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ECON1001E,FIntroduction

Part I

Introduction

Macroeconomics versus Microeconomics Tentative Nature of Economic Knowledge The Assumption of “Economic Man”

What is Economics?

Studies inflation, unemployment, business cycle, economic growth, income inequality

Studies how a consumer’s decisions, a firm’s decisions, and a laborer’s decisions, etc.

Economics is the studies how economy functions —macroeconomics versus microeconomics

Microeconomics provides foundation for us to understand macroeconomics

Note the tentative nature of economic knowledge

What is Economics?

On Oct 4, 2008, Alan Greenspan tried to explain to the Congress what had gone wrong with the financial markets over the past year.

“In other words,” a house representative said, “you found that your view of the world, your ideology, was not right. It was not working.”

What is Economics?

“Precisely,” replied Greenspan. ‘That’s precisely the reason I was shocked, because I had been going for forty years or more with very considerable evidence that it was working exceptionally well.”

“The whole intellectual edifice collapsed in the summer of last year,” he added.

Why so few economists had forewarned the crisis? What is wrong with economics?

One view: Nothing wrong with economics – logically impossible to make such predictions

What is Economics?

Another view: Overconfidence in our knowledge, free market ideology, close tie between academic and business

Robert Lucas, the most distinguished macroeconomist alive, said in his presidential address to the American Economic Association in Jan 2003:

“Macroeconomics was born as a distinct field in the 1940s, as a part of the intellectual response to the Great Depression. The term then referred to the body of knowledge and expertise that we hoped would prevent the recurrence of that economic disaster.

What is Economics?

“My thesis in this lecture is that macroeconomics in this original sense has succeeded: Its central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades.”

According to Judge Richard Posner, in his book Failure of Capitalism, “On September 19, 2008, Lucas expressed skepticism that the economy would slip into a recession – where it had already been for ten months.”

What is Economics?

R. Posner, “Some of the media commentary has attributed the economic profession’s unsatisfactory performance to academic’s being overly reliant on abstract mathematical models…

“[but] professors of finance, who are found mainly in business schools rather than in economic departments, and whose field overlaps macroeconomics in regard to recession and depressions, tend to be deeply involved in the real world of financial markets..

What is Economics?

“The entwinement of finance professors with the financial industry has a dark side. If they criticize the industry and suggest tighter regulation, they may become black sheep and lose lucrative consultantships. This conflict of interest may have caused some economists to pull their punches.” (p.259, R. A. Posner, 2009)

The Assumption of Economic Man

In everyday life, the individual cares more about himself/herself than about others.

Adam Smith (1723-1790) in his Wealth of Nations (1776) used “self-love” to describe this propensity.

The Assumption of Economic Man

“ It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”

each participant in a competitive market is “led by an invisible hand to promote an end which was no part of his intention.”

The Assumption of Economic Man

In the chapter of “Biographies of Money Makers” ( 貨殖列傳 ) of his Records of the Historian, Sima Qian (司馬遷 ) wrote that:

天下熙熙，皆為利來；天下壤壤，皆為利往

夫千乘之王，萬家之侯，百室之君，尚猶患貧，而況匹夫編戶之民乎？

各勸其業，樂其事，若水之趨下，日夜無休時。不召而自來，不求而民出之

The Assumption of Economic Man

Economic man, or Homo economicus — individuals are selfish, narrowly defined.

In reality, individuals are often altruistic, concerned about the well being of others

“If I am not for myself, who will be for me? If I am only for myself, what am I? If not now, when?” (Rabbi Hillel)

Individuals are concerned about fairness too

The Assumption of Economic Man

Albert Rees, an accompanied labor economist at Chicago, administrator in the government, provost at Princeton University, president at Sloan Foundation.

“The neoclassical theory of wage determination, which I taught for 30 years and have tried to explain in my textbook … has nothing to say about fairness… Beginning in the mid-1970s, I began to find myself in a series of roles in which I have participated in setting or controlling wages and salaries. These included sitting on three wage stabilization bodies during the Nixon and Ford administrations….

The Assumption of “Economic Man”

“In none of these roles did I find the theory that I taught so long to be the slightest help. The factors involved in setting wages and salaries in the real world seemed to be very different from those specified in the neoclassical theory. The one factor that seemed to be of overwhelming importance in all these situations was fairness.”

The Assumption of Economic Man

Alfred Marshall (1842-1924), father of neo-classical economics

Who coined the term economics (rather than political economy)

In the opening pages of the Principles, Marshall dismissed the idea that economics should model the individual as a selfish calculating machine.

The Assumption of Economic Man

Even Smith wrote his The Theory of Moral Sentiment (道德情操论 ), in which he emphasized the importance of empathy in human society.

Fairness is rarely mentioned in today’s econ textbook. Its appearance, if any, only serves to show that the book is comprehensive.

Why bothers to clarify this?

The Assumption of Economic Man

Wrong policy prescription: Haifa’s day care centers A fine was imposed on parents who were late

picking up their children Parents responded to the fine by doubling the

fraction of time they arrive late. When after 12 weeks the fine was revoked, their

enhanced tardiness persisted unabated. The fine seems to have undermined the parents’

sense of ethical obligation to avoid inconveniencing the teachers and led them to think of lateness as just another commodity they could purchase.

The Assumption of Economic Man

It may turn good people into bad people. Economic students tend to be more selfish. (It also fails to attract to economics people with strong ethnical feelings)

“While my mom and kindergarten teachers taught me moral, my graduate economics tried to un-teach me”

But remember what Marshall defined one of the chief tasks of economics this way