplies
Market demand is the sum of individual demands
There are several factors determining QSand QD besides price
e.g. disposable income, preferences, technology, expectations etc.
basic relation depicted in previous figures reflects changes of Q caused
by changes of P ceteris paribus, i.e. all other conditions unchanged
CAUTION: in economics, supply QS = f (P) and demand
QD = g (P) are shown using inverse demand functions - i.e. as
f −1 QS = P and g−1 QD = P
“at what quantity demanded (or quantity supplied) do we find this price?"
i.e. we draw P prices on vertical axis, and quantity on horizontal axis
historical: Alfred Marshall drew it like this, but it also has deeper philosophical connections - namely both P
and Q are determined by market interactions; it also makes it easier to draw certain figures
Vladimír Hajko (FSS MU) Introduction to Economics 25 / 37
Supply & Demand Market Supply & Market Demand
Changes in S and D
Changing the price ceteris paribus (see previous slide) causes so called
“moves on the line” (left hand figure).
Changing other factors such as income, preferences, technology,
expectations etc. causes so called “move of the line” (right hand
figure)
Vladimír Hajko (FSS MU) Introduction to Economics 26 / 37
Supply & Demand Market Supply & Market Demand
S&D and Market
Supply and Demand interact ("meet" at the market)
the result of individual interactions of a large number of individuals
Multitude of questions
What price will prevail on the market?
What quantity of good will be offered and demanded at various levels
of price?
What quantity will be actually traded?
What if the price is somehow disturbed (e.g. regulated)?
Vladimír Hajko (FSS MU) Introduction to Economics 27 / 37
Supply & Demand Market Supply & Market Demand
Reaching Equilibrium
Market equilibrium is defined by price when both supply and demand
are balanced
In other words: equilibrium price P∗ leads to QS = QD
Vladimír Hajko (FSS MU) Introduction to Economics 28 / 37
Supply & Demand Market Supply & Market Demand
Markets Not in Equilibrium
What happens, when the price on the market is different from
equilibrium price?
The price does not clear the market, i.e. QS = QD (or rather
QS
(P) = QD
(P))
Vladimír Hajko (FSS MU) Introduction to Economics 29 / 37
Supply & Demand Market Supply & Market Demand
Examples
Increase in demand ⇒Price↑and Quantity ↑
Decrease in supply ⇒Price↑and Quantity ↓
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Supply & Demand Market Supply & Market Demand
Examples (cont.)
Simple international trade example ?.
Ban (left hand figure) or quota (right hand figure) on wheat imports.
Both lead to a decrease in wheat supply - S↓, P↑, Q ↓
When is the quota effective?
Vladimír Hajko (FSS MU) Introduction to Economics 31 / 37
Supply & Demand Market Supply & Market Demand
Competitive Markets
Conducted analysis apply only on competitive markets!
Many buyers and sellers with insignificant market share ⇒price-takers
No market-entry-barriers
Perfect information, no technology-barriers
Homogeneous product
Truly unhampered free market is almost non-existent
but it helps in conceptualization
Vladimír Hajko (FSS MU) Introduction to Economics 32 / 37
Supply & Demand Elasticity
Motivation
Supply and Demand usually not linear
What happens if the price changes a little?
On of the crucial managerial questions - is it profitable to lower the
price (and sell more) or vice versa?
Substitute goods - if we increase the price of X, Y (with unchanged
price) is getting relatively cheaper
Vladimír Hajko (FSS MU) Introduction to Economics 33 / 37
Supply & Demand Elasticity
Elasticity
Slope = change in f (x)
change in x
this is described by derivatives
let’s have y = f (x), then slope = y
x , if the change in x is small, then
slope = ∂y
∂x = ∂f (x)
∂x = derivative of f with respect to x
Elasticity: e = relative change in f (x)
relative change in x
Elasticity is a relative change, i.e.e =
y
y
x
x
= x
y
y
x , so for point
estimate of elasticity we get e = x
y
∂y
∂x
slope
Intuition:
High elasticity = huge shift of f (x) (Q) in response to a change in x
(P)
Low elasticity = little shift of f (x) (Q) in response to a change in x (P)
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Supply & Demand Elasticity
Elasticities
Which independent variables changes
Demand elasticities:
Price elasticty of demand ePD
Income elasticity of demand eID
Cross price elasticity of demand (price of some other good changes)
eCD
Supply elasticity:
Price elasticity of supply ePS
There are some special cases:0 , < 1; 1; > 1; ∞
Vladimír Hajko (FSS MU) Introduction to Economics 35 / 37
Supply & Demand Elasticity
Elasticity determinants
Necessary vs. luxury goods
Availability of substitutes
Market definition (apples x fruits x food)
Time scale
Share of income
Vladimír Hajko (FSS MU) Introduction to Economics 36 / 37
Supply & Demand Elasticity
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.
Hal R. Varian. Intermediate Microeconomics. A Modern Approach. W. W.
Norton & Company, 2010.
Vladimír Hajko (FSS MU) Introduction to Economics 37 / 37