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Introduction to Economics-khan Academy

Introduction to Economics-khan Academy

By: Kevin

20 Mar 2013

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Speaker: As we begin our journey into the world of economics, I thought I would begin with a quote from one of the most famous economists of all times, the Scottish philosopher Adam Smith, and he really is kind of the first real economist in the way that we view it now and this is from his, “The Wealth of Nations” published in 1776, coincidentally the same year as the American Declaration of Independence and its one of his, the most famous excerpts, “He generally, indeed...”, he being an economic actor, “neither intends to promote the public interest, nor knows how much he is promoting it. By directing that industry”, so the industry in control of that individual actor, “in such a manner as its produce may be of the greatest value, he intends only his own gain,” he intends only his own gain “and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.” And this term invisible hand if famous, “led by an invisible hand to promote an end which was no part of his intention.” He is saying, ‘look, when individual actors just act in their own self interest that often in aggregate leads to things that each of those individual actors did not intend’.

And then he says, “Nor is it always the worse for society that there was no part of it”, so it’s not always necessarily a bad thing, “by pursuing his own interest he frequently promotes that of the society more effectually than when he really intents to promote it”. So this is a pretty strong statement, it’s really at the core of capitalism, and that’s why I point out that it was published the same year as the American Declaration of Independence, because obviously America the founding fathers they wrote the Declaration of Independence, the Constitution, it really talks about what it means to be a democratic country, what are the rights of its citizens, but the United States in its overall, the overall experience of an American is at least as influenced by the work of Adam Smith, by these kind of foundational ideas of capitalism and they just both happened to happen around the same time.

But this idea, it’s not always that intuitive, individual actors by essentially pursuing their own self-interested ends might be doing more for society than if any of them actually tried to promote the overall well-being of society. And I don’t think Adam Smith would say there is always good for someone to act self-interested or that it's never good for people to actually think about the implications of what they're doing in an aggregate sense, but he's saying that frequently, frequently the self-interested action could lead to the greater good, could lead to more innovation, could lead to better investment, could lead to more productivity, could lead to more wealth, more a larger pie for everyone.

And now economics is frequently, and when he makes this statement, he is actually making a mix of a microeconomic and a macroeconomic statement. Micro is that people, individual actors are acting in their own self-interest and the macro is that it might be good for the economy or for the nation as a whole and so now modern economists tend to divide themselves into these two schools or into these two subjects, microeconomics - microeconomics which is the study of individual actors - microeconomics, and those actors could be firms, it could be people, it could be households and you have macroeconomics which is the study of the economy in aggregate - macroeconomics.

And you get it from their words, micro the prefix refers to very small things, macro refers to the larger, the bigger picture and so microeconomics just to restate it is essentially how actors make decisions, make decisions or I guess we could say allocations - decision/allocations, allocation of scarce resources and you are going to hear the words scarce resources a lot when people talk about economics. And a scarce resource is one that you don't have an infinite amount of, for example love might not be a scarce resource you might have an infinite amount of love, but a resource that would be scarce is something like food or water or money or time or labor these are all scarce resources and so microeconomics is, well how do people decide where to put those scarce resources, how do they decide where to deploy them, and how does that affect prices and markets and whatever else.

Macroeconomics is the study of what happens in aggregate to an economy, so aggregate what happens in aggregate to an economy from the millions of individual actors, aggregate economy. We now have millions and millions of actors and it often focuses on policy related questions, so do you raise or lower taxes, or what’s going to happen when you raise or lower taxes. Do you regulate or deregulate, how does that affect the overall productivity when you do these, so its policy, top down, top down questions.

And in both macro and microeconomics there is a, especially in the modern sense of it there's an attempt to make them rigorous, to make them mathematical, so in either case you can start with some of the ideas, some of the philosophical ideas or the logical ideas that say someone like an Adam Smith might have so you have kind of, you have these - and they were basic ideas about how people think, how people make decisions, so philosophy of people of decision-making in the case of microeconomics, decision-making; and then you make some assumptions about it or you simplify it, so I will do the right, this you simplify it and you really are simplifying, you say all people are rational or all people are going to act in their own self-interest, or all people are going to maximize their gain, which isn’t true, human beings are motivated by a whole bunch of things but you simplify these things so that you can start to deal with it in kind of a mathematical way.

So you simplify it so you can start dealing it, within a mathematical sense and this is valuable, it can clarify your thinking, it can allow you to prove things based on your assumptions and so, and you can start to visualize things mathematically with charts and graphs and think about what will actually happen with the market. So it is very-very valuable to have this mathematical rigorous thinking, but at the same time it can be a little bit dangerous because you're making these huge simplifications and sometimes the math might lead you to some very strong conclusions, conclusions which you might feel very strongly about because it looks like you’ve proven them the same way that you might prove relativity, but they were based on some assumptions that either might be wrong or might be oversimplifications or might not be relevant to the context that you're trying to make conclusions about.

So it's very-very-very important to take it all with a grain of salt, to remember that it's all based on some simplifying assumptions. And macroeconomics is probably even more guilty of it, in microeconomics you are taking these deeply complicated things, the human brain, how people act and respond to each other and then you're aggregating it over millions of people, so its ultra complicated, you have millions of these infinitely complicated people all interacting with each other so it's very complicated, many millions of interactions and fundamentally unpredictable interactions and then trying to make assumptions on those, trying to make assumptions and then doing math with that, that could lead you to some conclusions or might lead you to some predictions and once again it's very important, this is valuable it's valuable to make these mathematical models, to make these mathematical assumptions, these mathematical conclusions but it always needs to be taken with a grain of salt.

And so that you have a proper grain of salt and so that you are always focused on the true intuition and that's really the most important thing to get from a course of economics, so that you can truly reason through what's likely to happen, maybe even without the mathematics, I’d leave with two quotes and these quotes are little bit, they are a little bit funny, but they really I think are helpful things to keep in mind as you start to especially go deep into the mathematical side of economics.

So this right over here is a quote by Alfred Knopf who was a publisher in the 1900s, “an economist is a man who states the obvious in terms of the incomprehensible”, and I'm assuming when he's talking about the incomprehensible he's referring to some of the mathy stuff that you see in economics and hopefully we will make this as comprehensible as possible and see that there is value in this but it's a very important statement he’s making, often times it is stating a commonsense thing, it’s stating something that's obvious, it's obvious and it's very important to always keep that in mind, to always make sure that you have the intuition for what's happening in the math or to know when the math is going in a direction that might be strange based on oversimplifications or wrong assumptions.

And then you have this quote over here by Laurence J. Peter, most famous for Peter's Principles, professor at USC; “an economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today”. And once again important to keep in the back of one's mind because especially, and this is especially relevant to macroeconomics because in macroeconomics there's all sorts of predictions about the state of the economy, what needs to be done, how long will the recession last, what will be the economic growth next year, what will inflation do and they often prove to be wrong, in fact few economists even tend to agree on many of these things and it's very important to realize that because oftentimes when you're deep in the mathematics of the economics it might seem to be a science like physics but it's not a science like physics, there's open, it is open to subjectivity and a lot of that subjectivity is all around, is all around the assumptions that you choose to make.