Post by Gelare on Jan 19, 2008 3:48:00 GMT -5
Foundations of Economics
"Time to go shopping!"
Welcome, students, to the first lesson of Economics 101 - Survey of Economics. I am Dean of the Royal Academy and your professor, Gelare. In this lesson I'll be explaining the basic groundwork of economic theory, so that throughout the course you can better understand such complex economic questions, such as, "Why does everyone have more money than me?"
I will be posting this lecture over time, partially to make my life easier and also to get feedback from you, the students. Economics can be dry material sometimes, and I, personally, am drier than the Sahara desert. So please let me know what parts of the lecture you like and what parts you don't in the discussion thread.
Wants, Endless Wants
"I'll take one of those, and one of those, and three of those, and ooh, how about four of those, and..."
Everybody wants things. If you didn't want things, you would have no reason to get up in the mornings. Some basic things, such as food and clothing, everybody wants. Some things, like iMacs, only some people want. Also, people want some things more than others. I want diamonds more than I want dirt. I want a powerful computer more than I want a broken computer. The data of everything you want and how much you want it, is called your preferences. Everybody has a set of preferences, and they dictate whether you buy organic or inorganic strawberries, regular or premium gasoline, an X-Box 360 or a Wii.
Let's say you want a burger. I come up to you and ask, "How much do you want that burger." You probably say something like, "I really want that burger, it looks delicious." But if you wanted to be helpful to an economist, you would instead say, "I would be willing to pay four dollars and fifty seven cents for that burger, not more, not less." An economist wants to know exactly how much you want that burger, and so does the business owner, so he can price that burger as high as possible while still making sure you're willing to buy it. We can ask, "Would you buy it if it cost a dollar? How about two dollars? Three? Three-fifty? Four?" And so on. Eventually there will be a price where you say, "No, I would not spend that much on a burger," and then we know how much the burger is worth to you. We know that you want a burger more than you want chicken nuggets, because you would be willing to pay $4.57 for the burger and only $3.18 for the chicken nuggets. So, do this for all goods, and then we know what your preferences are. Good for us.
In order for an economist to care about your preferences, they must meet two conditions: they must be complete, and they must be transitive. Your preferences are incomplete if I present you with some good and you say, "Y'know what, I really have no idea what I'd pay for that. Sorry, can't give you a number." Don't worry though, your preferences aren't incomplete. You might think they are, but they're not. You might think that you can't give me the dollar value of a year of your life, but you can. I can ask questions like, "How much would your quality of life have to improve over your whole life for you to forgo the last three years of your life?" It turns out a year of life is worth about a hundred thousand dollars. Kinda cheap, if you ask me.
Transitivity is a funny property, which I will illustrate with examples. I present you with three flavors of ice cream, chocolate, vanilla, and strawberry, and ask these questions:
"Which do you prefer: chocolate or vanilla?"
"Which do you prefer: chocolate or strawberry?"
"Which do you prefer: vanilla or strawberry?"
You answer that you like chocolate more than vanilla and more than strawberry, and you like vanilla more than strawberry. Thus, your preferences are transitive, and are Chocolate > Vanilla > Strawberry.
But what if you answered that you like chocolate better than vanilla, strawberry better than chocolate, and vanilla better than strawberry? Your preferences would look like this: Chocolate > Vanilla > Strawberry > Chocolate > Vanilla > Strawberry...
And so on. Wouldn't that be cool? You'd never be able to decide, stuck in an infinite preference loop. And that is what it means to have intransitive preferences.
Ultimately, in economics research, those preference requirements above just aren't that important, because let's face it, if someone has incomplete or intransitive preferences, why are you talking to them? Let a psychologist do it. Most studies are conducted in such a way that people are forced to have complete preferences, and anyone with intransitive preferences gets averaged out in the statistical analysis. But it helps to understand the fundamental assumptions economists make in their models, so you know why they reach the conclusions they do. Groundwork like this is very important in building economic models mathematically, so there are some basic axioms in place to build off of. Plus infinite loops of intransitivity are funny.
Consumer Culture
"Mmm, deeeelicious!"
Everybody wants something - we've just been over that. When you're looking for the best way to get as much of something as you can, you're looking at an optimization problem. Maybe you want to find the optimal combination of grains, fruits, vegetables, meats, and sweets to provide yourself with the most balanced meal. (If you do, don't pay any attention to the new food pyramid, it's simply godawful. The old one was so much better.) Maybe you want to balance your inventory in your shop in line with your expected sales so you don't run out of stuff to sell. But when we're talking about the most basic stuff in economics, we have two entities that interact with each other in the marketplace, and they each have their own optimization problem.
First, we have the consumers. Also known as "customers" or "suckers", these are the people in the economy who buy the finished goods that are produced. Consumers are the ones who buy the trendy faded jeans and the Whoppin' Big Quadruple Quarter Pounders with fries and a diet soda, not to mention water, electricity, automobiles, and everything else that goes into a day in the life. Consumers in economics have a special purpose, because what they want to have, what they want to optimize, is something called utility.
What is utility? Well, no one really knows. (This is going to be extra exciting when I get around to writing that philosophy lecture on Utilitarianism.) Utility is some weird cross between happiness, satisfaction, contentment, and the future. If you try to pin a definition on it, you're doomed to fail, but basically it's a general measure of what people want.
It seems all vague and nebulous now, but it's intuitively pretty simple. Eating chocolate increases your (my) utility; playing a video game increases your (my) utility; drinking coffee increases your (not my) utility. (I'm not a big fan of coffee.) Buying gasoline for your car doesn't directly increase your utility, but it allows you to get to where you want to go, where you can then better increase your utility than if you were stuck at home. Working definitely doesn't increase your utility, but it gets you money that you can then spend on utility-increasing things.
At any rate, you don't have to know exactly what utility is, because the rational consumer in economics does. The rational consumer knows exactly what is best for him or her, and what is best is, by definition, that which provides the most utility. Utility isn't just considered in the short-term, either. Sure, you get utility from drinking a strawberry banana smoothie, but you also gain utility from going to the gym to work off that smoothie, even though going to the gym sucks, because the increase in overall fitness means you might live longer (during which time you can enjoy more stuff) and it might make stuff you do more enjoyable (soccer is way more fun when you win).
An Example
"Holy crap, we actually get to do something!"
So, the consumer in Econworld wants to maximize his utility, and he knows exactly how to do it. Let's go ahead and do some modeling, then. (Not the kind with photographs.) Let's make up this world where there are only two goods - hamburgers and sodas. We have our friend, the consumer, walking around this barren, empty wasteland of a world, and in front of him, there is a restaurant where they sell only hamburgers and sodas. He's mostly okay with this - the consumer doesn't have existential crises like we do. He looks at the menu, reads the prices, reaches in his pocket, and pulls out - sweet! - a twenty.
Let's put some of these things in math terms. (Sorry, it could only be avoided for so long.) We have two goods, H and S - hamburgers and sodas. We read the prices on the menu: the price of a hamburger, PH, is two dollars. The price of a soda, PS, is one dollar. And our income/budget/constraint/cash on hand is twenty bucks. To sum up:
H = Hamburgers
S = Sodas
PH = 2
PS = 1
I = 20
So, what baskets, what combinations of stuff, can we buy? Clearly, we can buy ten hamburgers, since the price is two bucks and we have twenty. Similarly, we can buy twenty sodas. Sure, we can buy that stuff, but what do we want to buy? For that, we have to consult our utility function. The utility function is an equation that says how much utility one gets from stuff. If we say U = 2H, that means our utility is equal to twice the number of hamburgers we eat, and eating ten hamburgers will give us twenty utility. If we say U = .5S, that means our utility is half the number of sodas we drink, so drinking twenty will give us ten utility.
But now, it makes sense that we want a combination of goods, doesn't it? A meal is better with a burger and a drink than with only one or the other. This means...that I'm about to cross over into the math-heavy parts of economics. Maybe I need to expand the university to include a math department. Calc 101, anybody?
"Time to go shopping!"
Welcome, students, to the first lesson of Economics 101 - Survey of Economics. I am Dean of the Royal Academy and your professor, Gelare. In this lesson I'll be explaining the basic groundwork of economic theory, so that throughout the course you can better understand such complex economic questions, such as, "Why does everyone have more money than me?"
I will be posting this lecture over time, partially to make my life easier and also to get feedback from you, the students. Economics can be dry material sometimes, and I, personally, am drier than the Sahara desert. So please let me know what parts of the lecture you like and what parts you don't in the discussion thread.
Wants, Endless Wants
"I'll take one of those, and one of those, and three of those, and ooh, how about four of those, and..."
Everybody wants things. If you didn't want things, you would have no reason to get up in the mornings. Some basic things, such as food and clothing, everybody wants. Some things, like iMacs, only some people want. Also, people want some things more than others. I want diamonds more than I want dirt. I want a powerful computer more than I want a broken computer. The data of everything you want and how much you want it, is called your preferences. Everybody has a set of preferences, and they dictate whether you buy organic or inorganic strawberries, regular or premium gasoline, an X-Box 360 or a Wii.
Let's say you want a burger. I come up to you and ask, "How much do you want that burger." You probably say something like, "I really want that burger, it looks delicious." But if you wanted to be helpful to an economist, you would instead say, "I would be willing to pay four dollars and fifty seven cents for that burger, not more, not less." An economist wants to know exactly how much you want that burger, and so does the business owner, so he can price that burger as high as possible while still making sure you're willing to buy it. We can ask, "Would you buy it if it cost a dollar? How about two dollars? Three? Three-fifty? Four?" And so on. Eventually there will be a price where you say, "No, I would not spend that much on a burger," and then we know how much the burger is worth to you. We know that you want a burger more than you want chicken nuggets, because you would be willing to pay $4.57 for the burger and only $3.18 for the chicken nuggets. So, do this for all goods, and then we know what your preferences are. Good for us.
In order for an economist to care about your preferences, they must meet two conditions: they must be complete, and they must be transitive. Your preferences are incomplete if I present you with some good and you say, "Y'know what, I really have no idea what I'd pay for that. Sorry, can't give you a number." Don't worry though, your preferences aren't incomplete. You might think they are, but they're not. You might think that you can't give me the dollar value of a year of your life, but you can. I can ask questions like, "How much would your quality of life have to improve over your whole life for you to forgo the last three years of your life?" It turns out a year of life is worth about a hundred thousand dollars. Kinda cheap, if you ask me.
Transitivity is a funny property, which I will illustrate with examples. I present you with three flavors of ice cream, chocolate, vanilla, and strawberry, and ask these questions:
"Which do you prefer: chocolate or vanilla?"
"Which do you prefer: chocolate or strawberry?"
"Which do you prefer: vanilla or strawberry?"
You answer that you like chocolate more than vanilla and more than strawberry, and you like vanilla more than strawberry. Thus, your preferences are transitive, and are Chocolate > Vanilla > Strawberry.
But what if you answered that you like chocolate better than vanilla, strawberry better than chocolate, and vanilla better than strawberry? Your preferences would look like this: Chocolate > Vanilla > Strawberry > Chocolate > Vanilla > Strawberry...
And so on. Wouldn't that be cool? You'd never be able to decide, stuck in an infinite preference loop. And that is what it means to have intransitive preferences.
Ultimately, in economics research, those preference requirements above just aren't that important, because let's face it, if someone has incomplete or intransitive preferences, why are you talking to them? Let a psychologist do it. Most studies are conducted in such a way that people are forced to have complete preferences, and anyone with intransitive preferences gets averaged out in the statistical analysis. But it helps to understand the fundamental assumptions economists make in their models, so you know why they reach the conclusions they do. Groundwork like this is very important in building economic models mathematically, so there are some basic axioms in place to build off of. Plus infinite loops of intransitivity are funny.
Consumer Culture
"Mmm, deeeelicious!"
Everybody wants something - we've just been over that. When you're looking for the best way to get as much of something as you can, you're looking at an optimization problem. Maybe you want to find the optimal combination of grains, fruits, vegetables, meats, and sweets to provide yourself with the most balanced meal. (If you do, don't pay any attention to the new food pyramid, it's simply godawful. The old one was so much better.) Maybe you want to balance your inventory in your shop in line with your expected sales so you don't run out of stuff to sell. But when we're talking about the most basic stuff in economics, we have two entities that interact with each other in the marketplace, and they each have their own optimization problem.
First, we have the consumers. Also known as "customers" or "suckers", these are the people in the economy who buy the finished goods that are produced. Consumers are the ones who buy the trendy faded jeans and the Whoppin' Big Quadruple Quarter Pounders with fries and a diet soda, not to mention water, electricity, automobiles, and everything else that goes into a day in the life. Consumers in economics have a special purpose, because what they want to have, what they want to optimize, is something called utility.
What is utility? Well, no one really knows. (This is going to be extra exciting when I get around to writing that philosophy lecture on Utilitarianism.) Utility is some weird cross between happiness, satisfaction, contentment, and the future. If you try to pin a definition on it, you're doomed to fail, but basically it's a general measure of what people want.
It seems all vague and nebulous now, but it's intuitively pretty simple. Eating chocolate increases your (my) utility; playing a video game increases your (my) utility; drinking coffee increases your (not my) utility. (I'm not a big fan of coffee.) Buying gasoline for your car doesn't directly increase your utility, but it allows you to get to where you want to go, where you can then better increase your utility than if you were stuck at home. Working definitely doesn't increase your utility, but it gets you money that you can then spend on utility-increasing things.
At any rate, you don't have to know exactly what utility is, because the rational consumer in economics does. The rational consumer knows exactly what is best for him or her, and what is best is, by definition, that which provides the most utility. Utility isn't just considered in the short-term, either. Sure, you get utility from drinking a strawberry banana smoothie, but you also gain utility from going to the gym to work off that smoothie, even though going to the gym sucks, because the increase in overall fitness means you might live longer (during which time you can enjoy more stuff) and it might make stuff you do more enjoyable (soccer is way more fun when you win).
An Example
"Holy crap, we actually get to do something!"
So, the consumer in Econworld wants to maximize his utility, and he knows exactly how to do it. Let's go ahead and do some modeling, then. (Not the kind with photographs.) Let's make up this world where there are only two goods - hamburgers and sodas. We have our friend, the consumer, walking around this barren, empty wasteland of a world, and in front of him, there is a restaurant where they sell only hamburgers and sodas. He's mostly okay with this - the consumer doesn't have existential crises like we do. He looks at the menu, reads the prices, reaches in his pocket, and pulls out - sweet! - a twenty.
Let's put some of these things in math terms. (Sorry, it could only be avoided for so long.) We have two goods, H and S - hamburgers and sodas. We read the prices on the menu: the price of a hamburger, PH, is two dollars. The price of a soda, PS, is one dollar. And our income/budget/constraint/cash on hand is twenty bucks. To sum up:
H = Hamburgers
S = Sodas
PH = 2
PS = 1
I = 20
So, what baskets, what combinations of stuff, can we buy? Clearly, we can buy ten hamburgers, since the price is two bucks and we have twenty. Similarly, we can buy twenty sodas. Sure, we can buy that stuff, but what do we want to buy? For that, we have to consult our utility function. The utility function is an equation that says how much utility one gets from stuff. If we say U = 2H, that means our utility is equal to twice the number of hamburgers we eat, and eating ten hamburgers will give us twenty utility. If we say U = .5S, that means our utility is half the number of sodas we drink, so drinking twenty will give us ten utility.
But now, it makes sense that we want a combination of goods, doesn't it? A meal is better with a burger and a drink than with only one or the other. This means...that I'm about to cross over into the math-heavy parts of economics. Maybe I need to expand the university to include a math department. Calc 101, anybody?