Economics Past and Present

1. Economics Past and Present Lecture 0 – academic year 2013/14 Introduction to Economics Fabio Landini

2. Course outline Organizations: • Part I – Microeconomics (7 lectures) • Part II – Macroeconomics (9 lectures) + final session on the economic crisis Objective: Explain basic principles, concepts and methodologies of the discipline Classes will be both theoretical and applied (exercises and applications to real world problems) Exam: 1 exercise and 1 open question (like statistics)

3. (Brief) History of economic thought The study of economics is relatively new, having originated with capitalism (300 years ago) Before capitalism, economic activity was woven into family life and did not exist much outside of families. Markets were social meeting places, not just places to buy and sell.

4. (Brief) History of economic thought “Putting out system”

5. (Brief) History of economic thought “Market as a social place”

6. (Brief) History of economic thought Karl Polanyi (anthropologist): “pre-capitalist economy was embedded in society.”

7. (Brief) History of economic thought The emergence of capitalism (late 1700s – industrial revolution) brought in a Great Transformation (Polanyi): 1. Work began to take place outside of home in factories

8. (Brief) History of economic thought The emergence of capitalism (late 1700s – industrial revolution) brought in a Great Transformation: 2. Buying and selling became the main purpose of market

9. (Brief) History of economic thought The emergence of capitalism (late 1700s – industrial revolution) brought in a Great Transformation: 3. The pursuit of economic gain and progress became the main guiding principle of economic life – as opposed to custom or religion dictating it.

10. (Brief) History of economic thought In this new Era the birth of economics awaited only minds creative enough to sense the new realities. During the 18th and 19th century, a number of great thinkers/philosophers moved in this direction: Adam Smith, David Ricardo, Thomas Malthus, John Stuart Mill, Karl Marx

11. (Brief) History of economic thought Classical economists: markets as coordination device (Smith), importance of trade (Ricardo), capitalism as a conflictual system (Marx) -> Political Economy. More similar than sometimes argued: class conflict in Smith and praise of capitalism in Marx

12. (Brief) History of economic thought At the turn of the 20th century an intellectual revolution began to transform political economy into the science of economics. Critical in this switch was the importation of concepts from physics, which brought “economics” closer to natural sciences than to moral and political philosophy. Economics as the science of decisions, let’s take a closer look at it…..

13. The term economics . . . Comes from a Greek word (οικονομìα, si legge: oiconomìa) which means “management of a household”. To “manage” something, you must take decisions.

14. In a household/firm there are several decision that need to be taken… Who is going to work? Who is going to study? What and how much are we going to produce? Which resources are we going to use? At which price are we going to sell our products?

15. Scarcity, efficiency and management These decisions are easy if the resources are abundant (not scarce) On the contrary, if resources are scarce there exist a problem in their efficient use This generates a key links between scarcity and management / efficiency.

16. Summarizing… Economics is the study of the way in which society manages scarce resources. Problem: What is “society”? How can “society” manage scarce resources?

17. How does “society” take decisions ? Modern societies consists of many individuals. There is no single individual that decides for everybody… Economics explains: • How individuals take their decisions. • How individuals interact with each other. • The forces and tendencies that influence the economy as a whole. • A e B: subject of Microeconomics (Part 1). • C: subject of Macroeconomics (Part 2).

18. The seven principles of microeconomics Microeconomics con be condensed in 7 principles (N.G. Mankiw) 4 principles concerns point A, i.e. individual decisions The other 3 concerns point B, i.e. interactions among individuals.

19. 1. People face tradeoffs “To obtain something you are usually forced to give up something else.” Principle 1 derives from resource scarcity. Examples: • “Butter” (consumption) or “guns” (defence). • Work and health (e.g. Ilva in Taranto) • Leisure or work. • Less obvious: Efficiency or equity.

20. 2. The cost of something is what you give up to get it. “While taking a decision, individuals compare costs and benefits of alternative actions”. What matters is the “opportunity cost”, not the monetary cost Opportunity cost is the value of the best alternative option that one is forced to give up in order to obtain a certain good.

21. Example: Is University enrolment a good investment in Italy? • Average taxes paid by undergraduate students during the first 4 years (data 2003-04): 2.178 euro. • Other direct expenses to follow classes and write exams: 3.273 . • Foregone income (comparison with non-Univ. students): 65.838. • Total expenses: 71.739. • Income differential for university degree (wit respect to non-Univ. students, computed during the first 40 years of activity): 134.000. • Value of university degree neat of its cost: (134.000-71.739) = 62.408 • Average annual return of university degree: 9,9 %. Source: Moro-Bisin, La laurea: un ottimo investimento, www.LaVoce.info, 24/10/2005.

22. 3. Rational people think at the margin. Marginal variations are small incremental Δ with respect to e given plan of action. People usually decides on the basis of costs and benefits at the margin, not average costs and benefit. Example: airline companies and “last minute” discount.

23. 4. People respond to incentives. Rational people “respond to incentives”, i.e. decide comparing marginal costs and benefits. An action is preferred to an alternative when: MB > MC (MB= Marginal benefits; MC = Marginal costs). Good to know for politicians and policy makers. Example: aid to all unemployed or only to those that carry out some qualification training?

24. 5. Trade can make everyone better off. People can obtain important benefits from the possibility to trade Trade favours individual specialization and thus improves efficiency. Therefore: trade specialization efficiency more trade.

25. 6. Markets are usually a good way to organize economic activity. Individuals and firms that operate in a competitive market are driven by an “invisible hand” towards the social optimum (Smith). Competition is not destructive, it is not a zero-sum game. Rather, it is beneficial – at least when there exist many sellers and many buyers.

26. 7. Governments can sometimes improve market outcomes. In the case of market failures, the government can intervene to promote efficiency and/or equity. Sometimes, however, there are also government failures: governments not always seek efficiency… in these cases privatisations can restore efficiency

27. Economics as a science Economics is a science (≅ biology, physics) because it relies on the scientific method Scientific method: • Abstract models (“theories”) to understand reality (e.g., supply & demand) • Collection and analysis of real data to verify the theories.

28. Economics as a SOCIAL science Economics is not really like biology or physics. Economics = Socialscience, its laboratory is society -> institutions (e.g. social norms, custom, culture) matter. However: it is impossible to do repeated tests as in a Lab. Therefore: it is difficult to “verify” economic theories.

29. Conclusions Economists relies on the scientific method (theoretical models + data analysis). However: economics is a social science. It is more difficult to obtain answers from data. Indeed (as we will see): often economists achieves different conclusions… e.g. debate on how to solve the current Euro crisis (more at the end of the course…)