Principles of Economics
Sylvain Barde
The rules of the game
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Lectures
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Seminars
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The marking: exams and exercises
The lectures
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14 weeks times 2 hours
Attendance to the lectures is compulsory
Make sure you do the reading each week
Prepare questions on lecture points or the
reading that seem unclear
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Do not hesitate to ask questions during the
lecture
The course outline and lecture slides will be
made available on the ENTG
The seminars

A short seminar will be organised during
the first half hour of each lecture.
To go over the exercises for the week
 To clarify problematic points

Make sure you prepare the exercises,
they are part of the learning process !
 The exercises to be prepared for each
week are given in the course outline
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Exams and marks
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The overall mark for the module is a
weighted average:
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2/3 given by the seminar marks
1/3 given by final exam
The final exam is composed of
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Multiple choice questions
Review questions
A standard exercise
An applied exercise
Exams and marks
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The seminar mark is composed of
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50% : 3 « galops d’essai » (mock exams)
30% : average exercise mark
20% : personal mark, that takes into account
participation, turnout, etc.
The average exercise mark (incentives!) :
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You are free to hand in exercises every week
The mark is the average of your best 6 results
If you hand in less than 6 exercises, then your
average takes in the extra 0’s needed to make up the
6 marks...
Principles of Economics
Introduction
Principles of Economics
What is economics ?
The microeconomic approach
Modelling and microeconomics
What is a function ?
What is economics ?

“A cool head and a warm heart”

The centuries of human history reveal [-] that warm
hearts are not enough to feed the hungry and heal
the sick. Finding the best course to follow on the
road of economic progress requires a cool head, that
weighs objectively the costs and benefits of the
possible alternatives while keeping the analysis free
from wishful thinking, as much as is humanly
possible. (Paul Samuelson)
What is economics ?

Understanding the mechanisms behind market
economies

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This gives a better understand the issues that our
societies face and the policies that try and address
them.

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Ex: gains from trade, incentives and disincentives,
asymmetric information
Ex: global warming, poverty reduction, the subprime
bubble, etc.
Acquire skills that will serve you beyond SciencesPo and into your future occupations
Normative and positive economics

“Positive” statements:
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Are objective statements on the way the economy works,
typically extracted from a model
They can be shown to be true or false when checked
against facts
“If taxes on tobacco are raised, the price of cigarettes will
increase”
“Normative” statements:



Prescribe courses of action based on value judgements
They cannot be shown to be true or false, as these
categories do not apply here !
“Taxes on cigarettes should be increased to put smokers
off”
Micro and Macroeconomics

Microeconomics
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The study of the behaviour of individual agents
and their interactions
The main focus is on obtaining economically
meaningful insights from the optimising
behaviour of individual agents
Macroeconomics

The analysis of aggregated economic variables :
the unemployment rate, GDP, money, inflation,
growth, etc
Overall course outline
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Fall term : Microeconomics
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Theories of the agent
Market structures and equilibrium
Microeconomic issues and public intervention
Spring term : Macroeconomics
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Equilibrium in the goods market and the money
market
Relaxing the fixed price hypothesis
International growth and trade
Principles of Economics
What is economics ?
The microeconomic approach
Modelling and microeconomics
What is a function ?
The microeconomic approach

Microeconomics tries to understand the
behaviour of agents
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Resources are limited, therefore agents have
to make choices.
These depend on the incentives faced by the
agent
Because agents are different, they can benefit
from exchange
Producers and consumers therefore meet on
markets that ensure an efficient use of these
resources
The microeconomic approach

The aim of microeconomics if to answer the
following questions of consumers and
producers:
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What to consume ? (Which combination of
goods ?)
How much (Under which constraint ?)
What to produce ? (Which good ?)
How to produce it ? (Which technology ?)
How much to produce ? (Under which
constraint ?)
The microeconomic approach
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In order to answer these questions and
understand how agents make their
decisions, microeconomics models the
decision making process of the agent
These decisions are then “aggregated” in
order to obtain the decisions at the level of
a market.
But how can a simple model explain the
depth and complexity of human behaviour ?
Principles of Economics
What is economics ?
The microeconomic approach
Modelling and microeconomics
What is a function ?
Modelling and microeconomics

What is a model ?

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“A simplified representation of reality”
In other words, a representation which removes
the unnecessary complexity of reality to focus on
the key mechanisms of interest
“A model’s power stems from the
elimination of irrelevant detail, which allows
the economist to focus on the essential
features of economic reality.” (Varian p2)
Modelling and microeconomics
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It is important to understand that models are
central to how humans perceive reality
Human understanding of the world (not just in
economics !) comes from understanding
simplified versions of a complex world.

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The role of the scientific process is to separate
good and valid simplifications from invalid ones.
“One must simplify to the maximum, but no
more” Albert Einstein
Modelling and microeconomics

Illustration of a general, simple “model”
You are in Nice
 You don’t know your way around, and you
get lost.
 You ask a passerby where you are
 This person gives you two possible
answers as to your location


Which is the more useful (i.e. instructive
model) ?
Modelling and microeconomics
You are here
Modelling and microeconomics
You are here
Modelling and microeconomics

Modelling in microeconomics
Assume a simplified agent and
environment (even if you know that this is
unrealistic)
 Understand how things work in this ideal
situation.
 Then relax the simplifying assumptions
one by one and see how the mechanisms
change

Modelling and microeconomics
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The simplified agent used is typically called
the “Homo œconomicus”
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Has complete knowledge of his objectives
(preferences or production quantities)
Has complete knowledge of the conditions on all
the markets (perfect information)
Has a very large “computational capacity” to work
out all the possible alternatives and their
payoffs.
These simplifications can be relaxed
Principles of Economics
What is economics ?
The microeconomic approach
Modelling and microeconomics
What is a function ?
What is a function ?


“ Many undergraduate majors in
economics are students who should know
calculus but don’t – at least not very well”
(Varian, preface)
So before starting on the models and the
theory, it is important to understand the
components of models : functions
What is a function ?

A function is a relation between one
variable and a set of other variables
A variable is a quantity that can change
values and be measured on a given scale
 Temperature, pressure, income, wealth
etc.
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For example, crop yields (in kg/m2) are a
positive function of average rainfall (in
cm/m2), average sunlight (in W/m2) and
temperature (in ˚C)
What is a function ?

The same function can have different “faces”

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The same relation between variables can be
expressed in different ways
1: “Literary” representation
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This is the one from the previous slide, and
involves just mentioning the variables that enter
the function
“Crop yields are a positive function of average
rainfall, average sunlight and temperature.”
What is a function ?

2: Symbolic representation

A bit more “rigorous”, this uses symbols to
represent the relation between variables

y  f r , s, t
  

Mathematical symbol meaning “function of”


Where y is the crop yield, r is average rainfall, s
is average sunlight and t is temperature.
But... When read out, this just corresponds
to the literary version !!
What is a function ?

3: Algebraic representation

This is the “scary” one, because it involves
“maths” (algebra, actually)
y  10  0.9r  0.5s 2  et
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The problem is that to express a function this
way, you need to know exactly:
 The “functional form” (Linear, quadratic,
exponential)
 The values of the parameters
Finding these is often part of the work of an
economist
What is a function ?

4: Graphic representation

y
(kg/m2)
Often the most convenient way of representing a
function...
Crop yields as a function of rainfall

y  f r , s, t
r
(cm/m2)
  

What is a function ?


y
(kg/m2)
... But a diagram can only represent a link
between two variables (y and r here)
If temperature t increases, then a whole new
curve is needed to describe the relation
Crop yields as a function of rainfall
t1>t
y  f  r , s, t1 
  
y  f r , s, t

r
(cm/m2)
  

What is a function ?

The microeconomic approach examines the
decision of the agent: its aim is to choose
the “best” possible outcome
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The highest “satisfaction”, for consumers
The highest profit, for producers
Imagine a function f that gives satisfaction
(or profits) as a function of all the quantities
of goods consumed (or produced).
satisfaction  f  q1 , q2 ,..., qn 
What is a function ?

In terms of modelling, finding the “best
choice” is effectively like trying to find the
values of the quantities of goods for which
function f has a maximum
satisfaction
Maximum
Graphically, that’s easy!
But generally, how do
you find this maximum ?
q
What is a function ?

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One can find the maximum (or minimum)
of a function by finding the point for
which the slope is equal to zero.
Imagine you are climbing a mountain
blindfolded.
How do you know when you’re at the top?
 When you feel like you’re walking on a flat
surface !

What is a function ?
Y
Slope = 0
B
A
C
Slope < 0
Slope > 0
1
s
1
-s
X
What is a function ?
So we know we can find a maximum (the
“best” choice”) when the slope of the
relevant function is zero
 But we still need to find a way to
calculate the slope of the function !

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This is where calculus comes in:

The first derivative of a function gives us
this slope.
What is a function ?

Lets go back to our function f
y  f  x
The first derivative is the function f’ such
that
dy
s
 f  x
dx
Is the slope of f at point x
 Given a functional form for f, the first
derivative can be found using the
following, simple, rules

What is a function ?
f  x
f  x
k (constant)
0
x
1
ln x
n x n 1
1
2 x
1x
ex
ex
x
n
x
What is a function ?

Partial derivatives

What if the function f is a function of several
variables ? (often the case in economics !)
z  f  x, y   x2  y3

Several slopes can be calculated (as many as
there are variables, 2 in our case)

Each is calculated by treating the other variables
like constants
What is a function ?
z  f  x, y   x  y
2
3

Partial derivative of f with respect to x

z
 f x  x, y   2 x
x
Partial derivative of f with respect to y
z
 f y  x, y   3 y 2
y