ECON 221Exam # 1 Study Guide Lectures: 1 - 9Lecture 1 (August 21) – Intro to Microeconomics  What is Economics?o The study of decision-making.o More precise definition: The study of how agents choose to allocate scarce resources and how these choices affect society. o Difference between microeconomics and macroeconomics? Micro – The study of the “tiny bits” that make up the economy- Consumers- The Government- Small business owners- Politicians individually… etc.  Macro – The study of the economy as a wholeo Consists of: optimization and equilibrium Empiricism - How economists think of the world in theory  Optimization – choosing the best thing for you Equilibrium – when no one wants to change their decision, given what everyone else is doing. o Equilibrium  Once in equilibrium, we stay in equilibrium. Ex. Prisoner’s Dilemma Partner stays quiet Partner rats me outI stay quiet  Both get 1 year  I get 6 years, partner goes freeI rat out partner  I go free, partner gets 6 years  Both get 3 yearso Equilibrium outcome is not the “best” outcome, nor does it have to be.o Equilibrium and optimization are theoretical Economists want to do more than think of the world in theory Test whether these theories hold up by using actual data from the world using an “empirical approach” Lecture 2 ( August 26) – Empiricism  What do economists do?o Make predictions – How do we make these predictions?o Test those predictions – How do we test these predictions? MODELS o A model is a rough description of the world that captures essential features o Models generate testable predictions  Ex. Motives for charitable giving  Two possible motives - Concerns about needs being met- “Feeling good” These are two examples of models of giving – both models generated predictions - Meeting needs -> government spending decreases donations- Feeling good -> government spending doesn’t impact donations Theory and Empirics  How do we empirically test predictions? First step is getting data.o We must be careful, “just looking at data” is not enough to determine whether one thing causes another…o Two main concerns  Reverse causality - Want to know if X causes Y (X  Y)- Maybe X and Y are correlated, but could be that Y causes X  Omitted variable bias- Want to know if X  Y- X and Y are correlated, but maybe there is an outside factor causing both X and Y to increase o CORRELATION DOES NOT IMPLY CAUSATION – causation is what we care about o Models and empirical results are used to make policy, so we need to know WHATcauses WHAT  Ex. Educational achievement and happiness are correlated  If government wants to increase happiness, should they spend a lot of A model describes theworld in theoryUse the model togenerate a testablepredictionTest the predictionusing dataPrediction holds up  SuccessThis model can be used tomake future predictionsA model describes theworld in theoryUse the model togenerate a testablepredictionTest the predictionusing dataPrediction fails Start overCome up with a differentmodelmoney on education to achieve this? Identifying causation o Ideally: randomized experiments, like in psychology o Components of a randomized experiment  A “treatment” group A “control” group  Random assignment to groupso Blood drive example: Approach people walking past Randomly tell them either:- “There is a blood drive” control group- “There is a blood drive and you will be paid” treatment group- Random assignment to treatment eliminates any concerns about reverse causality or omitted variables  Result: Control group donated more than treatment group- Model implicitly being tested: Monetary incentives make people dothings.- Empirical result: No, not for things like donating, volunteering… etc.o True experiments are not always possible – for a lot of questions economists are interested in, proper experiments are not possible  Ex. Do higher income taxes discourage work?- Ideal approach: Take a group of people and randomly assign high taxes to some and low taxes to others…- Not a feasible experiment o Alternative “Natural” experiments  Economists look to pre-existing data on situations that are close to random. Ex. Does a scholarship lead to better academic outcome? Natural experiment approach: - Find a scholarship with a cutoff SAT score of 1300 - There is come randomness to SAT scores (1400 is clearly better than 1300, but 1300 vs. 1310 comes down to chance)- Look at people just above and below the cutoff (1300 vs. 1290) – they’ve essentially been randomly assigned to receive a scholarship (treatment group) or not (control group) o In using data: correlation does not imply causation o To learn something about causation: randomization Lecture 3 (August 28) – Optimization  Optimization – People do the best they can for themselveso But almost nothing is “free”, so there are almost always costs involved  So “Doing the best that you can” does not mean “Have the most of everything”  It mean “Find the BEST balance of BENEFITS and COSTS” o In economics we are interested in direct financial costs and “opportunity costs”o Opportunity cost – The cost of an alternative that must be forgone in order to pursue a certain action. – The benefits you could have received by taking an alternative action.  Examples: - Costs associated with owning and running a coffee shop?- Costs of going to college?- Costs of volunteering at a homeless shelter? When making an “optimal” decision, you must weigh benefits and costso Weighing benefits and costs Optimization involves finding the highest “net benefit” (benefit – cost) - Ex. You run a theater and want to advertise a show you are putting on. Ads cost $100 but run once a day.o With an ad, people will learn about the show and buy tickets.o With a bunch of ads, the same people are seeing the same ad repeatedly. o You can predict how much you’ll make based on the number of ads you put up. (Ticket sales).Ads Ticket Sales Ad Cost Net Benefit0 $50 $0 $501 $300 $100 $2002 $500 $200 $3003 $550 $300 $2504 $575 $400 $175 This what the book calls “Optimization in levels”  the best choice is whichever has the highest “net benefit” o Easy because we were able to compare monetary