Prior Questions Question of method Micro vs.

Macro Schools of thought

Economics II
Lecture slides I

Avishek Konar

Assistant Professor
Jindal Global Law School

February 9, 2019

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Before we begin with Macroeconomics

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

What is economics?

What is economics?

One can come up with multiple book definitions. Let us consider a

couple.

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

What is economics?

What is economics?

One can come up with multiple book definitions. Let us consider a

couple.
1. Study of the allocation of scarce resources

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

What is economics?

What is economics?

One can come up with multiple book definitions. Let us consider a

couple.
1. Study of the allocation of scarce resources
2. The study of how we sustain life and enhance it’s quality. This consists
of four essential activities:

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

What is economics?

What is economics?

One can come up with multiple book definitions. Let us consider a

couple.
1. Study of the allocation of scarce resources
2. The study of how we sustain life and enhance it’s quality. This consists
of four essential activities:
(i) Production
(ii) Consumption
(iii) Distribution
(iv) Resource maintenance

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

What is economics?

What is economics?

One can come up with multiple book definitions. Let us consider a

couple.
1. Study of the allocation of scarce resources
2. The study of how we sustain life and enhance it’s quality. This consists
of four essential activities:
(i) Production
(ii) Consumption
(iii) Distribution
(iv) Resource maintenance
It is tempting to immediately jump to ask what the difference
between micro and macro is. But I would want us to spend some
time on the question of method before we proceed to that question.

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Methodological Individualism

The philosophical premise on which modern economics, also called

neoclassical economics, is based is called methodological
individualism.

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Methodological Individualism

The philosophical premise on which modern economics, also called

neoclassical economics, is based is called methodological
individualism.
Methodological Individualism is the idea that social phenomena are
results or outcomes of individual decisions or actions.

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Methodological Individualism

The philosophical premise on which modern economics, also called

neoclassical economics, is based is called methodological
individualism.
Methodological Individualism is the idea that social phenomena are
results or outcomes of individual decisions or actions.
Just as objects are composed of atoms, society is comprised of
people. One way to approach the problem would be to study the
atoms to say something about the object.
Similarly, to understand social phenomenon, contends MI, it is
imperative that we understand, and hence model, individual decision
making.

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Methodological Individualism contd.

Economists are ultimately interested in the social phenomenon —say

the allocation that comes about due to perfect competition and the
prices that are determined in the market. But individual decisions and
choices are causal intermediaries. To have any bearing on social
outcome via policy making, economists need to understand individual
choices.
In microeconomics, you will recall, we set up an axiomatic structure to
understand individual behaviour: start with assumptions on preference
(rationality etc.), then reach conclusions via deductive logic. The idea
is that we can aggregate this to understand social phenomenon.

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Methodological Individualism contd.

Economists are ultimately interested in the social phenomenon —say

the allocation that comes about due to perfect competition and the
prices that are determined in the market. But individual decisions and
choices are causal intermediaries. To have any bearing on social
outcome via policy making, economists need to understand individual
choices.
In microeconomics, you will recall, we set up an axiomatic structure to
understand individual behaviour: start with assumptions on preference
(rationality etc.), then reach conclusions via deductive logic. The idea
is that we can aggregate this to understand social phenomenon.
determines
Preferences −−−−−−→ Individual choice

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Methodological Individualism contd.

Economists are ultimately interested in the social phenomenon —say

the allocation that comes about due to perfect competition and the
prices that are determined in the market. But individual decisions and
choices are causal intermediaries. To have any bearing on social
outcome via policy making, economists need to understand individual
choices.
In microeconomics, you will recall, we set up an axiomatic structure to
understand individual behaviour: start with assumptions on preference
(rationality etc.), then reach conclusions via deductive logic. The idea
is that we can aggregate this to understand social phenomenon.
determines Aggregation
Preferences −−−−−−→ Individual choice −−−−−−−−→ Social phenomenon
over individuals

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Methodological Individualism contd.

Economists are ultimately interested in the social phenomenon —say

the allocation that comes about due to perfect competition and the
prices that are determined in the market. But individual decisions and
choices are causal intermediaries. To have any bearing on social
outcome via policy making, economists need to understand individual
choices.
In microeconomics, you will recall, we set up an axiomatic structure to
understand individual behaviour: start with assumptions on preference
(rationality etc.), then reach conclusions via deductive logic. The idea
is that we can aggregate this to understand social phenomenon.
determines Aggregation
Preferences −−−−−−→ Individual choice −−−−−−−−→ Social phenomenon
over individuals
Not the other way round! (Methodological Individualism)

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Structure in consumer behaviour

The structure of both consumer and producer behaviours are similar.

Let us try to recall one, to get an idea about the methodological
structure.

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Structure in consumer behaviour

The structure of both consumer and producer behaviours are similar.

Let us try to recall one, to get an idea about the methodological
structure.  
   
Preference + Budget Constraint = Choice 
 

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Structure in consumer behaviour

The structure of both consumer and producer behaviours are similar.

Let us try to recall one, to get an idea about the methodological
structure.  
   
Preference + Budget Constraint = Choice 
     
Choice
 =
 Individual demand 

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Structure in consumer behaviour

The structure of both consumer and producer behaviours are similar.

Let us try to recall one, to get an idea about the methodological
structure.  
   
Preference + Budget Constraint = Choice 
    
Aggregation over  
Choice
 =
 Individual demand  all−individuals
−−− −−−−−−→ Market demand 

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Structure in consumer behaviour

The structure of both consumer and producer behaviours are similar.

Let us try to recall one, to get an idea about the methodological
structure.  
   
Preference + Budget Constraint = Choice 
    
Aggregation over  
Choice
 =
 Individual demand  all−individuals
−−− −−−−−−→ Market demand 
We start with individual preference, make assumptions on what is
admissible as preferences, impose conditions of rationality etc. After
that deductive logic follows, and we reach individual demand. We
aggregate that to get market demand.
We will return to this conversation often, over this semester, to point
out that MI is a very important assumption in the terrain of
ideological contestation, and not a minor quibble on method.
Lecture Slides I Avishek Konar
Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Is any alternative method possible?

Consider a couple of examples:

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Is any alternative method possible?

Consider a couple of examples:
1. We observe more male students in math classes. We see even more
male faculty members in math/engineering departments than females
etc. Intuitive conclusion: women are not good at math?

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Is any alternative method possible?

Consider a couple of examples:
1. We observe more male students in math classes. We see even more
male faculty members in math/engineering departments than females
etc. Intuitive conclusion: women are not good at math?
2. Incidence of poverty is greater in black neighbourhoods.

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Is any alternative method possible?

Consider a couple of examples:
1. We observe more male students in math classes. We see even more
male faculty members in math/engineering departments than females
etc. Intuitive conclusion: women are not good at math?
2. Incidence of poverty is greater in black neighbourhoods.
MI would try to understand individual decisions/choices, where social
structures would be treated as constraints. However, the point of
entry would still be individual motivations/preferences.

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Methodological Individualism

Is any alternative method possible?

Consider a couple of examples:
1. We observe more male students in math classes. We see even more
male faculty members in math/engineering departments than females
etc. Intuitive conclusion: women are not good at math?
2. Incidence of poverty is greater in black neighbourhoods.
MI would try to understand individual decisions/choices, where social
structures would be treated as constraints. However, the point of
entry would still be individual motivations/preferences.
Another way of analyzing this would be to start with a social
structures (patriarchy, slavery, colonialism, racism) and then try to
understand how individual subjectivities are shaped, and how
structures impinge on individual choices. In short, opposite of MI.
As you can see, assuming MI implicitly implies our agreement on
things with political implications. Hence the need for cautious
thinking.
Lecture Slides I Avishek Konar
Prior Questions Question of method Micro vs. Macro Schools of thought

Microeconomics

Microeconomics

British economist John Maynard Keynes wrote a book titled The

General Theory of Employment Interest and Money in 1936. This
split up the discipline in to two subfields: microeconomics and
macroeconomics. We will discuss some of the history and politics of
this, but let us remind ourselves what this broadly classification
means, and why we should need to study macro at all.

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Microeconomics

Microeconomics

British economist John Maynard Keynes wrote a book titled The

General Theory of Employment Interest and Money in 1936. This
split up the discipline in to two subfields: microeconomics and
macroeconomics. We will discuss some of the history and politics of
this, but let us remind ourselves what this broadly classification
means, and why we should need to study macro at all.
Microeconomics focuses on how decisions are made by individuals
and firms and how they interact with one another. Examples:
Individual decision to allocate income between consumption, education,
health care, and savings.
Firms deciding how much coffee/sandwiches to produce etc.
Making a choice of what to purchase.

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Microeconomics

Macroeconomics?

Macroeconomics examines the aggregate behaviour of the economy

(that is, how the actions of all the individuals and firms in the
economy interact to produce a particular level of economic
performance as a whole).
Concerned with the determination of aggregate variables: Gross
Domestic Product (GDP), Unemployment level of the economy,
Inflation (increase in the overall price level in the economy, not a
particular price), Consumption levels, Savings and Investment levels
Can we not simply then add up or aggregate whatever we learned in
microeconomics? Why spend time and energy on macroeconomics at
all?

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Microeconomics

Macroeconomics: More than the sum of its parts

In macroeconomics, the behaviour of the whole economy is, indeed,
greater than the sum of individual actions of the constituents of the
economy (Individuals, firms etc.). We consider two examples, the paradox
of thrift and Jevon’s paradox.

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Microeconomics

Macroeconomics: More than the sum of its parts

In macroeconomics, the behaviour of the whole economy is, indeed,
greater than the sum of individual actions of the constituents of the
economy (Individuals, firms etc.). We consider two examples, the paradox
of thrift and Jevon’s paradox.
Paradox of thrift: When families and businesses are worried about
the possibility of economic hard times, they prepare by cutting their
spending, i.e. they save more per rupee income. −→ Intuitively, this
should lead to an ↑ in the overall savings of the economy −→
aggregate savings of the economy is either constant or ↓.
Reduction in the spending depresses the economy leading to a decline
in the overall income of individuals —hence individuals have less
money to save from, eventually leading to either a decline in the
aggregate savings of the economy, or saving remains constant.
Lecture Slides I Avishek Konar
Prior Questions Question of method Micro vs. Macro Schools of thought

Microeconomics

More than the sum of its parts: Another example

Jevon’s Paradox: Occurs when technological progress increases the
efficiency with which a resource is used (↓ amount necessary for one
person), but overall consumption of that resource ↑ Consider fuel
efficiency ↑ —this will lead to lower overall fuel consumption, and
potentially less resource use (even others). Two other effects kick in:
First, the demand for the particular resource in question (fuel in our
example) ↑, because it is cheaper, so although every person uses less
fuel, more people are now driving because it is cheaper to drive →
leading to a greater overall consumption of fuel
Secondly, since those who were using fuel in the first place are now
spending less on fuel, the amount of money they can spend on other
resources has ↑, leading to an overall ↑ in the consumption of other
resources.
Lecture Slides I Avishek Konar
Prior Questions Question of method Micro vs. Macro Schools of thought

Schools of thought in brief

The following is a brief and a broad brush presentation of two schools

of thought. In class, we have also discussed the history and politics of
it, which is more important than recognized.
Certain theories are in the mainstream of the discipline, not
necessarily because they are better or correct or others have been
disproved. A lot depends on the social and political times that we live
in, and we see some theories gaining prominence and others receding
to the margins.

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Schools of thought in brief contd.

We cannot talk about all schools of thought because of time

constraint among others. Primarily, we will be drawing attention to
two competing theories, which roughly we are going to call the
classical school and the Keynesian school.
What I want to underscore at the very outset is that there is no one
theory that is correct, or right. All of them depend on crucial
underlying assumptions. My endeavour it will be to draw attention to
some of the assumptions and how they work towards specific
conclusions, and then sometimes mention or point to other
possibilities even though we may not have time to discuss them in
detail. Students are expected not to learn any of these as the right
way of doing economics. They should try to carefully discern what
the main assumptions are and the results they drive.
Lecture Slides I Avishek Konar
Prior Questions Question of method Micro vs. Macro Schools of thought

Assumptions of the Classical school

Assumptions of the Classical school

Classical School
1. The economy is self regulating. Price adjusts instantaneously for such
regulation to happen. Markets are efficient, and problems (like those of
unemployment, recession) are best resolved by the market itself without
any government intervention.
2. Government intervention not only cannot help, more strongly, it will
actually make the problem worse.

Lecture Slides I Avishek Konar

Prior Questions Question of method Micro vs. Macro Schools of thought

Assumptions of the Keynesian school

Assumptions of the Keynesian school

Keynesian School
1. Economic slumps are created by inadequate spending or inadequate
demand.
2. Price is sticky, and there is no instantaneous adjustment in prices, at
least not in the short run. Hence, markets will not be completely self
regulatory.
3. Government intervention can increase aggragate demand (AD), and
hence get the economy out of recession via demand management
policies (fiscal or monetary policies).

Lecture Slides I Avishek Konar