Economics is the study of

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Economics is the study of human behaviour in
attempting to use scarce resources to satisfy
unlimited wants.
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Economics is a science resting on the postulate
of selfishness/maximizing self-interest to
explain human behaviour (notes p. 1)
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Science

• Belief events do not happen accidentally, but
  follow some universal rules patterns. If
  conditions are duplicated, so too will be the
  outcome.
• Aim to establish these universal rules so that
  we are able to explain to predict the
  occurrence of similar events in the future.

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Economics is a social science

• Basic unit of study individual
• Belief an individual makes his own choice his
  behaviour follow certain rules or some
  predictable patterns.
• Aim to explain or predict an individuals choice
  and the consequent behaviour.

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Positive Normative Economics
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1.1.1 Positive statement vs. Normative statement
Identify the differences between the following
two statements.
1. The unemployment rate was 3 in 1997.
2. The unemployment rate should be 0.
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1. Positive statements

• describe, explain and predict something.
• says nothing about whether the consequences are
  good or bad, or about what we should do.
• can be tested by an appeal to facts.

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2. Normative statements

• about what ought to be (should be), or about what
  a person, organization, or nation ought to do
  (should do).
• depend on your values or preferences.

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Questions (Textbook p. 17)

• Restrictions on drug selling are needed to
  protect the health of patients.
• Restrictions on drug selling will lead to higher
  prices of drugs.
• A higher tax imposed on cigarette can discourage
  its consumption.
• Consumption of cigarette should be discouraged to
  improve peoples health.

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Questions Answers

• Restrictions on drug selling are needed to
  protect the health of patients. (N)
• Restrictions on drug selling will lead to higher
  prices of drugs. (P)
• A higher tax imposed on cigarette can discourage
  its consumption. (P)
• Consumption of cigarette should be discouraged to
  improve peoples health. (N)

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1. Positive Economics (Textbook p.10)

• explains and predicts economic phenomena.
• contains positive statements.
• tells us only what will happen under certain
  circumstances. (what is or what will be)
• e.g. If the supply of vegetables decreases, the
  price of vegetables will increase.

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1. Positive Economics

• nothing about whether the consequences are good
  or bad, or about what we should do.
• can be tested by an appeal to facts.

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2. Normative Economics

• makes statements about what ought to be (should
  be), or about what a person, organization, or
  nation ought to do (should do).
• depend on your values or preferences.
• e.g. the Hong Kong Govt must notice that
  unemployment is a more serious problem than
  deflation .

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Microeconomics versus Macroeconomics ( Wong
1999 14)

• Microeconomics
• The study of decision making undertaken by
  individuals (or households) and by firms
• Pollution
• Crime
• Health Care
• Education

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Microeconomicsversus Macroeconomics

• Macroeconomics
• The study of the behavior of the economy as a
  whole
• Inflation
• Taxes
• Unemployment

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Economic Theory (Wong 1999 29)
A theory is a set of statements (d, p, tc p)
that are systematically (logically) organized for
explaining predicting phenomena.
Observe the traffic congestion on a four-lane
highway. We often find that the car queues in
each lane is more or less the same in length. Why?
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Postulate Drivers are assumed to maximize the
value of their time (or minimize their travelling
time) the object to be maximized.
Test condition If the traffic congestion occurs
on a four-lane highway,
Implication

• Consequent event then drivers in the longer
  queue will turn to join the shorter one.
  Eventually, the queue of cars in each lane is
  more or less the same in length.
• Conditional sentence

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Example
Postulate Drivers are assumed to be
wealth-maximizers.
Test condition If the fine for illegal parking
increases from 320 to 1,000,
Implication
Consequent event then the number of illegal
parking will decrease.
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1. Considering the school environment, such as
school regulation, canteen facilities, school
library services so on, construct 2 sets of
theory (a postulate, state the test condition and
predict the possible outcomes). 2. Are drug
trafficking committing suicide constrained
maximisation behaviour? (Deadline 11/9)
Homework Question
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Postulate Students maximize their self-interests.
Test condition As the price of a set lunch in
canteen increases from 15 to 20,
Consequent event the number of students going
out for lunch will increase.
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Mistakes for Homework 1 Q.2 Most of you think
any behaviour based on economic principles are
maximizing their self-interest, including You
are scolded by me / I hit you / You bite me /
Rape / Killing someone / Hurting yourself ARE
THESE REALLY RATIONAL, NOT MAKING YOURSELF WORSE
OFF? REMEMBER YOU WILL LIVE FOR ABOUT 63 MORE
YEARS!! Constraints? Accordingly, anything could
happen based on the postulate of constrained
maximisation!!!!! Such a postulate could make any
implications! Is it useful? Think of the
constraints? Define constrained maximisation!
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The process of constructing an economic theory or
model
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The process of testing an economic theory or model
Implications predictions are refuted by
evidence, the theory is amended or discarded.
Implications predictions tested against
evidence
Implications predictions are not refuted
(confirmed) by evidence
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Definitions and assumptions
Logical deduction
Implications and predictions are refuted by
evidence, and the theory is amended or discarded.
Implications and predictions
Implications and predictions tested against
evidence
If implications and predictions are supported by
evidence, the theory is confirmed.
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Economics as a Science

• Economics is an empirical science.
• Real-world data is used to evaluate the
  usefulness of a model.
• Models are useful if they predict economic
  phenomena.
• Economic models predict how people react, not how
  they think.

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Economic Science

• Model, Theory, Reality
• Model is abstract, like the TV weather map.
• Reality is the facts/problems to be
  understood--will it snow today?
• Theory is the link between the model and
  reality--by using a weather map and the equations
  that lie behind it (a model), meteorologists can
  predict when it will snow (reality).

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The Economic PersonRational Self-Interest

• It is not from the benevolence of the butcher,
  the brewer, or the baker that we expect our
  dinner, but from the regard to their own
  interest.
• Adam Smith, An Inquiry into the Nature and
  Causes of the Wealth of Nations, 1776

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The Economic PersonRational Self-Interest

• Economists assume that people make choices in
  their own self-interest and in a rational manner.

• Rationality Assumption
• The assumption that people do not intentionally
  make decisions that would leave them worse off

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Rational people think at the margin.

• Marginal changes are small, incremental
  adjustments to an existing plan of action.

People make decisions by comparing costs and
benefits at the margin.
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The Economist as a Scientist

• The economic way of thinking . . .
• Involves thinking analytically and objectively.
• Makes use of the scientific method.

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The Scientific Method

• Uses abstract models to help explain how a
  complex, real world operates.
• Develops theories, collects, and analyzes data to
  prove the theories.

Observation, Theory and More Observation!
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What is theScientific Method?

• Problem identification
• Model development
• Testing a theory

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Identify the problem
Develop a model basedon simplified assumptions
Collect data andtest the model
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Attributes of a Useful Economic Theory (notes p.
2)

• a. It comes from a simplified version of the real
  world
• b. Assumptions may be unrealistic.
• E.g. Exchange two persons, two goods
• E.g. Law of demand other things being constant
• Note The value of a theory is not judged by its
  realistic assumptions but by its ability to
  explain to predict events. (Lam 1996 11)
• c. The arguments must be logically consistent or
  valid with axioms or postulates.

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Attributes of a Useful Economic Theory

• d. Implications and predictions must be testable.
  
• e. The theory is potentially refutable by facts
  (not tautological).
• f. Variables in the theory must be observable.
  Tastes are not observable.
• g. The power to generalize

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Tautology

• always true by definition
• can never be refuted
• e.g. 1 1 2
• e.g. A four-legged animal has four legs.
• tells us nothing about WHY.

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Which of the following is a refutable statement?
(1) An increase in the number of university
graduates will drive up the market wage rate.
(2) When an individuals preference changes, his
consumption behaviour also changes.
A. (1) only
B. (2) only
C. None of the above
D. All of the above
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Attributes of a Useful Economic Theory

• h. Great predictive power, NOT forecasting power
• Prediction
• e.g. derived from a theory
• If given conditions are met, certain events will
  happen
• Forecast
• got from observing trend of past events
• e.g. forecast of typhoon

1.1.3 Logical nature of a testable (or refutable)
hypothesis P.2
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1.2.1.1 Wants, Scarcity, Choice and Opportunity
Cost ( Wong 1999 3)
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Wants

• human desires for various goods and services
• physical and psychological needs
• when a particular want has been satisfied, new
  wants will emerge.
• unlimited

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Scarcity

• the situation in which the limited resources
  available are insufficient to satisfy unlimited
  wants
• a universal phenomenon

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Choice and Cost( Wong 1999 7)
Unlimited wants
Limited resources
Scarcity
Choice
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You have four choices of how to spend a Saturday
night.
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Which option will you choose? Why?
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What is the cost of choosing the above option?
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Choice and Cost
Unlimited wants
Limited resources
Scarcity
Choice
Chosen option (the highest valued option)
Cost (the highest-valued option forgone)
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1.2.1.2 Fundamental problems in Economics (Wong
1999 13)
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1. Problems in allocating resources
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a. What to produce?

• What kind of goods and services to be produced?
• What quantity is to be produced?

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b. How to produce?

• what method of production is used?
• choose the least costly method of production

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2. Problems in distribution of goods and services
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c. For whom to produce?

• the choice of the distribution of goods and
  services among the people in the economy
• More gt Notes P.3 gt dgtg

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1.2.2 Scarcity, Competition Discrimination
(Wong 1999 4-5)
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Society more than one person
Scarcity
Competition
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Competition

• the process by which conflicts of interests among
  the members of a society due to scarcity is
  resolved
• inevitable in a society
• exists in every society, whether it is capitalist
  or socialist

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Types of Competition
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Price competition

• prevails in free market economy where most of the
  property is privately owned and can be freely
  exchanged.
• people who are willing and able to pay the market
  price will get the thing they want
• e.g. an auction market

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Non-price competition

• all forms of competition, other than that of
  price
• e.g. violence, first-come, first served,
  height, beauty, ...

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Competition and Discrimination
Scarcity
Society
Competition
Discrimination
Winner
Loser
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Competition and Discrimination

• The aim of competition is to determine winners
  and losers. All forms of competition is
  discriminatory (separate the winners losers).
• Each form of competition favours certain kinds of
  people while discriminating against others.

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Determine the discriminating criteria type of
competition for the following events.
Price/Non-price competition
Events
Discriminating criteria
1. A studying place in SKHLKYSS
HKCEE result, conduct
Non-price
2. Mr. HK
Appearance, physique,...
Non-price
3. An auction for lucky number
Ability to pay
Price
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Determine the discriminating criteria type of
competition for the following events.
Price/Non-price competition
Events
Discriminating criteria
4. Govt clinic
Time
Non-price
5. Govt subsidized place for the aged
Family background, financial situation, age, ...
Non-price
6. Singing contest
Voice, musical ability, style, ...
Non-price
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Scarcity, competition discrimination are
interrelated to one another in a society.
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2nd Homework Assignment

• Universities in Hong Kong discriminate against
  students with poor grades when they apply for
  admission. Discrimination can be avoided if
  admission is not based on exam results. Do you
  agree with this statement? Explain your answer.
  (8 marks)
• Deadline 23rd September, 02

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1.2.3 Free Good and Economic Good
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What is a good?

• Any desired entity or object
• something which some is preferred to none
• tangible and intangible

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Economic or scarce good

• one whose supply is insufficient to satisfy all
  human wants for it
• any entity or object which a person cannot have
  as much as he or she would like
• something which more is preferred to less
• costs are incurred in obtaining economic goods.

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P
S1
P1
D
S1
A
Q
0
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Free good

• one whose supply is so abundant that it can
  satisfy all human wants for it
• any entity or object which a person has as much
  as he or she desires
• no one wants more of a free good, because
  everyone is satisfied with the amount he or she
  has.
• no one is willing to incur a cost for free goods.

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P
S2
D
S2
A
0
Q
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It is because the quantity available is less
than we want.
Besides, we have to use resources to provide
education. There is a cost of providing it.
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1.2.4 Production Possibility Curve
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a. Assumptions of PPC

• A country produces only two goods.
• Resources available are given.
• Technology is given.

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a. The definition of PPC

• shows all combinations of two goods that a
  country can produce, given the resources and the
  best technology available.

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a. The construction of PPC
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Good Y
Production possibility curve
5 4 3 2 1
PPC
0
Good X
1
2
3
4
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b. The use of PPC

• Wants
• Scarcity
• Choice
• Cost

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Find the cost of producing an additional unit of
gun
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The cost of producing an additional unit of gun
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c. The shape of PPC
Slope of PPC Opportunity cost
Increasing cost of producing each extra unit of
gun

• increasing slope of PPC
• ? getting steeper from L to R

? concave to the origin
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The Law of Increasing (Relative) Costs
Figure 2-3
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Opportunity Cost and Marginal Cost
Increasing opportunity cost of tapes...
15
10
Soda (millions of bottles per month)
5
0 1 2 3 4 5
0 1 2 3 4 5
Tapes (millions per month)
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Opportunity Cost and Marginal Cost
MC
means increasing marginal cost of tapes.
5
4
3
Soda (millions of bottles per month)
2
1
0 1 2 3 4 5
Tapes (millions per month)
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Figure 2-1
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Efficiency in production
Inefficient production
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d. Economic growth
Relax assumptions of fixed resource
technology. Allowing an increase in the resources
available or/and an improvement in the technology
? production of guns butter ?
? economic growth
? PPC shifts outwards (or to the right)
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The Scope of Economic Analysis
Good Y
PPC
0
Good X
Figure 4 Shifting of the production possibility
curve
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1.3.1a. What is Utility?

• The want-satisfying power of a good or service
  (Miller)
• a numerical ranking of a consumer's preferences
  among different commodity bundles (Ruffin
  Gregory).
• a numerical value that reflects the relative
  rankings of various bundles of goods (Perloff).

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• 1.3.1d. Wealth is the total value of a person's
  accumulated savings plus the discounted present
  value of that person's expected future labor
  income (Stockman).
• stock of assets owned (Miller)
• value of all the things that people own (Parkin)

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1.3.1e. Income is the value of money and goods
that a person receives during some time period.
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1.3.1f. Basic assumptions again

• Consumers are utility maximisers? Utility
  maximization is an assumption that people try to
  achieve the highest level of utility given their
  budgetconstraint (Taylor).
• Producers are either income or wealth maximisers
• Having more wealth/income enables people to
  consume more satisfy more wants.

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1.3.2 Importance of the postulate of maximisation

• All economic theories are built on the
  constrained maximisation (self-interest) axiom.
• In the real world, it doesnt matter whether or
  not people try to maximise.
• Fallacy of denying the antecedent(s) claim that
  A is not true and by implication that B is
  also not true.
• Milton Friedman never question the assumptions

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1.3.2 Importance of the postulate of maximisation

• behaviour of survivors tends to approximate
  maximising decision, i.e., principle of
  survivorship
• Examples of survival principle plant evolution
  adaption to environment
• In conclusion, maximisation implication axiom is
  helpful in economic thinking, but it is not a
  necessary one

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1.3.3.1 The If A, then B prediction
If (A) true, then (B) true valid Then false gt
if false valid Then true gt if true invalid
FAC If false, then false invalid FDA e.g. If
people are utility maximisers, ... e.g. gravity
animal motion
B with clouds
A raining
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1.3.3.2 Saying that a person maximises utility
may seem to be a camouflage for our ignorance
Utility 50 Utility 50 Cost 30
constraint Cost 60 constraint Prediction
there is a lower chance that people will jump
into a raging current to save life (refutable
implication)
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Conclusion The World is bigger than Economics.
You may apply economic theory into the real
world, but not to fit everything into Economics.
Read Cheung et al. (1989) Ch.1
The World
Economics