The Principles and Practice of Economics
DR . CL AUDI A HUP K AU
1
Module 1
1.1 T HE S COP E OF ECON OM I CS
1.2 T HR E E P R I NCI PLES OF ECON OMI CS
1.3 I S ECON OM I CS G OOD FOR YOU ?
Module 1 INTRODUCTION TO ECONOMICS 2
The Scope of Economics
Economics studies how agents make choices with scarce resources and
how those choices affect society.
➢Choice, not money or wealth, is the unifying feature of all things
studied by economists
➢Two important concepts in this first definition:
❑Economic agents: any group or individual that makes choices (consumers,
households, firms, governments, etc.)
◦ In general, economic agents choose optimally (more later)
❑Scarce resources: goods of which there are not enough to satisfy everyone’s
wants
◦ Could you name a good that is scarce and another that is not?
Module 1 INTRODUCTION TO ECONOMICS 3
The Scope of Economics
Positive economics: description of what economic agents actually do
◦ Example 1a: What is the mean wage in different sectors of the economy?
◦ Example 1b: Is there a gender income gap in Spain? What are the
determinants? Labor market composition, discrimination,
temporality/part-time, etc?
Normative economics: a decision-maker determines what economic agents
should do
◦ Example 2a: What is the best job offer a worker should accept given her
qualifications and preferences?
◦ Example 2b: Should we introduce public policies to reduce this gap?
Which ones will be more effective?
◦ Notice that first we should decide on a subjective question. Normative
analysis results in public policies.
Rubén Veiga
Module 1 Duarte INTRODUCTION TO ECONOMICS 4
The Scope of Economics
Microeconomics: The study of how individuals, households, firms,
governments make choices and how those choices affect prices, the
allocation of resources and the well-being of other agents.
◦ In Micro, we study an isolate piece of the whole economy.
◦ Examples: consume choice, the study of electricity markets design, policies,
competitive behavior of firms/parties.
Macroeconomics: study the economy as a whole
◦ The big picture of a county’s economy: studies aggregate production,
inflation, economic cycles, labor market performance, monetary policy, etc.
◦ Examples: the effect of last labor reform on unemployment and GDP,
adequacy of NGEU program to stimulate the economy
➢Macro or micro?
o In general, we can ask both micro and macro questions about a particular topic.
Module 1 INTRODUCTION TO ECONOMICS 5
Three Principles of Economics
1. Optimization: choosing the best feasible option, given the available
information
2. Equilibrium: a situation in which everybody is simultaneously
optimizing; nobody would benefit from changing his or her own
behavior
3. Empiricism: using data to figure out answers to interesting questions
Module 1 INTRODUCTION TO ECONOMICS 6
The First Principle of Economics: Optimization
Making the best choice possible with given information
➢“possible”/”feasible”: options that are available to an agent.
➢“given information”: sometimes agents do not have full information about
possible options. Changing the available information at the time of decision can
change the optimal choice.
➢“best”: that depends on the agent’s preferences!!
Crucial concepts for optimization
❑Trade-offs: when we make a decision, we give up something to get something
else
❑Budget constraint: usually, we are forced to choose (and face a trade-off) due to
a limited budget.
❑Opportunity cost: the best alternative (respect to a particular choice) use of a
resource. Usually, we express it as monetary value.
❑Cost-benefit analysis: optimization method that compares benefit and costs in a
common unit of measurement. We can write up the benefit-costs of every
possible choice and compare.
Module 1 INTRODUCTION TO ECONOMICS 7
The First Principle of Economics: Optimization
Trade-offs: What is the optimal level of pollution in Madrid?
Module 1 INTRODUCTION TO ECONOMICS 8
The First Principle of Economics: Optimization
Example 1: Buy a book for 20€ in store A or
or drive 3km and buy it in store B for 10€.
◦ What are the benefits of buying the book in
store A?
◦ And the costs? Can we write them in
monetary terms?
◦ Trade-offs? Budget-constraint?
◦ Cost-benefit analysis: Let’s see it in the
blackboard…
Example 2: Buy a laptop for 1000€ in store A
or drive 3km and buy it in store B for 990€.
◦ Different answer?
Module 1 INTRODUCTION TO ECONOMICS 9
The First Principle of Economics: Optimization
Example 3: Consider the option of spending today’s afternoon in
Instagram/Tiktok/other “free” apps. What is the opportunity cost of that?
o What is the best alternative use of that time?
o In particular, think about something that can be put in monetary terms. How
much money could you make working those hours instead?
Module 1 INTRODUCTION TO ECONOMICS 10
The Second Principle of Economics: Equilibrium
Situation in which nobody would benefit by changing his/her
own behavior
Example: Think about what happens in the queue of grocery store…
➢Think about other examples: housing market, two political parties
competing for the same electorate, etc
➢Again, notice that decisions are optimally made given available
information!
Module 1 INTRODUCTION TO ECONOMICS 11
The Second Principle of Economics: Equilibrium
Free-rider problem:
o When an agent enjoys the benefits of a choice without assuming all of its
costs.
➢Example: keeping your kitchen cleaned in a shared house. If one flat mate
goes watch TV instead of cleaning the dishes, he enjoys the benefits without
assuming the costs.
• Is this house in equilibrium?
• Is the free rider issue worse in a flat with 2 people or in a flat with 6?
➢Another example: using your diesel car to commute.
Module 1 INTRODUCTION TO ECONOMICS 12
The Third Principle of Economics: Empiricism
Analysis using data to figure out answers to interesting questions
Crowded beaches and hot
temperatures go together.
So if we want to make it cooler, keep
people from going to the beach!
Module 1 INTRODUCTION TO ECONOMICS 13
The Third Principle of Economics: Empiricism
Correlation ≠ causation
Rubén Veiga
Module 1 Duarte INTRODUCTION TO ECONOMICS 14
Is Economics Good for You?
Cost-benefit analysis of attending this course
Benefit: understand that we apply economic thinking in our everyday
life
Cost: tuition, stress, opportunity cost (other available courses)
Am I tricking you? Are you really choosing to attend this course?
Module 1 INTRODUCTION TO ECONOMICS 15
