Chapter 1: Introduction

Wei HUANG
CUHK Business School
Economics for Business Studies I
DSME 1030 Fall 2023
 Outline

• What is economics?

• How to think like an economist?

• Why do we study economics?

 The Scope of Economics

• Economics is the study of how agents choose to allocate

scarce resources and how those choices affect society.
• Positive economics
• What people actually do
• Normative economics
• What people ought to do
The Scope of Economics
 Microeconomics and Macroeconomics

• Microeconomics focuses on the individual parts of the

economy.
• How households and firms make decisions and how they
interact in specific markets
• Macroeconomics looks at the economy as a whole.
• Economy-wide phenomena, including inflation, unemployment,
and economic growth
 Ten Principles of Economics
• How People Make Decisions
交
• People face tradeoffs. defi ,
• The cost of something is what you give up to get it.
。• Rational people think at the margin.
• 激勵
People respond to incentives.
From
• How People Interact Micro
交易
• Trade can make everyone better off. To
• Markets are usually a good way to organize economic activity. Macro
• Governments can sometimes improve economic outcomes.
• How the Economy as a Whole Works
• The standard of living depends on a country’s production.
• Prices rise when the government prints too much money.
• Society faces a short-run tradeoff between inflation and unemployment.
 Principle 1: People Face Tradeoffs.
“There is no such thing as a free lunch!”
• To get one thing, we usually have to give up another thing.
• Guns v. butter (scarce income)
• Food v. clothing (scarce income)
• Leisure time v. work (scarce time)
• Efficiency v. equity (scarce public resource)
• Good memory v. bad memory (scarce memory)
• Making decisions requires trading off one goal against another.
 Principle 2: The Cost of Something Is What You
, Give up to Get It.

• Decisions require comparing costs and benefits of 成本 t 好處

alternatives.
• Whether to go to college or to work?
• Whether to study or go out on a date?
• Whether to go to class or sleep in?
機會成本 ie 所犧牲的代價
.

• The opportunity cost of an item is what you give up to

obtain that item. ag part ime > 讀書≥ hall life
.
-

v x X

opportunity ost :

譸
 Principle 3: 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.
• The “marginal revolution” marked the beginning of the
period of neoclassical economics.
 Many Apples a Day Keep the Blues Away

Apple
Number 0 1 2 3 4
Happiness 0 5 8 10 11

Suppose the cost of an apple is 2.5, how many

apples should Bob eat?
 Principle 4: People Respond to Incentives.

• Marginal changes in costs or benefits motivate people to

respond.
• The decision to choose one alternative over another
occurs when that alternative’s marginal benefits exceed
its marginal costs!
• Example: how does a seat belt law affect auto safety?
• Example: how does financial insurance affect financial security?
 Principle 5: Trade Can Make Everyone Better Off.

• People gain from their ability to trade with one another.

• Competition results in gains from trading.
• Trade allows people to specialize in what they do best.
• Absolute advantage vs comparative advantage
 Principle 6: Markets Are Usually a Good Way to
Organize Economics Activity.
• A market economy is an economy that allocates resources
through the decentralized decisions of many firms and
households as they interact in markets for goods and
services.
• Households decide what to buy and who to work for.
• Firms decide who to hire and what to produce.
 Principle 6: Markets Are Usually a Good Way to
Organize Economics Activity.
• Adam Smith made the observation that households and firms
interacting in markets act as if guided by an “invisible hand”.
• Because households and firms look at prices when deciding what to
buy and sell, they unknowingly take into account the social costs of
their actions.
• As a result, prices guide decision makers to reach outcomes that tend
to maximize the welfare of society as a whole.
 Principle 7: Governments Can Sometimes
Improve Market Outcomes.
• Market failure occurs when the market fails to allocate
resources efficiently.
• When the market fails (breaks down) government can
intervene to promote efficiency and equity.
• Market failure may be caused by
• an externality, which is the impact of one person or firm’s actions on
the well-being of a bystander.
• market power, which is the ability of a single person or firm to
unduly influence market prices.
• The invisible hand is even less able to ensure that economic
prosperity is distributed fairly.
 Principle 7: Governments Can Sometimes Improve
Market Outcomes.
• An example of externality: a group of fishermen and a chemical factory
are competing for a stream. The factory is in upstream and the
fishermen are in downstream. If the factory is allowed to produce, its
product yields a profit, but it kills all the fish. If the factory does not
operate, the fishmen gain from fishing. How to solve the problem?
 Principle 8: The Standard of Living Depends
on a Country’s Production.
• Standard of living may be measured in different ways:
• By comparing personal incomes.
• By comparing the total market value of a nation’s production.
• Almost all variations in living standards are explained by
differences in countries’ productivities.
• Productivity is the amount of goods and services produced
from each hour of a worker’s time.
 Principle 9: Prices Rise When the Government
Prints Too Much Money.

• Inflation is an increase in the overall level of prices in the

economy.
• One cause of inflation is the growth in the quantity of
money.
• When the government creates large quantities of money,
the value of the money falls.
 Principle 10: Society Faces a Short-run Tradeoff
Between Inflation and Unemployment.
• The Phillips Curve illustrates the tradeoff between inflation and
unemployment:
Inflation  Unemployment
It’s a short-run tradeoff!
 Scientific Method (Galileo Galilei)
• Explain the observed phenomena in a reproducible way.
• Develop models of the world
• A model is a simplified description, or representation, of the world.
• All scientific models make predictions.
• Test those models with data—evaluating the match between
the models and the data
• The predictions can be checked with data—facts, measurements, or
statistics that describe the world.
• Economists practice empiricism by using data to create empirical
evidence.
 Three Principles of Economics
• Optimization
• All choices are tied together by optimization.
• Equilibrium
• The economic system is in equilibrium when each agent feels that he
or she cannot do any better by picking another course of action.
• Empiricism
• Empiricism is analysis that uses data or analysis that is evidence-
based.
 Optimization

• Economic agents try to optimize, meaning that

economic agents try to choose the best feasible
option, given the information that they have.
• Trade-off
• Budget constraint
• Opportunity cost
• Cost-benefit analysis
 Constrained Optimization
Apple Banana
Number 0 1 2 3 4 0 1 2 3 4
Happiness 0 5 8 10 11 0 6 9 11 12

• Suppose the costs of an apple and a

banana are both 1, and Bob’s income is
4. How many apples and bananas
should Bob purchase?
 Equilibrium

In equilibrium, everyone is simultaneously optimizing, so nobody would benefit by

changing his or her own behavior.
 Empiricism
• The economic way of thinking . . .
• Involves thinking analytically and objectively.
• Makes use of the scientific method.

• The scientific method: observation, theory, and more observation.

• Uses abstract models to help explain how a complex, real world operates.
• Develops theories, collects, and analyzes data to evaluate the theories.
確立因果關得的
Aim : Empiricism
• Economists use data to determine whether our theories about human
behavior match up with actual human behavior.
• Causality and Correlation
• Causality: one thing directly affects another 因 果
• Correlation: a mutual relationship between two things (positive, negative, zero)
• If we observe a positive correlation between education level and income level,
can we conclude that high education leads to high salary? NO
• If we observe a positive correlation between income level and health直接有因果
level, can
X
we conclude that high income leads to good health? NO ~
• When Correlation Does Not Imply Causality 教育⽔平V 海收入⽔平
•
道漏量逆向因果你
Omitted Variable and Reverse Causality
&

存在烤量量ag ⼯作經驗技能
 Empiricism

• Economic Experiment
• Experiment is a controlled method of investigating causal
relationships among variables
• Lab Experiment
• Field Experiment
• Natural Experiment
 Lab Experiment

• Random assignment of subjects

• Incentivized experiment
• Target variable can be controlled
• Enables causal inference
 Field Experiment

• Random assignment of subjects

• Incentive in the real life
• Target variable can be controlled
• Enables causal inference
 Natural Experiment
• Assignments of subjects are exogenously determined by nature
• Incentive in the real life
• Target variable can not be controlled
• Enables causal inference
 Why do we study economics?
• Make you a more astute participant in the economy.
• Understand the economic insights of human society, human behavior,
and economic policies.
• Provide theoretical and methodological foundation for the other
subjects in business school.

This is where our journey begins…