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Introduction to Economics
Class 1
 What Is economics?
“the branch of knowledge concerned with the production, consumption, and transfer of
wealth” (Oxford Dictionary)
“the study of how people interact with each other and with their natural surroundings in
producing their livelihoods, and how this changes over time” (Core Econ)
 Distinguish between
o Macroeconomics: study of the overall economy
o Microeconomics: study of individual agents and markets
 Agricultural revolution
11,000 years ago, it led to a change from hunter-gatherer to sedentary society; slow but
revolutionary, it created an agricultural surplus allowing groups of priests, rulers, warriors
etc. to develop

 The Hockey stick of growth

 GDP per Capita

GDP=Total Value of Goods and Services Produced in an Economy in a year==Total
Income; GDP per capita: GDP/number of residents
GDP between 1000-2000
o 1000: The world is quite poor and the GDP equally distributed
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o 1500:In Italy becomes wealthier but essentially the rest remains the
same
o 1700:Most the world is still poor, but England starts to grow with Italy
o 1820:Europe has gone wealthier; under the US, colonies become
independent countries
o 1950:The US/Northern Europe are much wealthier, up to 2008; the gap
between India and wealthy countries narrows
o After the fall of communism Economy is not that flat anymore and
poverty tends to get down
N.B Countries that rely on natural resources are very sensitive to fluctuations such as Qatar relied
on oil
 World trade before 1500
Extensive trade centered around the Indian Ocean
China and “India” the major drivers of trade
Pattern of manufactures flowing from China/India in return for primary goods (agricultural,
precious metals)+slaves from Africa
Europe: on the periphery of this system
Called a world system (Pacific Islands, Oceania and Americas were excluded)
Notable that it was polycentric: not controlled by central power
Cities not self-sufficient, so needed to trade with each other
 World in 1500
Very few developed civilisations (e.g Japan, Korea, China, Indonesia etc. China being the
wealthiest)
Columbus discovers America and that changes the development and reduces the isolation
70% of world’s population living on same 42.5 miles
Farming wasn’t developed enough in order to support populations
The places who tend to be the poorest historically are the wealthiest in the modern day
and vice versa (e.g Morocco’s economy declined)—> Reversal of Fortune

 Globalization
Growing interconnections between the economies of different countries
o Globalization of trade (exports and imports)
o Globalization of factors of production (Migration and internal capital flows)
Globalization is not a modern phenomena

Three waves of globalization:

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o Mid 19th century to World War I

o World War II to the 1970s (the “Bretton Woods system”)
o Post 1970s–present

The first globalization

o Age of discovery: Huge profits, mercantile expansion, rapid establishment of trading

network; rapid change in the history of mankind

o Marks the discovery of new markets and countries (such as precious metals, corn,
potatoes, sugar, tobacco, slaves, low quality imitations of Italian goods)

o Also important changes in shipbuilding take place (expanding the distance that can be
traveled; reduction in manpower; change in sails allowed sailing across the wind; reduction
in transport costs

o Improvements and conquests in navigation (people understand what the world looks like)

o Mercantilism: economies are intervening in order to help their own countries, benefitting
from trade (e.g precious metals)/ Economic nationalism that seeks to limit the competition
faced by domestic producers

o trading posts are established

o As a result, by 1800, Europe (many European countries) controls 35% of the world surface
even though it was relatively poor. This will be a proximate cause for what will happen
after the 18hundreds

o Geographical features can (perhaps) explain why it was Europeans emphasized expansion
(Fragmentation of states; Need for expansion to gain access to new products; Acces to
atlantic; Not constrained by need to fight Mongols)

 Important dates
1393- Henry the navigator
1460
1488 Bartholomew Diaz rounds Cape of Good
Hope
1499 Vasco di Gama rounds Africa and sails to
India
1492 Columbus sets sail for Americas
1497 John Cabot discovers Newfoundland and
Nova Scotia
1519 Magellan sails around South America
1519- Cortes conquers the Aztecs
1521
1530’s Pizarro conquers the Incas
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Class 2
 Economic’s research (Causality)
Economics studies why things happen and how to change them for the better; hence it is
important to distinguish between cause and effect (CORRELATION IS NOT CAUSATION)
Methods used in this research
o Theoretical models: use mathematics to provide simplified version of human
interactions
o Empirical model/econometrics: test whether there are casual relationships between
variables
Casual Analysis
o Exogenous (easier to identify causality)
o Endogenous

Casual chains
o Proximate (immediate) causes: Immediate cause before some event
o Ultimate (root) cause: deeper or underlying cause
o Intermediate cause: between the two
 Measuring Economic Development
See formula for GDP
 Global Economic Development (Why Europe?)
o Proximate causes
◦ Disease
◦ Gun-powder technology

Disease

Spread of disease (“the Columbian Exchange”) played a major role in the European conquests of
the Americas; European advantage in disease immunity may be explained by agricultural allowing
large population centers; domestication of animals

o Exchange of diseases from Europe to Americas after 1492

o Huge population declines of up to 85–90%, at least partly due to disease

o Clearly assisted (at least) some European conquests

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Gun-powder technology

(Kennedy, 1987) Competitive countries’ markets led to innovation; A series of wars taxed the
capacity of the warring powers; Massive increase in size and expense of war; Technological
changes lead shift away from cavalry to infantry; Necessitated much larger numbers of troops;
Also expansion in size and cost of shipping

o Guns but also piercing weapons, armor

o Boats (with guns) and naval technology
o Tactics and military discipline
o Fortifications

 Tournament Model I; II; III

o I. Europe fights a lot mostly because it’s fragmented
◦ Concept of culturally prized glory
◦ China was not hegemonic (not fighting each other), hence although they’re
fighting a lot, the expenses are not big
◦ The Ottoman Empire’s location meant prioritised cavalry and galleys and
aimed fiscal capacity
◦ The Mughal Empire was frequently fighting, but small prize and difficulties in
tax raising was present, hence low expenditure
o II. Japan, just like Britain, is a small island. Japan, being Initially split in many
kingdoms, fought a lot in an early period, this brought the period of firearms
development to an end
o III.Things could have been different
◦ Europe could have been united
◦ China could have been fragmented
◦ Non-Europeans could have established different institutions

Class 3
 Institutions
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Technical distinction between “good” and “bad” institutions; Institutions are the rules of
the game in society and define/shape human interaction/ behavior; They are humanly
devised (deliberately human built) and deliberate; They incentivise behavior
o Political inst.
o Economic inst.
o Culture and social norms

They are important: in deciding the size of the pie and its distribution; determining
legal framework; economic management; deciding tax system and rates; corruption
and expropriation

The rules of the game

A set of rules to organize the division of economic outcomes

o The Dictator Game

o The Ultimatum Game

 Institutions at Society-Level
Contribute in the organization of society
o Formal Inst. (e.g. government system; laws)
o Informal Inst. (e.g. social norms)

Include both

o De jure (written in law) (e.g. constitution)

o De facto (how it works in practice)

Pareto Criterion= No-one can be made better off without someone being made worse
of

 Bad VS Good
o Bad institutions: Discourage productive economic activity and encourage resources
to be used
◦ Vague
◦ Extractive
◦ Involve corruption
◦ Expropriation of property
◦ High taxes
◦ Rent-seeking: spending resources without economic benefits activities
◦ Divert resources to non-productive ends
o Good institutions: protect and encourage economic productivity, incentivize
innovation and investment, promote development and trade
o E.g. The Glorious Revolution (England, 1689) Representative government;
Protection of property rights;
Patent system
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Hence, credit markets can flourish because lenders will be repaid and
inventors will research because they can claim the rewards from their
inventions

 Property rights (legal protection of ownership)

It represents the right to exclude others and to benefit from or sell the things owned. This
institution allows the process of trading and investment in a defined and protected way; it
hinders expropriation and boosts efficiency, hence, economic development.
It leads to:
o Clearly defined laws
o Effective legal systems

o Patents (Giving the owner of an invention exclusive ownership for a specified length
of time)

o Private vs Public ownership

 Modernization Theory
Democracy is beneficial toward economical development, wealth, urbanization,
Industrialisation, education

 Lipset 1959

o Economic growth allows more complex and longer term view of politics among
“lower strata”

o “only those that have nothing to lose ever revolt” (De Toqueville) Importance of
large middle class to avoid extremism

o Development of voluntary associations and “mass society” as higher income allows

for more leisure time

 Feudalism and Serfodm

o Medieval Europe

o Areas within a realm (quasi-independent) were ruled by feudal lords, who granted
land (fiefs) to their vassals

o Power split between Curch and King and nobility and monarchy

o Little intergenerational mobility between classes

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 Absolutism: Development of centralized authority (Monarch)

o Absolute monarchy (monarch’s power is absolute)

o Associated with development of unified market and direction of national economy

o Commerce controlled by governement (mercantilism)

 Absolutism and capitalism

o Absolute rule can aid development of trade

o But also an inherent tension between capotalist freedom and absolute rule,
particularly in international sphere where activities take place beyond jurisdiction
(power to make legal decisions)

o Expropriation risk deters investment

o Absolute rulers can constrain capitalism (e.g. helping uncompetitive firms)

o Early capitalist states also those that established representative assemblies earlier

 Representative assemblies

o Emerge in Europe after 1000AD

o Some governed should give some form of consent to governors

 Alternatives to representative assemblies

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o No similar assemblies elsewhere

o Song dynasty in China

o Abbasid Caliphate had well developed bureaucracy

o Byzantins had advisory senate that shriveled away over time

 Why do Europeans develop representative assemblies?

o Different Ideas

o Differences in economic development

 Why Europe II?

o Nature of intrastate competition, including warfare may be a causality in this case.

o States needed funds to promote more and more wars
o Also development in, for instance, cavalry was needed
o Trading had to be increased
o As a result, 90% of spending goes toward war, usually leading to declarations of
bankruptcy; even for wealthy states, it resulted quite impactful
o Hence it is not only about technology but also about the growth of warfare

o High spending particularly affected the Hapsburgs, monarchs of Spain

o Taxes tend to get higher
o What countries do to resolve this, they start to borrow money, which leads to
development of financial institutions and finally the creation of a modern financial
system
o People, hence tend to innovate
o Also there’s an expansion for trade purposes (strong governments were
fundamental as well as the existence of contracts)
o The increase of trade led to bill exchanging in banks
o This enables advanced trading systems
o This particularly happens in Britain and United Provinces (Examples of good
institutions)
o Countries began to develop sophisticated systems of banking and credit
 How do governments finance spending?
o Taxation which can be done by force; it is limited
o Borrowing which relies on individuals’ willing to lend; I can borrow how much as I
like, however according to individuals’ willing to lend

 Representative assemblies and property rights

o For investment in an economy to occur need strong property rights
o BUT not enough to establish property rights
o Institutions can be a mechanism to solving this problem
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o In a famous paper North and Weingast analyze this paper using England’s 1689
Glorious Revolution

 The Glorious Revolution

o James II replaced as King of England, Scotland, and Ireland by his daughter (Mary)
and her husband William of Orange

o Before the Glorious Revolution English Kings raised money in several ways harmful
to economic growth (Monopolies expropriation; use of royal prerogative)

o Glorious Revolution established era of “Parliamentary sovereignty” (Parliament was

permanent; held sole right to rasie taxes; could monitor royal expenditure; had
credible treath tof removing the king

North and Weingast argue that the GR established institutions that could solve this
problem

o We can test the results of these institutional changes through looking at credit
markets

o Before GR Crown raised money through forced loans, often not repaid

o Afterwards, Parliament raised new taxes to pay for each new long-term loan

o Bank of England incorporated to handle government’s debt creating further control

on spending, since the Bank was run by Parliament

 Interest rates

o R  Interest

o P  probability of default (Before using the formula, divide the percentage p by

100)

o R > (1/1-P) – 1 = P/1-P

o If R < P the subject won’t lend

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