Topic 1: What is Economics?

ECO 1001: Introduction to Economics (Spring 2022)

Ayush Pant
How some others have • Grade 11-12
responders in the UK

responded • What may this result

in?
• If MONEY is what one thinks about in economics, then we seek its management
as the sole purpose of economics.

• When economists potentially fail at doing so, then…

Bashing economics is common among
students and journalists.
Doing so is worrisome.
 Very worrisome…

Dr. Raghuram Rajan, MIT Econ Ph.D. with Shaktikanta Das, the first non-economist in
around 30 years of academic experience around 30 years holding such a position.
and perfect record.

Many such examples. Can you suggest others?

So, what is economics?
• It seems I have been hinting that economics is more than money.

• So, then, what is it? Any suggestions?

Economics is what economists do!

• This may sound rather silly but let’s begin by exploring what exactly is it that
economists do.
And what do economists do? A starting point: Google it!
Let’s hear directly from some economists…
… and a couple of more economists describing
their research
It seems what identifies economics are the
topics we study.
• What kind of food to purchase

• Whether to educate children

• How to make complex purchases

• When to persecute

• How much to pollute

• How to select among a pool of candidates…

… and many more.

Economics is the
“science” of human
behavior and choices
as a relationship
A natural question: How is
between ends and
economics different from
scare means that psychology, sociology,
have alternate uses. neurosciences, etc.?
 • Economists use

1. theoretical modeling, and

We differ 2. empirical analysis.

in our • We will look at both and what the critics

methods. have to say about them. Doing so will allow

us to put things in perspective, and
understand what economics really is.
 Theoretical modeling
• Economists usually construct mathematical models of real-life
choice situations under certain assumptions.

• One may ask a lot of questions about theoretical modeling:

o Why model?

o Why mathematics?

o What assumptions? Why any assumption?

Can you try answering these questions before going further?

Why model?
A realistic map of Delhi Metro

• How helpful is it in guiding you

from T3 to Sector 56, Gurgaon?
A “model” map of Delhi Metro

• Is this more efficient?

A model is a simplification
of the reality to help
understand it better.

• What
simplifications/assumptions
have been made here?

• Are they valid?

A model, by definition, will make
assumptions to simplify the reality.
• Making unreal assumptions is a
necessary evil – models do not
become bad simply because they
are making certain assumptions.

• Why might one call this a bad

model of the Delhi Metro?
• The answer lies in the assumptions.

• We do not expect commuters to

make their journeys based only on
the Metro color line.
Models of human behavior are more
complex than the models of Delhi metro.
What explains the rise of right-wing nationalism in our country?

• Drawing room conversations would lead us to believe that it is

because we are all “crazy.”

• But “crazy” explains any human phenomenon.

o Supporters of the current government name call non-supporters and vice vera.

• Unfortunately, assuming crazy cannot be the way forward or be called

science. Instead, we assume rationality.
Models of human behavior are more
complex than the models of Delhi metro.
What explains the rise of right-wing nationalism in our country?

• Rationality is preference maximization, whatever that may be.

o What does a typical voter want? What do different voters want?
o What do you think? Give your answer in one-two words here.

• Preferences are context-dependent.

o When investing in stock markets, one wants maximum monetary return.
o When making decision on a child’s behalf, parents take their happiness into account.
o When making donations, one probably has altruistic motives in mind.
Models of human behavior are more
complex than the models of Delhi metro.
What explains the rise of right-wing nationalism in our country?

• But isn’t assuming rationality as crazy as assuming crazy?

o You and I may disagree on the underlying preferences that lead to the observed data.

• Let us see where logic can lead us based on our assumed preferences.
Whether our result is intuitive and grounded will resolve our differences;
newer ideas (forces) may come out of it.

• Mathematics is merely the language of logic that we use to assess our

models and make them consistent and comparable.
Economists don’t use mathematics because they are smart, it is because we are
stupid.
-anonymous Nobel laureate
A model is a simplification of the reality to understand the
underlying forces observed in the real-world.

Mathematics – or more precisely, logic – is the common language

of economic modeling.

• Remember, mathematics and logic do not lie!

By design, we make certain simplifications in a model. These are

called assumptions.
Critics’
views on
economic
modeling
Critics’ wishlist Nobel wins in the past decade for research
done the past 40 years

Nobel Year Achievement/contribution

Dale Mortensten and Chris Pissarides 2010 Imperfections in labor markets – search
frictions

Alvin Roth 2012 Exchange in the absence of markets –

market design

Jean Tirole 2013 Regulation of monopoly power

Angus Deaton 2015 Wealth and income inequality; consumption,

poverty and welfare

Richard Thaler 2017 Altruism and irrationality

Abhijit Banerjee, Esther Duflo and Michael 2019 Experimental approach to alleviating global
Kremer poverty
We understand the limitations of our
theoretical models.
• Rationality may be problematic.
o Does everyone make decisions with full knowledge of their preferences?
o What about the role of emotions?

• Overemphasis on logic may limit our toolbox and the questions we ask.

• A theoretical model is still a “figment of our imagination” unless tested with

data.

• Ideally, theoretical modeling backed with empirical results.

How important is theoretical modeling in
Economics?
• If you were to believe the critics,
Share of articles

Impenetrable
mathematics
100%

• What do you think is the share of published economic theory articles?

How important is theoretical modeling in
Economics?
• The reality:
Share of articles
1
23%

3
53%
2
24%

1 2 3
Empirical analysis is key to Economics.

• Economists extensively use primary (and secondary) data to

understand how people behave and to evaluate policies.

• The main challenge is measuring causality.

o Turning the switch off causes the light to go off. This is obvious to us.

o Consider the alien’s problem who is visiting the Earth for the first time.
 The alien’s problem

• All residents in a city are carrying

umbrellas and it is raining. The two
are correlated.

• But did carrying an umbrella cause

the rains or the other way round?

• We are like these aliens who are trying

to figure out our societies.
A more concrete
example.
• Let’s say that the share of students who
get into an IIT is 25% in School P vs. 5% in
School G.
o School P is a private school and
School G is a government school.
o Suppose getting into an IIT is a good
thing, so that we want that to happen.

• Does School P cause the students to do

better?
A more concrete
example.
• This is a non-trivial question. What may
cause issues in our estimation?
o School P has students whose parents
can afford expensive tuition.
o School P selects brighter students.
o School P has better peers.
o In either case, the (quality of the)
school does not cause the students to
do better.
 Establishing causality

Imagine two parallel universes, identical in every way except for

Heena’s school choice.
School G School P
 Establishing causality
• But it is impossible to find examples of such parallel universes in the real
world.

• Most economists try to create the equivalent of parallel universes on a day-

to-day basis.
o Find ways to keep everything the same but for the policy or treatment we want to
evaluate.
o You will study the many techniques of doing so in your various courses here at Ashoka.
o A first one: Randomized Control Trial (RCT)
What is an RCT? Why randomize?
Next best thing to creating parallel universes:

• Split the population randomly into two groups and offer the policy to a selected
group.

• Randomization allows us to observe similar individuals under all but one different
scenario.

• The same things that affect one group are expected to influence the other group in
all other dimensions.

• As a result, separates out the effect of the policy among the selected group.
Further note on RCTs

• RCTs have taken the world by storm in the last 15-20 years.

• Are RCTs a silver bullet?

o Offer is random, compliance is not – cannot force people to take the
policy, or to even stick with it.

o Control group can be contaminated by the existence or knowledge of

treatment – Experimenter effect.
Quick FAQs on “creating” parallel universes
1. Is randomization always necessary?
o No, but a valid counterfactual is. There are other methods available.

2. Is a pilot enough?
o For troubleshooting: yes, for evaluation: no.
o Scaled up interventions have general equilibrium effects, i.e., what happens in the big picture when all
forces interact with one another.

3. Aren’t qualitative methods more informative?

o Interviews are a good way to uncover mechanisms and are complementary to systematic data
collection.
o They are not substitutable.
Bringing
everything
together with
an example…
• What is Economics?

• Economics for policy

• The role of economic theory and

evidence-based policy-making
 • Policy challenge: How to get the medical staff to
Oriana Bandiera (LSE)
remote villages?
and her journey to
• Policy: Select nurses from the local community,
Zambia in 2010…
train them and send them back to the villages.
 Mr.
Mwila’s
concern
 Nurses’ dilemma
Whether to incorporate the new nurses (CHA: Community Health Assistants)
into the hierarchy of the ministry or keep them separate.

Gives the new nurses a career path as Severs their ties with the local
they participate in the hierarchy of the
community.
ministry.
• What does it do to their motivation?
• What does it do to their motivation?

• Increases extrinsic motivation. • Decreases intrinsic motivation.

 The question
Who is more effective in
delivering public services –
intrinsically motivated or
career-driven extrinsically
motivated individuals?
 • Zambia is a large country with 48 districts
with a (fairly) homogeneous population.
Think like an • Program to be implemented nationwide.
economist -
• Split Zambia’s 48 districts randomly into
“Creating”
parallel two equal- sized groups of districts:

universes 1. Social benefit/community group

2. Career opportunities group

• Randomized Control Trial.

Recruitment adverts in the two groups
Social Benefit Group Career Opportunities Group
One group did a lot better after 2 years…

• ⇑ institutional deliveries by 30%

• ⇑ children visits by 24%

• ⇑ children weighted by 22%

• ⇑ polio vaccination by 20%

• Share of malnourished children fell by 25%

Can you guess which group? Click here.
Understanding the forces
at play
• To replicate the results in other locations, we
must understand not only which group did
better but why did it to do better.

• Let us build an economic model:

o It must be a simplification of the reality to

understand the forces at play.

o It must be based on logic.

Think like an economist – Building
models
Go back to our “definition” of economics:
Potential applicants

Economics is the science which studies human behavior as a

relationship between ends and scarce means which have
alternative uses.
What do the potential What is scarce here?
applicants want?
Assumption 1: Applicants differ in their levels of social motivation.

Social motivation
Assumption 2: Applicants care about money and helping others.
Low rewards

Social motivation
Medium rewards

Social motivation
High rewards

Social motivation
 Material benefits

Social motivation
Implication 1: Other things equal, increasing material benefits attracts
less prosocial applicants.
Are we
forgetting
something?
Does the quality of work depend
only on intrinsic motivation –
here, prosociality?
Assumption 3: Applicants differ in their levels of ability.

Ability
Assumption 4: Higher ability are paid more in private sector.

Low rewards
Ability
 Medium rewards

Ability
 High rewards

Ability
 Ability Material benefits

Implication 2: Other things equal, increasing material benefits attracts

more talented applicants.
All possible applicants may be arranged as follows.
Understanding the effect of increasing material benefits

With low rewards

only low talent-
high social
motivation apply.
Medium
rewards get
some higher
ability
applicants as
well.
High rewards
open space for
both socially
motivated and
talented
applicants.
 ✔️

Key result: Higher rewards attract more prosocial and more talented
applicants and permits better candidate selection.
What role did an economic model play?

• Without the model, we were thinking of skills and prosociality as

separate elements.

• Combining the two changed the story: It is true that increasing the
monetary benefits brings in less generous applicants, but who cares?
o Application ≠ Selection

• But how do we know this was the case?

Their logic-driven results confirm their intuition.
COMMUNITY More skilled CAREER

<
Same prosociality

25% lower malnourished

children!
Scarce resources →
opportunity cost
• Applicants in Zambia could only do one job
– time is scarce.

• Becoming nurses required giving up their

private sector jobs.

• Talented people earn more in the private

sector.

⟹ Talented people only apply when given

enough incentives.

What would have been the impact of

believing Mr. Mwila’s naïve interpretation?!
The ideal method of Economic sciences
Start with a real-world or policy-relevant problem.

Recognize that the reality is complex and

proceed to build a model based on logic Make use of minimal assumptions in your model.
and intuition.

Your model should predict a causal link between two variables.

Collect adequate data to uncover the Use field or lab data or a combination of the two.
strength of the hypothesized causal link.
 Anecdotes vs. sciences

• A short amusing or interesting • The intellectual and practical activity of

story about a real incident or deriving evidence from the systematic

person. study of the structure and behavior (of

the social world) through observation
• Evidence derived from selected
and experiment.
histories.
 Anecdotes vs. sciences

• Dan Pink’s TED Talk – if you • Systematic meta-analysis of causal

reward people for doing well, they effect of incentives – if you reward

do badly. people for doing well, they do well.

• 19 million+ views on YouTube o Example: CHW in Zambia.

• Most cited article on incentives – Ed

Lazear, AER ’00 - 2.5 thousand cites.

For each person who has read Lazear’s paper, there are 7600 who have seen Pink’s video!
What you will do in this course
• I will provide a steppingstone into the world of Economics.

• We will look at many topics, but without going too deep into any of them.

• Combined these topics will show you how economists have thought of the world until now.

• Do not lose the big picture – Economics is not identified by its topics but by critical thinking
= logic + intuition + empirics .

You should go into the world and explore your own topics empowered with this tool.
Some
sources to
get into the
mode.
 Some
sources to
get into the
mode.