Why Study Economics? John Maynard Keynes answer

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Why Study Economics? John Maynard Keynes answer

• the ideas of economists and political
  philosophers, both when they are right and when
  they are wrong, are more powerful than is
  commonly understood. Indeed, the world is ruled
  by little else. Practical men, who believe
  themselves to be quite exempt from any
  intellectual influences, are usually slaves of
  some defunct economist.
• Much of you political beliefs are shaped by
  economic philosophy. Much of what you take in
  business has its roots in economic theory. An
  understanding of economics is necessary if one is
  to understand society.

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Conventional Wisdom

• A vested interest in understanding is more
  preciously guarded than any other treasure. It is
  why men react, not infrequently with something
  akin to religious passion, to the defense of what
  they have so laboriously learned. Familiarity may
  breed contempt in some areas of human behavior,
  but in the field of social ideas it is the
  touchstone of acceptability. Because familiarity
  is such an important test of acceptability, the
  acceptable ideas have great stability. They are
  highly predictable. It will be convenient to have
  a name for the ideas which are esteemed at any
  time for their acceptability, and it should be a
  term that emphasizes this predictability. I shall
  refer to these ideas henceforth as the
  conventional wisdom. (Galbraith, 1958, pp. 67,
  italics added)
• The Truth or Thinking vs. Memorization

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Alternative Perspectives

• Austrian
• Institutionalist
• Radical (or Marxists)
• Feminist
• Religious
• Post-Keynesian

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Economics Defined

• Economics - is the study of how human beings
  coordinate their wants and desires, given the
  decision-making mechanisms, social customs and
  political realities of the society.
• Economics - The study of the choices people make
  with respect to scarcity.

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Micro vs. Macro

• Microeconomics - the study of individual choice,
  and how that choice is influenced by economic
  forces.
• Macroeconomics - the study of the aggregate
  economy OR the study of economy as a whole,
  which includes inflation, unemployment, business
  cycles, and growth.

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The Basic Questions

• The Basic Questions of Society
• What to produce?
• How much to produce?
• How to produce?
• For whom to produce?

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The Fundamental Problem

• Scarcity - the goods available are too few to
  satisfy individuals desires.
• Scarcity is the fundamental economic problem.
• Scarcity forces us to make choices.

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Costs and Benefits

• COSTS
• Marginal cost - additional cost above the costs
  already incurred.
• Sunk cost - costs that have already been incurred
• BENEFITS
• Marginal Benefits - the additional benefits above
  what have already been derived.

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Economic Decision Rule

• If the relevant benefits of doing something
  exceed the relevant costs, do it. If the relevant
  costs of doing something exceed the relevant
  benefits, dont do it.

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Explaining Behavior

• from McCloskey, Diedre. The Secret Sins of
  Economics.
• P vs. S Variables
• Economics is focused on P variables.
• Prudent - Wise in handling practical matters
• Profit Revenue minus costs
• Price
• Economics tends to ignore love, courage, justice,
  faith, hope. These can be summarized as the
  Solidarity, the Sacred, or the S variables.
• Anthropology focuses on the S variables.
• In sum, B f(P, S).

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Two Applications of Cost-Benefit Analysis

• The Decision to Have Children
• Voting in Elections

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Why do people have children?

• from the work of Gary Becker
• Children are like durable goods
• Children are expensive to maintain
• Children can yield returns over a long future
• Children are a store of value
• A prudent parent considers costs and benefits in
  making the decision to have children.
• When we investigate changes in fertility rates we
  find that economic factors determine how many
  children parents choose to have.

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Population Growth

• The Data 1620 2,302
• 1700 250,000
• 1720 500,000
• 1740 1,000,000
• 1776 2.5 million
• 1820 10 million
• 1914 100 million
• Today over 300 million
• Growth rates
• 17th century gt5 per year
• 18th, 19th century 3 per year
• 20th century lt 2, peak of 1.75 for the baby
  boomers

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Birth Rates

• Maximum birth rate
• 60 per 1,000 persons
• 1800 55 per 1,000 persons
• 1900 30 per 1,000 persons
• Today lt 20 per 1,000 persons

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Why were birth rates higher in the 19th century?

• Lower median age
• 15.9 in 1790
• 19.4 in 1860
• 34.0 today
• Abundant land
• Urban fertility rates were lower than rural
  fertility rates. Why?
• Children are durable goods. Urban residents have
  more choices in consumption.
• Children are investment goods. Children had a
  greater return on farms then they did in urban
  settings.

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Voting Behavior

• Why do people vote?
• What are the costs?
• What are the benefits?
• If we only consider P variables, voting makes
  little sense. One needs to recognize the
  importance of S variables.

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Opportunity Cost

• Opportunity Cost - the value of the next best
  alternative foregone in making a decision.
• Examples of Opportunity Cost

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Economic Theory

• Economic theory - Generalizations about the
  workings of an abstract economy. OR
• A shorthand way of telling a story.
• That Only Works in Theory
• For a theory to have value, it must be consistent
  with empirical observation. If it only works in
  theory, it is not a good theory.
• We only talk about good theories in this
  class!!!!

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Models and Principles

• Economic models - A framework that places the
  generalized insights of the theory in a more
  specific contextual setting.
• Economic principle - A commonly held economic
  insight stated as a law or a general assumption.

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Building and Testing a TheorySteps 1-3

• Decide on what it is you want to explain or
  predict.
• Identify the variables that you believe are
  important to what you want to explain or predict.
• State the assumptions of the theory.
• Ceteris Paribus - A Latin term meaning all
  things held constant.
• Econometrics - the social science in which the
  tools of economic theory, mathematics,and
  statistical inference are applied to the analysis
  of economic phenomena.

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Building and Testing a TheorySteps 4-7

• 4. State the hypothesis
• Test the theory by comparing its predictions
  against real-world events.
• If the evidence supports the theory, then no
  further actions is necessary.
• If the evidence rejects the theory, then
• conclude the theory is incorrect.
• conclude the data is inadequate.

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Positive vs. Normative Economics

• Economic policy - An action (or inaction) taken,
  usually by government, to influence economic
  events.
• Positive economics - The study of what is and how
  the economy functions.
• Normative economics - The study of what the goals
  of the economy should be.
• Art of economics - the application of the
  knowledge learned in positive economics to the
  achievement of the goals one has determined in
  normative economics.