Introduction to Economics

Lecture 1: Prosperity: Empiricism

and Models
Lecturer:
Dr. Nguyen Anh Phuong
PhD, MSc, BA, FHEA
Outline

1. Course Overview

2. What Is Economics? (Morning Session)

3. Economic Models (Morning Session)

4. Income Inequality and Poverty (Afternoon Session)

Course Overview

No. Topic
Prosperity: Empiricism and Models (Introduction)
1.
Literature: Chapters 2, 20 in Mankiw and Chapters 1, 2, 6 in CORE
Demand, Supply, and Market (Part 1)
2.
Literature: Chapters 4, 10, 14 in Mankiw and Chapters 7, 12 in CORE
Demand, Supply, and Market (Part 2)
3.
Literature: Chapters 5, 7, 9, 20 in Mankiw and Chapter 9 in CORE
Demand, Supply, and Market (Part 3)
4.
Literature: Chapters 7, 13, 14, 15, 16 and 17 in Mankiw
Money and The Economic Cycle (Macroeconomics)
5.
Literature: Chapters 25, 26, 29, 30, 34, and 36 in Mankiw
International Economics (Micro and Macroeconomics)
6.
Literature: Chapters 9, 31 in Mankiw and Chapter 18 in CORE

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Course Overview

This module aims to introduce students to key economic tools and concepts in
order to prepare them well for taking microeconomic and macroeconomic
modules

Class attendance is compulsory, and we will give credits to active class

participants. A positive answer/comment will be recorded as a “+” sign.
Students will be asked randomly to answer questions, to give comments
during a session, based on the provided list of participants.

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Course Overview

Evaluation: Final exam 100%

Principles of Economics by G. Mankiw. The latest is the 8th edition.

However, the 7th edition available at the library is also usable.

Course schedule, syllabus and learning materials are uploaded on e-

learning system.

Lecturer‟s contact detail: phuong.nguyenanh1093@gmail.com

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 What Is Economics? (Morning Session)

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What is economics?
Resources are scarce
Scarcity: the limited nature of society‟s resources
Society has limited resources
Cannot produce all the goods and services people wish to have
Economics
The study of how society manages its scarce resources
Economist study:
How people decide what to buy, how much to work, save, and spend
How firms decide how much to produce, how many workers to hire
How society decides how to divide its resources between national defense,
consumer goods, protecting the environment, and other needs.

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Why do we need to study economics?
Understand the world in which you live
+ Why are apartments so expensive in big cities?
+ Why are living standards so meager in many African countries?
A more astute participant in the economy
+ Once you take a job, you decide how much of your income to spend,
how much to save, and how to invest your savings
+ Run your own business
Better understanding of both the potential and the limits of
economic policy
+ What are the impact of externalities?
+ What are the effects of free trade with other countries?
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The Economist as a Scientist

Economists play two roles:

1. Scientists: try to explain the world
2. Policy advisors: try to improve it
As scientists, economists employ the scientific method
Dispassionate development and testing of theories about how the
world works – interplay between theory and empirical observation
Paying attention to historical events to study the effects of a key
natural resource on the world‟s economies

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The Economist as a Scientist

Assumptions
Simplify the complex world and make it easier to understand
Example: to study international trade, assume two countries and
two goods
Economists use models to study economic issues
Highly simplified representation of a more complicated reality
Built with assumptions

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 Economic Models (Morning Session)

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Our First Model

Circular-flow Model: visual model of the economy that shows how

dollars flow through markets among households and firms:
Two decision makers
Firms and Households
Interacting in two markets
Market for goods and services
Market for factors of production (inputs)

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Figure 1: The circular flow
Households:
 Own the factors of production,
sell/rent them to firms for income
 Buy and consume goods & services

Households
Firms

Firms:
 Buy/hire factors of production,
use them to produce goods and services
 Sell goods & services

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Figure 1: The circular flow

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Our Second Model

The Production Possibilities Frontier

Visual model of production in the economy
Shows the various combinations of output that the economy can
possibly produce given the available factors of production
Assumptions
The economy is considered to produce only two goods.
The quantities of factors of production and the technology available
to the economy are fixed.

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Figure 2: The Production Possibilities Frontier (PPF)

Inside or Outside the

Frontier
On or inside the Frontier
is feasible.
Outside the Frontier is
unfeasible.
Slope of the Frontier
Measuring the
opportunity cost of „a
car‟ in terms of
„computers
Not constant along the
curve – bowed shape
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Figure 2: The Production Possibilities Frontier (PPF)

Trade-off between the

outputs of goods at a given
time can change over time
Technological advance
in the „computer
industry‟
As the economy grows,
the „point C‟ becomes
feasible.
One endpoint of the
frontier stays the same
as there is no tech
advancement in car
production.
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Microeconomics vs Macroeconomics

Microeconomics
The study of how households and firms make decisions and how
they interact in markets
Macroeconomics
The study of economy-wide phenomena, including inflation,
unemployment, and economic growth

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The Economist as Policy Adviser

Positive statements: descriptive

Attempt to describe the world as it is
Confirm or deny by examining evidence: “Minimum-wage laws
cause unemployment”
Normative statements: prescriptive
Attempt to prescribe how the world should be: “The government
should raise the minimum wage”

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The Economist as Policy Adviser

Vietnamese Economic Advisory Group

Source: http://news.chinhphu.vn/Home/PM-establishes-independent-
Economic-Advisory-Group/20177/31346.vgp

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Summary

Economists are scientists

Make appropriate assumptions and build simplified models
The circular-flow diagram
The production possibilities frontier
Microeconomists: study decision making by households and firms and
their interactions in the marketplace
Macroeconomists: study the forces and trends that affect the economy
as a whole
A positive statement is an assertion about how the world is
A normative statement is an assertion about how the world ought to be
As policy advisers, economists make normative statements
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Quick Quiz

Please scan the QR code below to access to your FIRST quiz!

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 End of Morning Session!

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 Income Inequality, Poverty and Discrimination
(Afternoon Session)

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Income Inequality, Poverty and Discrimination

The distribution of income raises fundamental questions about the role of economic
policy
Why has the distribution of income grown more unequal than ever before?
Why are there so many poor people?
Why have we made so little progress in eliminating poverty?

Questions of fairness, in association with income inequality, poverty, and discrimination,

are normative ones, not positive ones.

The government can improve the market outcomes

The invisible hand allocates resources efficiently but not equally.
The government should redistribute income to achieve equality.

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The U.S. Income Distribution: 2014

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U.S. Income Inequality, 1950–2014

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Inequality around the World

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Poverty
Poverty rate
Percentage of the population whose family income
falls below an absolute level (poverty line)
Poverty line
Set by the federal government (three times cost of
providing an adequate diet)
Depends on family size
Adjusted every year to account for changes in the
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level of prices
Poverty

In 2014 in the U.S.,

Median family income = $66,632
Poverty line for family of four = $24,418
Poverty rate = 14.8%

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U.S. Poverty Over Time

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U.S. Poverty Rate by Group, 2012

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Problems in Measuring Inequality
Data on income distribution & poverty rate
Incomplete picture of inequality
Household annual income
1. Doesn‟t account for in-kind transfers
Transfers to the poor in the form of goods and
services rather than cash

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Problems in Measuring Inequality
Data on income distribution & poverty rate
2. Normal life cycle pattern
Causes inequality in the distribution of annual income
May not represent true inequality in living standards
Life cycle: regular pattern of income variation over a
person‟s life
People can borrow and save to offset life-cycle changes in
income (e.g., saving for retirement).

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Problems in Measuring Inequality
Data on income distribution & poverty rate
3. Transitory vs. permanent income
Transitory changes - need not affect standard of
living
A family‟s ability to buy goods and services
depends largely on its permanent income
Permanent income: a person‟s normal income

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Economic Mobility
Economic mobility
Many people move among income classes
Some reflects transitory variation in income
Some reflects more persistent changes in income
Many of those below the poverty line are there only
temporarily

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Political Philosophy
What should the government do about economic
inequality?
Political philosophies of redistributing income
Utilitarianism
Liberalism
Libertarianism

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Utilitarianism
Utility:
A measure of happiness or satisfaction
Utilitarianism:
Government should choose policies to maximize
society‟s total utility
Founders: Jeremy Bentham, John Stuart Mill

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Utilitarianism
Because of diminishing marginal utility
Redistributing income from rich to poor
increases utility of the poor more than it reduces utility
of the rich  social utility is maximised.
Yet, utilitarians do not advocate equalizing incomes
Would reduce total income of everyone due to
incentive effects and efficiency losses.

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Liberalism
Liberalism:
Government should choose policies deemed to be
just by an impartial observer behind a “veil of
ignorance.”
Founder: John Rawls
Maximin criterion:
Government should aim to maximize the well-being of
society‟s worst-off person
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Liberalism
Liberalism:
Calls for more redistribution than utilitarianism
(though still not complete equalization of incomes).
Income redistribution is a form of social insurance, a
government policy aimed at protecting people against
the risk of adverse events.

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Libertarianism
Libertarianism:
Government should punish crimes and enforce voluntary
agreements but not redistribute income
Advocate: Robert Nozick
Libertarians focus on the process not outcome:
Government should enforce individual rights,
should try to equalize opportunities.
So long as the income distribution is achieved fairly, even
if unequal, government should not interfere.

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Policies to Reduce Poverty
Poor families more likely to experience
Homelessness, drug dependence, health problems,
teen pregnancy, illiteracy, unemployment
Most people believe government should provide a
“safety net.”
We now consider a few such policies…

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1. Minimum-Wage Laws
Arguments for:
Helps the poor without any cost to government
Little impact on employment if demand for unskilled labor is
relatively inelastic.
Arguments against:
In the long run, demand for unskilled labor is likely elastic, so
minimum wage causes substantial unemployment among the
unskilled.
Minimum wage workers are more likely to be teens from middle-
income families than low-income adult workers.

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2. Welfare
Welfare: government programs that supplement the incomes of the
needy
Temporary Assistance for Needy Families (TANF)
Supplemental Security Income (SSI)
Critics: such programs create incentives to become or remain
needy; welfare contributed to the rise of the single-parent family.
The severity of such incentive problems is unknown.
Supporters: (1) no one choose to live the life of a single parent just
to qualify for welfare benefits; (2) welfare benefits (adjusted for
inflation) fell as single-parent families increased since 1970s.

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3. Negative Income Tax
Negative income tax:
Tax system that collects revenue from high-income
households and gives transfers to low-income
households
Taxes owed = (1/3 of income) – $10,000
How much income tax would a family with an
income of $90k, $30k, and $15k, respectively, pay?

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4. In-Kind Transfers
In-kind transfers: goods or services provided to the needy
Examples: homeless shelters, soup kitchens
Supplemental Nutrition Assistance Program (SNAP): Gives
low-income families a plastic card that can be used to buy
food at stores
Medicaid, government-provided healthcare for the poor
An alternative: cash payments
People - buy what they most need; but critics argue could be
used for drugs, alcohol

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Anti-Poverty Programs and Work Incentives
Assistance from anti-poverty programs declines as
income rises.
The result: Poor families face high effective marginal
tax rates (exceeding 100% in some cases!).
Such policies therefore discourage the poor from
escaping poverty on their own.
One possible solution: “Workfare,”
Requiring people to accept government jobs while
collecting benefits from the govt.
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Conclusion
Poverty is one of society‟s most serious problems.
Governments can sometimes improve market
outcomes.
Public policy can help reduce poverty and inequality
People face trade-offs.
Policies designed to improve equity often sacrifice
efficiency, so the proper scope of policy is the subject
of ongoing controversy
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Summary
Data on income distribution show a wide disparity in our
society. The richest 20% of families earn about ten
times as much as the poorest 20%.
• Problems in measuring inequality arise from
in-kind transfers, the economic life cycle,
transitory income, and economic mobility.
• When these factors are taken into account,
the distribution of well-being is probably less unequal
than the distribution of annual income.
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Summary
• Political philosophers differ in their views of the proper
role of government in altering the income distribution.
• Utilitarians believe that income distribution should
maximize the sum of everyone‟s utility.
• Liberals believe the government should aim to
maximize the well-being of the worst-off person in
society.
• Libertarians believe the government should aim for
equality of opportunity, not equality of income.
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Summary

• Policies such as welfare, minimum-wage laws,

negative income taxes, and in-kind transfers can
help the poor.
• Since financial assistance falls as income rises,
the poor face high effective marginal tax rates,
discouraging them from escaping poverty on their
own.

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 End of Afternoon Session!

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References

Mankiw N. G. (2017) Principles of Economics, Cengage Learning, Boston.

The CORE Team (2018) The Economy, CORE Econ, Oxford.