Introduction to Economics and Business

Reading questions: Week 4

Utrecht University School of Economics

ECB1IEBE
 Main question

What is the subject of macroeconomics?

▪ Macroeconomics is the branch of economics studying the behavior and performance of an economy
as a whole

▪ It focuses on the aggregates of the economy such as unemployment, growth rate, GDP and inflation

▪ It examines business cycles fluctuations and growth trend of the economy

 Question 2

What are the two typical issues dealt with in macroeconomics?

• Understanding macroeconomic fluctuations Real GDP

– answering why crises or unemployment
arise and, providing an intellectual basis for Recession
doing something about them
Expansion Growth trend

• Understanding long-term economic growth –

answering why growth in income and
employment arise and providing guidance on
Business cycle
how to foster them in the future

Time
 Question 3

How would you define macroeconomics?

1. Macroeconomics is the study of the relationships among aggregate quantities (or aggregates) such
as:
▪ GDP
▪ Employment, unemployment
▪ Inflation, interest rates, exchange rates
▪ The balance of trade (i.e., imports and exports)

2. Macroeconomics is the study of the economy taken as a whole

In most cases, the only practical way to study the economy as a whole is to use aggregates, so the two
definitions will typically pull in the same direction
 Question 4

What kind of phenomenon did set the stage for the creation of macroeconomics as a new field of economic analysis?
▪ Industrial Revolution brought about business cycles – difficult-to-understand alternation of good and
bad times

▪ By the 1920s, business cycles required a different sort of analysis from that appropriate to the behavior
of consumers and firms

▪ The Great Depression accelerated this reconceptualization of the required analysis

▪ As a reaction to this, macroeconomics then originated as a distinct field in the 1930s, created by
economists who wished to intervene in the economy to resolve the depression and to prevent future
recessions
 Question 5

Is macroeconomics a positive or a normative science?

• Two economists could agree on facts about how the economy works and its present condition – that is, they could
agree on a positive account of the economy (how things are in fact) – and still disagree about what should be
done (how we want them to be)

• Government being a part of the economy also blurs the dichotomy between a normative and a positive:
The goals of the policymaker are normative:
▪ Some hope to use policy to guide the economy to better outcomes
▪ Others wish to leave the economy to its own devices – which is itself a kind of policy

What the policymaker can do to achieve those goals is positive:

▪ Conduct rigorous macroeconomic analysis
▪ Use this information to inform policy, whichever direction policymakers, politicians, and citizens wish to take it
 Question 6

Is macroeconomics a social or natural science?

▪ Dichotomy: the fact that positive economics must account for the normative goals and actions of
policymakers is reflects the difference between social and natural sciences

▪ Inert matter: natural sciences can find relatively simple rules describing the behavior of inert matter
based on factual observations, whereas social behavior (e.g., beliefs, intentions, desires) can’t be
captured in the same way

▪ Precision: it will often suffice to understand what is typical about people, so prediction in social
sciences is rarely certain or precise
 Question 7

Why experimental method has not become a common methodology for macroeconomics? What kind of experiment is
possible in macroeconomics?

▪ Experiments are too hard: we simply do not know how, to manipulate different aspects of the
economy in order to control for all confounding factors
▪ Experiments raise ethical problems: we can hardly test the effects of unemployment on inflation
rates by intentionally creating mass unemployment
▪ Experiments can’t be simplified: we can’t observe a situation in which everything other than the
relationship of interest has been excluded, as economy is too complex to do such experiments on any
large scale
▪ Experiments can’t be repeated: we can’t observe the same population (or the same economy) with
the same initial conditions
 Question 8

What kind of role can models play in economics?

Models are meant to represent relationships allowing us to experiment on the model, even when we
cannot experiment on the thing that is modeled:

▪ Measuring instruments: measuring how sensitive one variable to changes in the other one (i.e.,
regression)

▪ A counterfactual experiment: altering the facts represented in the model to be different from what
they actually are in the world in order to answer a what-would-happen-if question

𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 = 𝛽 ∗ 𝐼𝑛𝑐𝑜𝑚𝑒 + 𝑟𝑎𝑛𝑑𝑜𝑚 𝑒𝑟𝑟𝑜𝑟

*random error is a deviation of the deterministic equation from a perfect fit to the data
 Question 9

What was Krugman’s original aim to address with the ‘New Economic Geography’ (about 20 years ago)?

▪ To make mainstream economists re-discover that “economies are not dimensionless points in space”.
Geography has an important role to play in the understanding of economic growth, yet this was
overlooked for decades

▪ To provide new insights for national economies that were becoming increasingly integrated (e.g., EU)

▪ To shed light on the worth of “intra-national” data, and the usefulness of differences between urban
and rural spaces in different research questions
 Question 10

What are the two main critiques about this New Economic Geography, which are addressed in this article?

▪ The geographers criticize this branch for reducing “the complexities and richness of economic
geography to stylized mathematical models” and claim that studying the development of real places
“requires recognition of local specificity and the role of historico-institutional factors”

▪ The economists criticize it for being too focused on forces that led to industrialization, manufacturing
hubs, and urbanization in previous centuries , rather than processes that are relevant to economic
development today or in the future. New Economic Geography was “more suited to the US economy
of 1900 than that of 2010”
 Question 11

What is Krugman’s response to the first critique?

▪ Different approaches offer both advantages and disadvantages, and both economics and geography should engage
with and cite each other more than they currently do

▪ While geographers are concerned with local specificity, economists are allowed to be concerned with more
abstract models, which yield conclusions that are useful in solving real-world economic problems

▪ Geographers can criticize economic models as being premature and poor in data, but quantitative and abstract
modeling can provide useful answers, the way Keynes came up with a simple two-equation model with a clear
answer to recessions: “boost demand with deficit spending”

▪ Economists want the ability to answer ‘what if’ questions: “if something were different, how would that change
the economic outcomes?”. It is impossible to answer this question with a geographers’ approach that emphasizes
the uniqueness of each individual case and the specifics of history
 Question 12

And how is this related to the original version of New Economic Geography?

▪ The original core-periphery model used only a few parameters (so-called ‘iceberg’ transportation
costs, economies of scale, and factor mobility) to produce conclusions about the agglomerated
structure of a simplistic economy

▪ The design of this approach was completely unrealistic and non-specific, the outcomes were reached
mathematically. The agglomeration outcomes themselves were condensed to three effects: market
access, cost of living and market crowding

▪ Yet, the model was not intended to be realistic, but “aggressively unrealistic”. It was supposed to
serve as a demonstration that economic models could yield new and interesting insights when applied
to geographical questions
 Question 13 and 14

What is Krugman’s response to the second critique? For which kind of economies is the New Economic Geography
best applicable?

▪ By focusing on tangible factors, like industry inputs, labour markets, and transportation costs, New Economic
Geography is more useful in describing the spatial dynamics of industrialization in America and Europe until the
mid 20th century

▪ Since then, intangible factors like knowledge spillovers and human capital have become increasingly important
to hubs in developed nations (e.g., Silicon Valley, New York, financial and political centers in the EU)

▪ Nevertheless, the original focus and conclusions of New Economic Geography are still highly predictive and
useful in understanding middle-income developing nations, especially industrialization and regional
specialization in China
 Question 15,16 and 17

What is the relation between macroeconomics and statistics?

▪ Macroeconomics uses statistical data to measure the aggregates (or economic behavior)
▪ Macroeconomics uses inductive methods of statistical and econometric inference (e.g., inferring general claims or
theories from individual observations), as we can’t employ the controlled experiments of the natural sciences
▪ Macroeconomic theories can be quantified and tested with statistical methods or models

How are geography and geometry related?

▪ Geometric models inform theories about space (and thus physical geography and economic geography)

Looking at the program of the dedicated minor Economic Geography, which of its geographical courses do you
expect to be related to New Economic Geography?
▪ All the courses relating to the role of geography in development, location or spatial theories, economics of cities
and clusters