ECONS101 - Full Subject Notes
1: Introduction to Economics
Learning Outcomes:
● Apply selected models and the 'economic way of thinking' to explain and solve economic
problems;
● Use elasticities and game theory to anticipate how buyers, sellers, and competitors will
react to changes in prices and other variables;
● Use descriptive and graphical models to explain the behaviour and decision-making of
firms that sell a differentiated product and have some market power;
● Apply the model of supply and demand to analyse market problems in markets with
perfect competition;
● Use descriptive and graphical models to explain how NZ's GDP, employment and overall
price level are determined, and how changes in the macroeconomy may influence the
behaviour of buyers and firms; and
● Apply your knowledge to problems arising within the general business environment.
Economics & Data Errors
Extrapolation Error: Extrapolating data and causing
error is when you look at a past trend and assume that
trend is going to continue into the future.
Causation & Correlation: To observe two variables
that change together and conclude that a change in one
variable causes a change in the other variable.
- Often, this leads to the ‘faulty causation
fallacy’, where we mix up correlation with
causation.
- Causation refers to a cause-and-effect relationship between two variables, i.e. where a
change in one variable produces a change in the other, ceteris paribus (all else being
equal).
- Correlation refers to an assessment that two variables have moved together, so that they
appear to be related. This might be because of a cause-and-effect relationship, but not
necessarily.
Causation vs Correlation: When two variables (A and B) move together in the same direction
(positive correlation) or opposite directions (negative correlation), it might be because A causes
,B. However, it might also be because: B causes A (reverse causation). Alternatively a third
variable (C) could cause (A and B) to appear related.
Spurious: It just happens because the data says it happens, however there is no relationship at
all.
Examples:
Consider the following three situations. Are these relationships causal (does a change in the
first variable cause the change in the second variable)?
● Students who brush their teeth get higher grades in school
- The data shows this however it is a correlation, brushing teeth is not causal to better
grades, there is likely to be a third variable causing better grades in the sample.
● Players who play violent video games are more likely to commit acts of violence
- This is no causal either, this is reverse causation - people who are naturally more violent
are more likely to play violent video games.
● In years where per capita cheese consumption is higher, more people have died by
becoming tangled in their bedsheets
- This is not causal, this is an example of spurious correlation. Where the data shows the
accuracy of the statement however there is no relation between the two variables.
Economic Models
How do we avoid making simple extrapolation and faulty causation errors?
- By using an appropriate model to extrapolate, or to explain relationships
A model is an abstraction or simplification of reality, e.g.
- A map
- A model aircraft
- A mathematical or theoretical model
An economic model is an explanation of how the economy, or part of the economy, works, e.g.
- We will use our first simple model of production shortly
A good model:
● Is clear: it helps us better understand something important
● Predicts accurately: its predictions are consistent with evidence
● Improves communication: it helps us to understand what we agree (and disagree) about
● Is useful: We can use it to find ways to improve how the economy works
Basic Economic Concepts
, ● Economics is about using models, and most models are about explaining choices.
Before describing economic choices, we need to have some basic concepts in mind:
● Ceteris paribus is an assumption we make in economic models. It translates as “other
things being equal” and it means that when we look at a change in the model, we are
assuming that everything else (including things that are not in the model) doesn’t change.
Everything else being equal.
● Incentives are economic rewards or punishments that influence the benefits and costs of
the alternatives that a decision-maker can choose. Influence our decision making - costs
go up we do less of it, benefits go up we do more of it.
● The relative price is the price of one good compared to another, which helps us to
compare alternatives.
● Economic rent is a payment or other benefit that a decision-maker receives above and
beyond what they would have received in their next best alternative. The profit that they
received by choosing the best option - how much better is A than B.
Opportunity Cost:
● When we choose one alternative we are also choosing to set aside (or forego) the other
alternatives we could have chosen.
● The opportunity cost is the cost of not pursuing the opportunity of doing something else -
any time you choose one thing, there is a cost to it - the cost of what you have given up.
● We can measure the opportunity cost of a decision as its’ cost measured in terms of the
best possible alternative foregone (i.e. we measure the opportunity cost as the value of the
best alternative we didn’t choose).
Explaining the Industrial Revolution
Observations of the Industrial
Revolution
, ● For most of history income was flat and consistent.
● Suddenly GDP per capita skyrockets.
Explain why the Industrial Revolution happened in Britain (rather than France or China or
somewhere else), using a model.
A simple model of production, can show how changes in relative prices create incentives for
innovation and ultimately created the conditions underlying the Industrial Revolution.
A model of production to explain the Industrial Revolution
Consider a simple model involving the choice between two inputs into production – with the
amount of one input (labour = L) measured on the x axis, and the amount of the other input
(capital = K) measured on the y axis
Different combinations of the two inputs (L,K), which we can refer to as “different production
technologies”, will produce different amounts of output
However, some production technologies will produce the same amount of output
How can we decide which production technology we should use?
The Production Decision
Let’s say that the firm wants to produce a total amount of production equal to X, and has several
production technologies (combinations of labour and capital) to choose from
We can easily eliminate any combination of L and K which requires more of both inputs than
some other technology
We say the eliminated combination is dominated by the better production technology
How do we decide among the remaining options?
Let’s assume the firm is trying to maximise its profits (profits are the firm’s economic rent from
this production decision)
The profit-maximising production technology will be the one that has the lowest cost to produce
X
Iso-Cost Line
An iso-cost line is a line that links all of the combinations of the inputs that have the same total
cost. Consider our simple two input model. The equation for total cost is:
𝑇𝐶=𝑝×𝐾+𝑤×𝐿
We can rearrange this into the equation for a straight iso-cost line with total cost equal to TC:
𝐾=𝑇𝐶/𝑝−𝑤/𝑝. With a y-intercept of TC/p and a slope of -w/p
● All iso-cost lines have the same slope (equal to -w/p, which is the relative price of the
two inputs)
- The only difference between them is the total cost (TC)
1: Introduction to Economics
Learning Outcomes:
● Apply selected models and the 'economic way of thinking' to explain and solve economic
problems;
● Use elasticities and game theory to anticipate how buyers, sellers, and competitors will
react to changes in prices and other variables;
● Use descriptive and graphical models to explain the behaviour and decision-making of
firms that sell a differentiated product and have some market power;
● Apply the model of supply and demand to analyse market problems in markets with
perfect competition;
● Use descriptive and graphical models to explain how NZ's GDP, employment and overall
price level are determined, and how changes in the macroeconomy may influence the
behaviour of buyers and firms; and
● Apply your knowledge to problems arising within the general business environment.
Economics & Data Errors
Extrapolation Error: Extrapolating data and causing
error is when you look at a past trend and assume that
trend is going to continue into the future.
Causation & Correlation: To observe two variables
that change together and conclude that a change in one
variable causes a change in the other variable.
- Often, this leads to the ‘faulty causation
fallacy’, where we mix up correlation with
causation.
- Causation refers to a cause-and-effect relationship between two variables, i.e. where a
change in one variable produces a change in the other, ceteris paribus (all else being
equal).
- Correlation refers to an assessment that two variables have moved together, so that they
appear to be related. This might be because of a cause-and-effect relationship, but not
necessarily.
Causation vs Correlation: When two variables (A and B) move together in the same direction
(positive correlation) or opposite directions (negative correlation), it might be because A causes
,B. However, it might also be because: B causes A (reverse causation). Alternatively a third
variable (C) could cause (A and B) to appear related.
Spurious: It just happens because the data says it happens, however there is no relationship at
all.
Examples:
Consider the following three situations. Are these relationships causal (does a change in the
first variable cause the change in the second variable)?
● Students who brush their teeth get higher grades in school
- The data shows this however it is a correlation, brushing teeth is not causal to better
grades, there is likely to be a third variable causing better grades in the sample.
● Players who play violent video games are more likely to commit acts of violence
- This is no causal either, this is reverse causation - people who are naturally more violent
are more likely to play violent video games.
● In years where per capita cheese consumption is higher, more people have died by
becoming tangled in their bedsheets
- This is not causal, this is an example of spurious correlation. Where the data shows the
accuracy of the statement however there is no relation between the two variables.
Economic Models
How do we avoid making simple extrapolation and faulty causation errors?
- By using an appropriate model to extrapolate, or to explain relationships
A model is an abstraction or simplification of reality, e.g.
- A map
- A model aircraft
- A mathematical or theoretical model
An economic model is an explanation of how the economy, or part of the economy, works, e.g.
- We will use our first simple model of production shortly
A good model:
● Is clear: it helps us better understand something important
● Predicts accurately: its predictions are consistent with evidence
● Improves communication: it helps us to understand what we agree (and disagree) about
● Is useful: We can use it to find ways to improve how the economy works
Basic Economic Concepts
, ● Economics is about using models, and most models are about explaining choices.
Before describing economic choices, we need to have some basic concepts in mind:
● Ceteris paribus is an assumption we make in economic models. It translates as “other
things being equal” and it means that when we look at a change in the model, we are
assuming that everything else (including things that are not in the model) doesn’t change.
Everything else being equal.
● Incentives are economic rewards or punishments that influence the benefits and costs of
the alternatives that a decision-maker can choose. Influence our decision making - costs
go up we do less of it, benefits go up we do more of it.
● The relative price is the price of one good compared to another, which helps us to
compare alternatives.
● Economic rent is a payment or other benefit that a decision-maker receives above and
beyond what they would have received in their next best alternative. The profit that they
received by choosing the best option - how much better is A than B.
Opportunity Cost:
● When we choose one alternative we are also choosing to set aside (or forego) the other
alternatives we could have chosen.
● The opportunity cost is the cost of not pursuing the opportunity of doing something else -
any time you choose one thing, there is a cost to it - the cost of what you have given up.
● We can measure the opportunity cost of a decision as its’ cost measured in terms of the
best possible alternative foregone (i.e. we measure the opportunity cost as the value of the
best alternative we didn’t choose).
Explaining the Industrial Revolution
Observations of the Industrial
Revolution
, ● For most of history income was flat and consistent.
● Suddenly GDP per capita skyrockets.
Explain why the Industrial Revolution happened in Britain (rather than France or China or
somewhere else), using a model.
A simple model of production, can show how changes in relative prices create incentives for
innovation and ultimately created the conditions underlying the Industrial Revolution.
A model of production to explain the Industrial Revolution
Consider a simple model involving the choice between two inputs into production – with the
amount of one input (labour = L) measured on the x axis, and the amount of the other input
(capital = K) measured on the y axis
Different combinations of the two inputs (L,K), which we can refer to as “different production
technologies”, will produce different amounts of output
However, some production technologies will produce the same amount of output
How can we decide which production technology we should use?
The Production Decision
Let’s say that the firm wants to produce a total amount of production equal to X, and has several
production technologies (combinations of labour and capital) to choose from
We can easily eliminate any combination of L and K which requires more of both inputs than
some other technology
We say the eliminated combination is dominated by the better production technology
How do we decide among the remaining options?
Let’s assume the firm is trying to maximise its profits (profits are the firm’s economic rent from
this production decision)
The profit-maximising production technology will be the one that has the lowest cost to produce
X
Iso-Cost Line
An iso-cost line is a line that links all of the combinations of the inputs that have the same total
cost. Consider our simple two input model. The equation for total cost is:
𝑇𝐶=𝑝×𝐾+𝑤×𝐿
We can rearrange this into the equation for a straight iso-cost line with total cost equal to TC:
𝐾=𝑇𝐶/𝑝−𝑤/𝑝. With a y-intercept of TC/p and a slope of -w/p
● All iso-cost lines have the same slope (equal to -w/p, which is the relative price of the
two inputs)
- The only difference between them is the total cost (TC)
