1 What is Economics?

Question 1

What does economics study?

Answer 1

The allocation of scarce resources amount “economic agents” - people, firms, industries, countries.

Question 2

Two concepts underpinning economics

Answer 2

Scarcity - this creates the allocation problem.

Trade-offs - existence of alternative means → judgements in allocation.

Question 3

Define opportunity cost

Answer 3

The value of the best foregone alternative which you give up in order to acquire it.

Question 4

What is meant by normative analysis?

Answer 4

The attempt to determine what is the best course of action/state of affairs.

Prescriptive.

Question 5

What is meant by positive analysis?

Answer 5

The attempt to understand the world around us.

Descriptive.

Question 6

What is meant by Pareto improvements?

Answer 6

Policies which may benefit everyone (or at least some people), while no one else suffers.

Question 7

Two main approaches to analysis?

Answer 7

Cost-benefit analysis.

Welfare analysis.

Question 8

Explain welfare analysis

Answer 8

Posits social preferences and goals, like helping the poor, elderly or children.

Also uses some cost-benefit analysis, but with weighting on further impacts on other social goals.

Question 9

Explain cost-benefit analysis

Answer 9

Weigh the gains and losses and suggests carrying out changes that provide greater benefits than harm.

^involves monetising Cs+Bs which is tricky.

NETS.

Question 10

Who is Homo Economicus?

Answer 10

A hypothetical person who behaves in exact accordance with their rational self-interest.

Question 11

Models and instrumentalism

Answer 11

Models are often not meant as literal, descriptive accounts of how people behave.

“Instrumental” - simply meant as devices designed to generate quantitative predictions.

Question 12

Does economics tell us what motivates people?

Answer 12

Paul Samuelson’s choice-revealed preference.

Absolute virtue of refusing to take any a priori view on what motivates people. De Gustibus Non Est Dispuntandum.

Question 13

How do we construct models in economics?

Answer 13

Agents behave consistently → behave as if they are maximising something which can be described mathematically by an objective function.

Firms → thing = profit → profit function

People → thing = “utility” → utility function

Question 14

Orthodoxy in economic methodology

Answer 14

The existence and nature of a person’s “utility function”, must be determined empirically by observing their behaviour in various situations.

Question 15

Why do economists build models? (4)

Answer 15

• Capture the (relevant) elements of the economy or phenomenon we are trying to analyse.
• Describe how agents act, and how they interact with each other and their (economic) environment.
• Determine the outcomes of these actions: an equilibrium.
• Study what happens (how the equilibrium changes) when conditions change – comparative statics.

Question 16

Inductivism vs deductivism

Answer 16

Inductivism: observation of specific facts leads to inference of general principles.

Deductivism: general principles lead to prediction of specific facts.

Question 17

+ emphasises observation and systematic empirical work as major means of attaining knowledge.

• one can never simply gather all the facts.
• fact gathering is subjective (which facts should be gathered, which ignored?)
• fact gathering using judgement necessarily pre-supposes some kind of theory

Hume: in essence, the sample evidence only tells you about the sample.

Question 18

What does Karl Popper say?

Answer 18

• A good theory must be falsifiable, state conditions for falsifiability, undergo and survive empirical testing.

This view is empirical but anti-inductivist (which seeks verification).