What is Economics?

What it's not

• Business/Management
• Accounting
• Finance

Economics is a science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.

Micro

Actions of individuals and firms

Macro

Activity in a country, market, the world

Models

Every model is wrong, but some are useful

Supply and Demand

Experiment time!

Market equilibrium

Conditions:

1. Equal access to information
2. No externalities
3. No monopolies (perfect competition)

Elasticity

Consumer theory

p1x1 + p2x2 = m

The budget constraint

Indifference Curves

Perfect substitutes

The consumer is willing to substitute one good for the other at a constant rate.

Perfect complements

Goods that are always consumed together in fixed proportions.

Marginal rate of substitution

The slope of an indifference curve is known as the marginal rate of substitution (MRS). The name comes from the fact that the MRS measures the rate at which the consumer is just willing to substitute one good for the other.

Game Theory

The study of mathematical models of conflict and cooperation between intelligent rational decision-makers

• The set of players is N = {1,...,n}.
• Player i has a set of actions, ai, available. These are generally referred to as pure

strategies. This set might be finite or infinite.

• Let a = a1 × ··· × an be the set of all profiles of pure strategies or actions, with a generic element denoted by a = (a1, . . . , an).

• Player i’s payoff as a function of the vector of actions taken is described by a function ui : A → IR, where ui(a) is i’s payoff if the a is the profile of actions chosen in the society. 

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Prisoner's dilemma

Dominant strategies

A dominant strategy for a player is one that produces the highest payoff of any strategy available for every possible action by the other players.
That is, a strategy ai ∈ ai is a dominant (or weakly dominant) strategy for player i if ui(ai, a−i) ≥ ui(a′i, a−i) for all a′i and all a−i ∈ a−i.

A strategy is a strictly dominant strategy if the above inequality holds strictly for all a′i ̸= ai and all a−i ∈ a−i.

Nash equilibrium

A pure strategy Nash equilibrium4 is a profile of strategies such that each player’s strategy is a best response (results in the highest available payoff) against the equilibrium strategies of the other players.
A strategy ai is a best reply, also known as a best response, of player i to a profile of strategies a−i ∈ a−i for the other players if
ui(ai, a−i) ≥ ui(a′i, a−i) for all a′i.

A best response of player i to a profile of strategies of the other players is said to be a strict best response if it is the unique best response.
A profile of strategies a ∈ A is a pure strategy Nash equilibrium if ai is a best reply to a−i for each i. That is, a is a Nash equilibrium if
ui(ai, a−i) ≥ ui(a′i, a−i) for all i and a′i.

An advertising game

Experiment time!

Competition and Industrial Economics

Competition

• Perfect competition
• Oligopoly
• Monopoly

Perfect Competition

In the long run, profits in an industry with free entry will induce other firms to enter that industry and thereby push profits toward zero.

When profits are zero it doesn’t mean that the industry disappears; it just means that it stops growing, since there is no longer an inducement to enter.

Monopoly

Monopoly

Price discrimination

1st, 2nd and 3rd degree

Under first-degree price discrimination, or perfect price discrimination, each unit of the good is sold to the individual who values it most highly, at the maximum price that this individual is willing to pay for it.

Second-degree price discrimination is also known as the case of non- linear pricing, since it means that the price per unit of output is not constant but depends on how much you buy.

Third degree p.d.: the monopolist sells to different people at dif- ferent prices, but every unit of the good sold to a given group is sold at the same price.

Examples of this might be student discounts at the movies, or senior citizens’ discounts at the drugstore.

Oligopoly

Cournot model

Behavioral Economics

Economic experiments

• Participants play games (or take decisions). Choices are recorded as data. 
 • Experiments can take place in a laboratory or in the “field“.

Experiments investigate real choices in contrast to surveys with attitudinal questions 

They show the revealed preferences of the participants

Economic experiments

Behavioral / experimental economics argues that
a) people often make choices that do not maximize their utility.
b) psychological and physiological evidence is relevant for economic theories.
Therefore, not only choices but also expectations, brain activity, physiological processes, eye movements, etc. are measured in experiments.

Economic experiments

Should economists deal with expectations, emotions, social norms, happiness, or should they restrict themselves to revealed preferences?