Introduction to Summer Study

June 10, 2013

Over the course of my experience with education I have struggled over and over with motivation and procrastination. This summer I have decided to prove to myself that I can overcome these issue by writing a daily blog that reviews all of my economic studies starting at first year. I am looking to not only post notes from my studies but also discuss what I think of them as well as find interesting issues that are happening and attempt to discuss them within an economic framework. I welcome insight from other people as well as any corrections that need to be made. I am not perfect and this is meant as a learning opportunity. As such, I will make mistakes and I always appreciate constructive feedback.

I am starting with first year microeconomics and am using the textbook “Economic Principles: Seven Ideas for Thinking about Almost Anything” by Douglas Allen. I am using this textbook for two reasons, the first is that it was what I used in my first year course and the second is because I have it readily available to me. While I do not always completely agree with everything that is stated in the textbook it will serve as an outline to follow as I work my way through the material. I will try to discuss two chapters a day from the textbook, although today I will be starting with the first three as the first chapter is short and just an introduction to economics as a course of study. Towards the end of the textbook I may slow down depending on how much time I want to take with each economic concept in order to completely understand it for myself.

The discussion today will focus on what Professor Allen calls the first two principles of economics, maximization and substitution. In addition to that, there will be some discussion of what economics actually is as well as the ideas that go along with both maximization and substitution. As this is looking at the ideas through the first year course, a lot of these concepts will be greatly simplified.

To start off with I will talk about what economics actually is. The textbook defines economics as “A particular way of thinking about behavior.” I find this interesting as most textbooks define economics as the study of allocation of scarce resources. The textbook definition defends this by arguing that how people allocate scarce resources is their behavior and so both definitions are the same. While I find this convincing, I feel that the textbook definition is much too general as it could apply to any of the social sciences and many fields of study outside of that. As such, for myself, I will stick to the classic definition of economics as the study of scarce resources.

In order to talk about scarce resources I will have to define scarcity. Scarcity is when if a goods price is set to zero, in other words it is free, more will be desired than what is available. Scarcity is what forces us to make choices as if goods were not scarce we would not have to choose between them. It also forces prices to be positive (above zero) and as such is a core idea in economics.

To illustrate that it forces prices to be above zero, imagine the following scenario. Two people want one item, lets say a mug. The mug is being given away by a third person so who gets the mug? What would normally happen is person 1 would say I will give you $1 for the mug. In response person 2 would say I will give you $2. This will continue on until the price of the mug is equal to the value for the person who wants it the most. In this way scarcity makes prices positive.

In order for economists to study what they wish to, like many other areas, they make models. An economic model should satisfy four general criteria.

1. It should be formal, that is it should be clear about its assumptions.

2. It should be testable, in other words, it should be able to be proven wrong.

3. It should be simple and have a clear purpose.

4. Finally, it should hold consistent to the general facts about the world.

One of the key necessities in economic models for simplicity’s sake is that we make assumptions about the world.

One of the main assumptions that economics makes is that people are fundamentally the same. This is not the same as saying the people are all identical in all aspects but instead is just saying that people primarily want the same things. Around the world people want food and shelter, good health and security, and in general a better life for their children. There are other things as well that people all have similar motivations for.

Another assumption that economics makes has to do with the first principle in the textbook, that of maximization. According to the textbook maximization is the idea that “all individuals are motivated by greed.” Greed and self-interest are the same thing according to the textbook and as such any economist who says that individuals are self-interested is really just saying that people are greedy. I disagree with this statement though and to show what I mean I will give the definitions of both words from the Merriam-Webster dictionary. According to the dictionary greed is defined as a selfish and excessive desire for more of something than is needed. Self-interest however is defined as a concern for one’s of advantage and well-being. I believe that this second idea is much closer to what economists believe. Most definitions about greed define it as being excessive or abnormal whereas self-interest does not. As the textbook itself says more is not always better. So for my own purposes I will define maximization as the idea that all individuals are motivated by their own self-interest.

When both firms and individuals follow the idea of maximization we end up in an equilibrium. In economics an equilibrium is a situation in which no one wants to change their behavior. This is defined as people at equilibrium are indifferent. Indifferent according to the textbook is defined as “letting someone choose for you.” While this works as a general understanding of indifference it is not really a strict definition and so I am not a big fan of this definition. In economics indifference means that an individual receives the same utility between all of the options. In this sense someone could choose any of them for you and you would receive the same amount of utility as if they had chosen any other option. Utility in economics is a representation of preferences over some set of goods and services. It is the idea that you receive satisfaction from these things.

In order for a person to be indifferent they are required to have a choice. In economics substitution is the idea that everyone is willing to trade some amount of good for some amount of another. In other words people are willing to substitute one good for another. Substitution does not specify quantities it just says that there is some quantity that one would be willing to trade at even if it is very high.

People use substitution in order to trade-off quantities of one good for quantities of another. This way you can get different bundles of goods in order to maximize your utility. In order to trade there has to be a difference between the marginal values of the people involved.

Marginal value is the maximum amount of one good an individual is willing to sacrifice in order to obtain one additional unit of another good. Without marginal value we could not have trade. Some misconceptions that are often stated are that trade always involves one party with a surplus and that trade involves exchanging items of equal value. While trade can involve people with a surplus it does not need to. As for items of equal value, that would make trade very difficult as if people view what they are giving away as having the exact same value as what they are getting that will make them indifferent to the trade and as such they will have no incentive to participate it in. Instead what happens is that people with differing marginal values get together and so are able to trade with each other.

Economics textbooks tend to use the example of two people with two goods and so I will give an example here. We have two people Mark and Suzie and they have apples and oranges in differing quantities:

Mark	Suzie
3 apples, 12 oranges	6 apples, 6 oranges
4 apples, 7 oranges	7 apples, 4 oranges
5 apples, 3 oranges	8 apples, 3 oranges

Each person has three bundles which they are indifferent about, in other words they don’t care which bundle they have. These bundles are just given to them and they are able to get any of these bundles without trading with each other.

If we say that each person has the middle bundle then we can see how they can be made better off through trade. Mark will have 4 apples and 7 oranges and he is willing to trade 4 more oranges for 1 apple. This means that the apple has a marginal value of 4. Suzie meanwhile is willing to trade 1 apple for 2 oranges. So the apple to her only has a marginal value of 2.

If Mark gives Suzie 3 oranges and she gives him 1 apple, both of them are made better off than if they had not traded as Mark ends up with 5 apples and 4 oranges and Suzie ends up with 6 apples and 7 oranges. This demonstrates how voluntary trade can be mutually beneficial.

According to the textbook voluntary trade is mutually beneficial to all parties involved and I believe that this is a key concept that I want to talk about for a little bit. The key concept here is that the trade must be voluntary. There are situations where people are involved in a trade between third parties and as such have no say, in these cases the trade is not voluntary for those people and often the trade is not beneficial.

This is a summary of the talking points in the first three chapters of the textbook and I hope that I have explained and summarized it accurately. I will be posting again tomorrow about the next two chapters and will in the future hope to talk about other things such as economic books and what is going on in the news. Feedback is always appreciated.