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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