Quote of the day

“I find economics increasingly satisfactory, and I think I am rather good at it.”– John Maynard Keynes

Wednesday 26 August 2015

Year 12 Introduction to Economics and Economic Theories.

This blog will be central to the course. You must subscribe to it, and in your account settings tick the box requesting emails when new material is posted. Posts will be a mixture of context - articles, columns and other news relating to current economic affairs (the examiners expect you to be up to date with current events); and content relating to the next lesson. These latter posts are mandatory reading, as they will contain source material that you must study prior to the lesson, in order that we can learn how to apply the material during the lesson.

You are not expected to understand every concept we study prior to the lessons on those concepts; you are expected to have read up from the text book, watched posted videos, and looked at online resources, all before the lesson. You should make notes in your folders from all these resources, and you should formulate any questions you have about the material and bring them to class.

By doing this work before the class there will be more time to explain and understand how concepts are applied, which will help your overall understanding of the best approach to your exams. So let's crack on:



What is Economics?



First, watch this video:







Most introductions to economics will highlight that it is the study of scarcity, although this is a little misleading; in truth, it is the study of how resources are allocated to meet "wants" (i.e. what people demand), and because people will always want more than can be supplied, some wants will remain unfulfilled. So you will study resource allocation, but this is not as simple as it sounds; there are numerous different elements to be considered:


            How prices and quantities of items are determined in market economies
            How much value markets create for society      
               How taxes and regulation affect economic value
            Why some goods and services are under-supplied in a market economy
            How firms compete and maximise profit
            How households decide what to consume, how much to save, and how much to           work (or, more generally, how people respond to incentives)
            Why some economies grow faster than others
            What effect monetary and fiscal policy has on economic well-being





In order to fully understand what economics is, it’s important to also understand a bit about what economics isn’t. For example, economics and finance are related but separate fields, and it’s not an economist’s job to tell people what stocks and bonds they should be investing in.

It is, on the other hand, an economist’s job to understand the relationship between interest rates and bond prices. In a similar fashion, many of the topics discussed in The Economist deal with politics and current events and are not specifically economic-related, despite the title of the publication.

For macroeconomics we will investigate what is happening in the economy as a whole, and the role played by policy makers in trying to manage economic activity so that sustained and sustainable growth takes place. Take a look at this video clip explaining the difference between macroeconomics and microeconomics – and note how many of the concepts unique to each use concepts and models from the other:

https://www.youtube.com/watch?v=ukQ1ZVCp72o

For macroeconomics, perhaps the most important area of study is the trade cycle. Hopefully you are aware that no economy performs in a linear fashion, there are always ups and downs as the economy grows faster, slower, or even shrinks. The changes in the rate of growth have multiple impacts across the economy, and with the interconnected nature of modern economies, changes elsewhere have an impact here too. Economics is very much in the news - China is going through significant upheaval, and there have been some major policy moves to affect this, but no one knows if the outcome will be favourable or not.

But even though we cannot be sure what the outcome of such policy moves will be, that does not stop us trying to foresee all possible outcomes, good or bad. Your job as economists is to understand the tools we can use to try and make these predictions - models and theories - and the limitations these have. Consider this quote:


“There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.” ― Frédéric Bastiat


Bastiat did his work in the 1800s, when many great thinkers were applying themselves to the study of economics. Even back then he (they) understood that a policy action may not have the intended outcome. Why? Because models and theories can only work up to a certain point; there is always at least one significant variable that cannot be accurately predicted. As you are studying in the 21st century you can take advantage of everything that has been uncovered and revealed to date, namely that there is an upside and a downside to nearly every form of economic activity and policy. It is crucial that you bear that in mind in everything you write and consider in economics, particularly macroeconomics.


Background to Economic Theory

The history of economic thought is widely believed to have begun with Adam Smith. It is readily apparent, looking around you, that the profit motive drives firms, and that most of you will seek high-paying jobs when you enter the world of work. But if everyone truly sought to maximise income/profit, at the expense of everyone else, would our world look the way it does today? In fact, while his book, The Wealth of Nations, explored the concept of self advancement leading to progress in society, it was another book exploring how we work together for mutual benefit, The Theory of Moral Sentiments (1759), that developed thinking about how economies progress.

In our first lessons we will look at three main schools of economic thought, classical economics, an early school of thought that emphasised free markets and self-correcting economic mechanisms, as explained in this video:






We will also look at  Keynesian economics, a huge step-change in economic thinking made by one man, John Maynard Keynes, as a result of his study of the Great Depression and the background of World War II (which he predicted). Whereas classical economics emphasised laissez-faire (non-interventionist) policy, Keynes believed governments had a duty to step in when economies were either growing too slowly or too fast. 





For decades after WWII Keynesian economics was the theory of choice for policy makers, right up until the 1970s when global events conspired to create an unprecedented economic storm. During the 1970s much of the developed world experienced rising inflation AND rising unemployment, two things which were supposed to move in opposite directions. At this point policy makers turned to a fresh school of thought, developed several decades earlier, but revised to take account of (then) current economic circumstances: Monetarism. 

Although it would be nice to think of these changes as linear, with movement from one theory to another, in fact economics is a huge arena of thought, with different economists taking existing theories and refining them, and with others borrowing from different schools of thought to combine existing but separate ideas and concepts. In truth, policy is usually a mix of different approaches, aimed at different parts of the economy. We will study this after we have looked basic models of the economy, and how economic performance is measured.

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