The Road Ahead

Readers of this blog: I’ve finally finished applying to PhD programs and can devote the time this blog needs.

Previously, I’ve posted a few simple, introductory notes to give an overview of some of the basic concepts of economics.  I have a few more introductory slides left, but after that, the blog will change rather abruptly.

Economics is largely an exercise in making mathematical models.  To help you understand and evaluate these models, as well as make some of your own, I will spend considerable time on mathematics and statistics.  You will learn about mathematical proofs and develop the habit of wanting to see one for each new mathematical claim.  You will learn everything I am able to teach about statistical methods and data analysis.  After this, we can cover economic models in great depth, all the while evaluating their accuracy and the situations to which they apply.

 

A word of warning: When I say I will “spend considerable time on mathematics,” I really mean it.  There will be a lot of math, and some of it is rather advanced.

Don’t worry, though–you will not be forced to memorize arcane rituals and recite them on an exam.  I will try to present the concepts as comprehensibly as I can, with links to other sources.  You might find this blog a complement to college math–each one makes the other easier and more enjoyable.

Done well, math can be a lot of fun.  If you were not “good at math” in high school, or if you did not enjoy it, you’re in good company–mathematicians often have similar complaints.  To show you another possibility, hopefully more enjoyable, I will link you to the YouTube channel Numberphile, which gives lively explanations to many mathematical puzzles.

https://www.youtube.com/user/numberphile

 

An Incomplete List of Specialties Within Economics

Some academic specialties, grouped by subject matter:

Related to firms:

–Industrial organization:  IO deals with the profit-maximization problem of the firm.  In particular, IO deals with the firm’s strategy in interacting with the market.  IO researchers study things like estimating market demand, types of competition between firms (especially the tremendous complexities possible in imperfect competition), limited information, barriers to entry, capacity constraints, etc.  Industrial organization also deals with the firm’s response to public policies such as regulation.  Even more than other areas of economics, IO makes extensive use of game theory.  The findings of the field are useful to corporate management, of course, but also to academics seeking to characterize markets and to regulators seeking to anticipate and prevent unintended consequences and perverse incentives from regulation.

–Operations research / operations management: Likewise concerned with profit maximization by firms.  Whereas IO deals more with outward-facing strategy—how the firm interacts with the market—OR, by contrast, is more focused on the internal Continue reading

Core Fields of Economics

Every student of economics is required to study these fields, at a level appropriate to the degree they are pursuing, before they can graduate.  At the PhD level, there is typically a core exam to assess the student’s proficiency in the core subjects, which the student must pass to receive their degree.  In subsequent posts to this blog, I will describe the fundamental theories of the core fields in some detail, complete with mathematical notation and figures.

1) Microeconomics, also called economic theory.

The basic principles of economics: What are consumers, and how do they behave?  Same question for firms and markets.  Conceptual and mathematical tools for the analysis of firms, consumers, markets, trade, and strategy.  Game theory and its applications in economics.  Incorporating the findings of economic specialties into the central framework.

2) Econometrics.

The intersection of economics with mathematical statistics.  Econometricians study the methods of data analysis, techniques for regressions and estimation, as well as causal inference.  They especially emphasize the use of data easily available to economists (surveys, censuses, market research, occasionally experiments in a lab or in collaboration with an external organization) to answer questions of interest to economists, such as the generating process for income, the returns to education, or a method for estimating the demand curve for any good.  Econometricians develop methods to deal with some of the difficulties faced by economic research—the processes we’re interested in are complicated, heterogeneous, and depend on many unobservable factors; it’s often not feasible to conduct the experiments we would like, but some information can be obtained by investigating natural data, etc.  It’s trivial to find statistical relationships in the data (correlations, conditional means, best-fit lines etc), and in a large random sample, these indicate similar relationships in the population.  To find causal effects, ideally you would run an experiment with a treatment group and a control group; however, it is not always feasible or ethical to experimentally find things like whether depriving a person of education reduces their lifetime earnings; and experiments on the macroeconomy (would the USA have been better or worse off without the stimulus?) are often impossible.  Even so, Continue reading

Overview of Economics

What is economics?
[Figure 1: diagram of economy]

BookScanCenter economy diagram

General definition:
Economics is the study of the efficient, strategic use of limited resources. For consumers, this means deciding strategically how much to spend and what to spend it on, how much to save, and how much to work. (Etymologically, the word “economics” comes from the Greek “oikonomika,” meaning the management of the household—so the “consumer theory” sense of the word is the oldest.) For producers, it means deciding how much to produce, how to produce it, and at what price to sell it.
Economists typically model producers and consumers as rational agents, each solving an optimization problem that can be represented mathematically.

Consumers:
A consumer is a person (or sometimes a group or organization) who buys and uses goods and services.
Consumer’s objective: maximize “utility” within choice set, constrained by budget.
Result of consumer optimization:
1) A “demand function” for goods, describing the quantity of each good this consumer would buy, as a function of prices.
2) “Labor supply”—how many hours would this consumer want to work, as a function of wages.

Details: Consumers have preferences over bundles of goods and services that they can consume. Economists model the consumer’s preferences mathematically in terms of a “utility function,” that maps more-preferred outcomes to higher utilities. Consumer choice is modeled as a constrained maximization problem, in which a consumer finds the vector of goods that maximizes their utility subject to a budget constraint. Traditionally, economists assume that consumer choice is “rational,” ie that for any consumer, there exists a function U() such that the consumer always chooses the set of goods (from within the choice set) that maximizes the function U(). In this course, we will discuss the postulates that must be satisfied by such a function. In general terms, though, “rational” behavior requires both certain conditions on the preferences themselves, to avoid circular/self-contradicting/otherwise paradoxical preferences; as well as strategic behavior which is consistent with these preferences.
If I have time, I may eventually cover behavioral economics. Real consumer preferences are known to be only imperfectly rational, and behavioral econ tries to use this knowledge to generate a more psychologically-realistic consumer theory. However, developing functions that behave like humans is quite difficult (and would probably be a triumph in the field of artificial intelligence), and many economists continue to use the classical assumptions of rationality: even if we know the theory is an imperfect approximation of consumer choice, it still describes a sound strategy—and in fact, sophisticated consumers may choose to act in accordance with theory.

Firms:
A firm (also called a business) is an organization that produces or trades goods. Firms acquire money (revenue) by selling the goods they produce, but they also incur costs by buying inputs (labor, capital, land, materials, etc). Firms are owned by one or more consumers, who may be sole proprietors, partners, shareholders in a corporation, etc. The firm strategically maximizes its profits, which benefits its owners by relaxing their budget constraints (ie giving them more money).
Economists often speak of “producers,” and the branch of microeconomics that describes firms is called “producer theory.” Technically a producer is any person, organization, or entity that produces goods, but most producers are firms. Even if a good is produced by a single individual, that individual must still maximize their profits from production, so we often use “producer” and “firm” interchangeably to refer to someone who produces goods and sells them with the intent of maximizing profit.
Firm’s objective: Maximize profit.
Result of firm optimization: “Supply function” of goods, describing the quantity of goods produced as a function of market price.

Market:
Goods (or services, labor, bonds, or any other traded thing) are traded in a market. Historically this could refer to an actual place, but now when we speak of the “market for X,” we refer to the sum total of everyone who is buying or selling X.