Chapter 2 The tools of economic analysis

David Begg, Stanley Fischer and Rudiger Dornbusch, Economics , 8th Edition, McGraw-Hill, 2005 PowerPoint presentation by Alex Tackie and Damian Ward ©The McGraw-Hill Companies, 2005

Models and data

• Model – a framework based on simplifying assumptions – helps to organise our economic thinking • Data – the economist’s link with the real world – time series – cross section 1 ©The McGraw-Hill Companies, 2005

Real and nominal

• Many economic variables are measured in money terms • Nominal values – measured in current prices • Real values – adjusted for price changes compared with a base year – measured in constant prices 2 ©The McGraw-Hill Companies, 2005

Diagrams

… help to analyse patterns and trends in data Real fares 1989/90-2002/03 0.16

0.15

0.14

0.13

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0.1

19 89 /9 0 19 90 /1 19 91 /2 19 92 /3 19 93 /4 19 94 /5 19 95 /6 19 96 /7 19 97 /8 19 98 /9 19 99 /0 20 0 00 /0 20 1 01 /0 20 2 02 /0 3

3 ©The McGraw-Hill Companies, 2005

Diagrams (2)

… help to analyse patterns and trends in data No of trips 1989/90-2002/03 7.5

7 6.5

6 5.5

5 19 89 /9 0 19 90 /1 19 91 /2 19 92 /3 19 93 /4 19 94 /5 19 95 /6 19 96 /7 19 97 /8 19 98 /9 19 99 /0 20 0 00 /0 20 1 01 /0 20 2 02 /0 3

4 ©The McGraw-Hill Companies, 2005

Diagrams (3)

… help to analyse patterns and trends in data Real revenue 1989/90-2002/03 1300 1200 1100 1000 900 800 700 600 198 9/ 90 199 0/ 1 199 1/ 2 199 2/ 3 199 3/ 4 199 4/ 5 199 5/ 6 199 6/ 7 199 7/ 8 199 8/ 9 199 9/ 00 200 0/ 01 200 1/ 02 200 2/ 03

5 ©The McGraw-Hill Companies, 2005

Economic models:

an example

• To organise our thinking we need a simplified picture of reality • focusing on key elements • Quantity of tube journeys demanded = f(Prices, income, preferences) 6 ©The McGraw-Hill Companies, 2005

Relationships

Diagrams help economists to explore relationships between economic variables Fares and revenues 1989-2003 15 14 13 12 11 10 650 750 850 950 Real revenue (£m 1998/9 prices) 1050

7 ©The McGraw-Hill Companies, 2005

Evidence in economics

• Scatter diagrams help us to confront economic theory with empirical reality •

Econometrics

takes this further using statistical techniques • Evidence may allow us to reject a theory • or accumulate support for it 8 ©The McGraw-Hill Companies, 2005