A Tiny Introduction to Economics

A Tiny Introduction to Economics

Macroeconomics … using statistics to understand reality Microeconomics … looking at specific groups and their decisions

Definition

The study of how society makes choices in managing its scarce resources and the consequences of this decision-making

Issues like

• scarcity and choice
• trade-offs and Opportunity Cost
• marginal thinking (Marginal Changes)
• incentives and reaction to them

Scope:

• which policy measures reduce unemployment?
• how should central banks conduct monetary policy?
• how can we avoid that firms pollute the environment?
• why do people become criminals?

Examples

The impact of legalized abortion on crime.

Theory: With legalized abortion the crime rate decreases because the people that are not born, would later in life become a criminal with a higher chance.

Great example because:

• a lot of variability for 50 different states
• a lot of data on other aspects of this problem

Oil and the duration of dictatorships

Theory: Dictators with a lot of natural resources should have longer duration in their dictatorships, since they have more resources to burn through to keep the people happy.

Up or Down? Toilet Seat Etiquette

a mathematical system about if it is worth it to always put down the toilet seat after peeing.

On the efficiency of ACDC

• Bon Scott had a nice voice which was the signature part of the band
• Bon Scott died of alcohol
• They found Brian Johnson, a very similar voice
• huge controversy about who was the better vocalist

They did:

• played an Ultimatum Game experiment
• game was played in 2 rooms separately
  • one room played music from Bon Scott
  • one room played music from Brian Johnson
• Scoring: Which got more total income (accepted offers)
• Brian Johnson Music won

Scarcity and Choice

• economic activity: interaction between households and frims
• households cannot meet all wants and needs
• scarcity: society has limited resources, cannot meet all needs of all people
• how to best allocate resources for best meeting of needs/wants

Trade-Offs

• trading off benefits/costs of options
• at societal level are different trade-offs

Marginal Thinking

Revenue $R(x)$ and Costs $C(x)$

let profit be a function: $\pi (x)=R(x)-C(x)$

then we can maximize the function (derivative = 0) $\frac{d\pi (x)}{dx}=\frac{dR(x)}{dx}-\frac{dC(x)}{dx}=0$

This model requires rationality of all participants.

Marginal Quantities: When changing the inputs a little, how does the output change.

Finding a way that the marginal revenue matches their marginal costs. Then their profit is maximized.

Abstraction and Mathematics

Economics often use abstract models, often in mathematical form.

Advantages:

• transparent language for results and benchmarks
• allowing a (hopefully) straightforward way to confront the theoretical results with empirical evidence through predictions

Role Model of Physics:

• when throwing a fall off a building, what is the speed after 3 seconds?
  • Physics has no problem with using wrong model
  • the problem with this model is air friction
  • It doesn’t matter in our model, because it is negligible
• Economics wants to do it like that
  • a lot of abstractsion
  • a lot of assumptions, to keep complexity down
  • question: did I abstract and assume the correct things?
    • air friction negligible when dropping a ball 3 meters, but not when calculating for max speed of a falling ball

Problem of social sciences:

• Impossible (or at least very hard) to conduct experiment

The Toolbox of an economics:

• empiricism
• rationalism
• deduction
• induction

Popper Logic

• Popper Logic

Cause and Effect

Pattern Matching is used to derive insights from data.

Then we search for causality and implications of this patterns Correlation != Causality

Positive vs Normative Analysis

• Why is unemployment higher for teenagers than older workers?
• What should the government do to improve the well-being of teenagers?

Positive Statement … Can be falsified … scientific statements Normative Statement … includes opinions … cannot be tested

Positive and Normative statements tend to get mixed up.

Critical Thinking

6 rules of evidental reasoning (Lett, 1990)

• Falsifiability
• Logic
• Comprehensive
• Honesty
• Replicability
• Sufficiency

Occam’s Razor

When there are 2 hypotheses that explain the situation equally well, then choose the simpler one.

Logical Fallacies

• Ad hominem
  • oh no, that guy is a nazi, therefore the statement must be wrong
• Argument from authority
• Appeal to ignorance
• Post hoc, ergo propter hoc
  • just because one thing happened after another doesnt mean, that they cause each other