Lecture 1 Thinking Like an Economist

Transcription

1 Lecture 1 Thinking Like an Economist Business 2017 Managerial Economics Economics 2017 Microeconomics I Kam Yu Fall 2018

2 Outline 1 Scientific Knowledge Induction and Deduction Uncertainty and Complexity 2 Economics as a Social Science Early Social Thinkers Economic History 3 Microeconomics The Market Economy The Economist Economic Modelling 4 Economic Thinking Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

3 Scientific Knowledge The Scientific Revolution Progress that is both rapid enough to be noticed and stable enough to continue over many generations has been achieved only once in the history of our species. It began at approximately the time of the scientific revolution, and is still under way. It has included improvements not only in scientific understanding, but also in technology, political institutions, moral values, art, and every aspect of human welfare. David Deutsch in The Beginning of Infinity Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

4 Scientific Knowledge The Scientific Method 1 Observations of the world. 2 Forming a theory or model behind the pattern: the theory has to be testable and falsifiable. 3 Repeated empirical testings of the theory. 4 Accept the theory as justified belief until it is proven false. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

5 Scientific Knowledge Induction and Deduction Tools Used in the Scientific Method The first step of recognizing a pattern, and the third steps of testing the theory by empirical observations are examples of the inductive method. Statistical techniques are often used in the inductive process. The theory, or model, is a deductive process. Results and consequences are derived from the assumptions by logical deduction. In physical and economic science, a theory is often expressed in mathematical form. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

6 Scientific Knowledge Induction and Deduction Inductive versus Deductive Thinking Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

7 Scientific Knowledge Induction and Deduction Covering the Chessboard Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

8 Scientific Knowledge Uncertainty and Complexity Hierarchies of Scientific Knowledge Many scientists think that any discipline of science can be derived from the knowledge from a more fundamental level. Sociology/Political Science/Economics Psychology Neuroscience Biology Biochemistry Chemistry Physics But cosmologist George Elllis does not agree with this principle. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

9 Scientific Knowledge Uncertainty and Complexity Why a Jumbo Jet Can Fly? Answer from physicists: It flies because air molecules move at different speeds at the top and bottom wing surfaces to create a pressure difference that lifts the plane against gravity Bernoulli s principle. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

10 Scientific Knowledge Uncertainty and Complexity Why a Jumbo Jet Can Fly? Answer from the pilots: It flies because the pilots are controlling the plane, with the skills they acquired under rigorous training. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

11 Scientific Knowledge Uncertainty and Complexity Why a Jumbo Jet Can Fly? Answer from engineers: It flies because the plane is designed to fly, using the technology in mechanical engineering, material science, and precision manufacturing. A car cannot fly because it was not designed to fly. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

12 Scientific Knowledge Uncertainty and Complexity Why a Jumbo Jet Can Fly? Answer from economists: It flies because the airline company running it is making a profit. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

13 Scientific Knowledge Uncertainty and Complexity It s a Complex World Because of complexity, each discipline of science may have it s own logical structure and cannot be derived from a more fundamental level. Social science probably cannot be studied using knowledge in physics or chemistry. But laws at the fundamental levels are still true. An airline flying the jumbo jets has to make a profit. But the airplanes must obey Bernoulli s principle. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

14 Scientific Knowledge Uncertainty and Complexity Why the Concorde is not Flying? Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

15 Scientific Knowledge Uncertainty and Complexity Why the Concorde is not Flying? It could fly at Mach 2.04, an engineering marvel. It took only 3.5 hours to fly from New York to Paris. It had an excellent safety record. During its entire operation history from 1976 to 2003, British Airways and Air France failed to make a single dim in profit on each flight. Effectively, tax payers in the two countries were subsidizing rich customers for supersonic travels. Since 2003, no commercial airline has operated any supersonic flight service. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

16 Economics as a Social Science Early Social Thinkers Thomas Hobbes Social contract theory Society needs a strong central authority to avoid chaos, which is the natural state of the world: In such condition, there is no place for industry; because the fruit thereof is uncertain: and consequently no culture of the earth; no navigation, nor use of the commodities that may be imported by sea; no commodious building; no instruments of moving, and removing, such things as require much force; no knowledge of the face of the earth; no account of time; no arts; no letters; no society; and which is worst of all, continual fear, and danger of violent death; and the life of man, solitary, poor, nasty, brutish, and short. Leviathan (1651) Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

17 Economics as a Social Science Early Social Thinkers Adam Smith Economic freedom division of labour, invisible hand, and self-interest: Every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it... he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.... It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

18 Economics as a Social Science Economic History Ancient History 12 Income per person (1800 = 1) Malthusian Trap Great Divergence Industrial Revolution 0 BC AD 2000 Figure 1.1 World economic history in one picture. Incomes rose sharply in many countries after 1800 but declined in others. Source: Gregory Clark (2007) A Farewell to Alms: A Brief Economic History of the World, Princeton University Press. typical English worker of 1800, even though the English table by then included Kam Yu (Lakehead) such exotics as tea, pepper, Lectureand 1 Thinking sugar. Like an Economist Fall / 36

19 Economics as a Social Science Economic History A Closer Look, Source: The Economy, Curriculum Open-access Resources in Economics (CORE). Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

20 Economics as a Social Science Economic History The World in Developing countries are catching up slowly but steadily. Extreme poverty has been declining over the years. 2 Wealth is not just measured in terms of dollar per person, but also in product variety. A Tale of Two Tribes: Tribe Income Per Person Stock Keeping Unit Yanomamö $ to 10,000 New Yorker $36,000 1 to 100 million Source: Beinhocker (2006, 8 9) 3 Prominent features of a modern economy: Division of labour The use of fossil fuel to underpin most economic activities Positive correlation between economic freedom and economic development Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

21 Microeconomics The Market Economy How Economists See the World Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

22 Microeconomics The Market Economy Ingredients of a Market Buyers Sellers Voluntary exchanges Terms and conditions of the contract Outcomes: market price and quantity of the exchanges Entrepreneurs: enterprising persons who discover and explore profitable opportunities and organize and manage production ventures Assumption: all parties behave in their self interests. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

23 Microeconomics The Market Economy The Economic Problem Two facts: 1 Resources such as capital, labour, energy, land, and talent are in limit supply (scarcity) 2 People always want more than what they have (unless you are a real Buddhist) Problems to be resolved: 1 What will be produced? 2 How will things be produced? 3 Who get what? 4 Who make these decisions? Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

24 Microeconomics The Economist What Do Economists Do? Social scientist study and explain how society resolve the economic problem by looking at people s incentives and behaviours under various constraints. Policy analyst Design and analysis of how government policies and regulations to achieve efficiency and fairness. Business consultant and advisor Translate an organization s problem into an economic model, find the best solution, and translate the results back into business actions and strategies. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

25 Microeconomics The Economist Tools that Economists Use Economic theory or models A model is an abstract representation of reality. Examples are a highway map a electrical circuit diagram an organization chart a formal mathematical system a prototype Empirical analysis collecting raw data, data construction, and statistical analysis. Forecasting Combining theoretical and empirical analysis to predict the future. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

26 Microeconomics Economic Modelling Modelling: Abstraction vs Reality Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

27 Economic Thinking Basic Assumptions Capitalism: private property rights and free market exchanges (economic freedom) Individual choice based on self interest Rationality self-interest standard of rationality present-aim standard of rationality bounded rationality Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

28 Economic Thinking Methodology The cost-benefit approach Actions are taken when the total benefit of the action exceeds the total cost. Marginal analysis Decisions are based on the extra (marginal) benefit of taking further action against the extra cost of doing so. Optimal Decision The best solution is often achieved when the marginal benefit is equal to the marginal cost. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

29 Economic Thinking Common Pitfalls in Decision Making In this course we focus on the neoclassical model. It assumes that agents behave in the rational manners prescribed in the assumptions. Psychologists have found that people s actual behaviours are different from the model. Some common observations are as follows: 1 Ignoring opportunity cost The nature of interest rate University education and life time earnings: For example, getting a BA degree involves 1 Direct costs: tuition fee, books and other expenditures, studying time, 2 Opportunity cost: lost incomes, lost work experience, spending time with family and friends. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

30 Economic Thinking Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

31 Economic Thinking Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

32 Economic Thinking 2 Failing to ignore sunk costs looking ahead, not backward the Vietnam war, the Iraq war,... 3 Measuring costs and benefits as proportions rather than absolute values 4 Failure to differentiate the concept of average value and marginal value Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

33 Economic Thinking Limitation of the Invisible Hand Externality (Sky-train free riders in Vancouver) Property rights (music downloads, east coast fishery) Transaction costs and Coase Theorem Economic institutions 1 informal institutions history, culture, religion, language, and other social norms and conventions. 2 formal institutions the constitution, laws and statutes, rules and regulations, government policies, etc. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

34 Economic Thinking Summary Capitalism as an economic system emerged after the industrial revolution. Economists try to use a scientific approach to study how people make decisions, and the social consequences of their individual behaviours. What we learn in this course is called the neoclassical models. It assumes that people behave in a rational manner. Studies have shown that people often behave differently from the neoclassical assumptions. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

35 Economic Thinking More on University Education David Brooks on the purpose of getting a university degree: 1 The commercial purpose: Getting a good job and starting a career 2 Cognitive purpose: Acquiring information and learning how to think 3 Moral purpose: Building an integrated self Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36

36 Economic Thinking The Importance of Critical Thinking Sociologists Richard Arum and Josipa Roksa found that graduates with good critical thinking abilities had a significant advantage in their career development. Those graduates were much less likely to be unemployed, lose their jobs during an economic downturn, or end up in an unskilled occupation. Most students are unaware of the differences due to increasingly inflated grades and the drumbeat of college self-promotion. So what is this elusive ability called critical thinking? It s multi-dimensional. Kam Yu (Lakehead) Lecture 1 Thinking Like an Economist Fall / 36