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WHY STUDY ECONOMICS? JOHN MAYNARD KEYNES ANSWER “the ideas of economists and political philosophers, both when they are right and when they are wrong,

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Presentation on theme: "WHY STUDY ECONOMICS? JOHN MAYNARD KEYNES ANSWER “the ideas of economists and political philosophers, both when they are right and when they are wrong,"— Presentation transcript:

1 WHY STUDY ECONOMICS? JOHN MAYNARD KEYNES ANSWER “the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.” Much of you political beliefs are shaped by economic philosophy. Much of what you take in business has its roots in economic theory. An understanding of economics is necessary if one is to understand society.

2 CONVENTIONAL WISDOM [A] vested interest in understanding is more preciously guarded than any other treasure. It is why men react, not infrequently with something akin to religious passion, to the defense of what they have so laboriously learned. Familiarity may breed contempt in some areas of human behavior, but in the field of social ideas it is the touchstone of acceptability. Because familiarity is such an important test of acceptability, the acceptable ideas have great stability. They are highly predictable. It will be convenient to have a name for the ideas which are esteemed at any time for their acceptability, and it should be a term that emphasizes this predictability. I shall refer to these ideas henceforth as the conventional wisdom. (Galbraith, 1958, pp. 6–7, italics added)

3 MORE QUOTES FROM JOHN KENNETH GALBRAITH Faced with the choice between changing one's mind and proving that there is no need to do so, almost everyone gets busy on the proof. The only function of economic forecasting is to make astrology look respectable. Economics is extremely useful as a form of employment for economists. Under capitalism, man exploits man. Under communism, it's just the opposite.

4 VARIOUS VERSUS Thinking vs. Memorization  Studying economics requires that you UNDERSTAND the theories and models presented and can use these to reach an answer. Ideology vs. Science Arguing from conclusion to evidence vs. Arguing from evidence to conclusion.  Ideologues “KNOW” their answer before they start looking at the evidence. Science has to look at the evidence before reaching an answer.  How do you know if a person is an ideologue? The person always gives the same answer.

5 DEDUCTION VS. INDUCTION Deduction: a method of reasoning in which on deduces a theory based on a set of almost self-evident principles. Induction: a method of reasoning in which one develops general principles by looking for patterns in the data. As computing power has increased, induction has become more prevalent. Abduction: a method of analysis that uses a combination of inductive and deductive methods.

6 Economics Defined Economics - is the study of how human beings coordinate their wants and desires, given the decision-making mechanisms, social customs and political realities of the society. Economics - The study of the choices people make with respect to scarcity.

7 Micro vs. Macro Microeconomics - the study of individual choice, and how that choice is influenced by economic forces. Macroeconomics - the study of the aggregate economy OR the study of economy as a whole, which includes inflation, unemployment, business cycles, and growth.

8 The Basic Questions The Basic Questions of Society ◦What to produce? ◦How much to produce? ◦How to produce? ◦For whom to produce?

9 The Fundamental Problem Scarcity - the goods available are too few to satisfy individuals’ desires. Scarcity is the fundamental economic problem. Scarcity forces us to make choices.

10 Costs and Benefits COSTS ◦Marginal cost - additional cost above the costs already incurred. ◦Sunk cost - costs that have already been incurred BENEFITS ◦Marginal Benefits - the additional benefits above what have already been derived.

11 Economic Decision Rule If the relevant benefits of doing something exceed the relevant costs, do it. If the relevant costs of doing something exceed the relevant benefits, don’t do it.

12 Voting Behavior (from the work of Deidre McCloskey) Why do people vote? ◦What are the costs? ◦What are the benefits? If we only consider standard economics, voting makes little sense. One needs to recognize the importance of non-economic variables.

13 Opportunity Cost Opportunity Cost - the value of the next best alternative foregone in making a decision. Examples of Opportunity Cost

14 Economic Theory Economic theory - Generalizations about the workings of an abstract economy. OR A shorthand way of telling a story. “That Only Works in Theory” For a theory to have value, it must be consistent with empirical observation. If it only works in theory, it is not a good theory. We only talk about “good” theories in this class!!!!

15 Models and Principles Economic models - A framework that places the generalized insights of the theory in a more specific contextual setting. Economic principle - A commonly held economic insight stated as a law or a general assumption.

16 Positive vs. Normative Economics Economic policy - An action (or inaction) taken, usually by government, to influence economic events. The work of John Neville Keynes Positive economics - The study of what is and how the economy functions. Normative economics - The study of what the goals of the economy should be. Art of economics - the application of the knowledge learned in positive economics to the achievement of the goals one has determined in normative economics.

17 Building and Testing a Theory Steps 1-3 1. Decide on what it is you want to explain or predict. 2. Identify the variables that you believe are important to what you want to explain or predict. 3. State the assumptions of the theory.  Why do we make assumptions?  Ceteris Paribus - A Latin term meaning “all things held constant.”  Econometrics - the social science in which the tools of economic theory, mathematics, and statistical inference are applied to the analysis of economic phenomena.

18 Building and Testing a Theory Steps 4-6 4.State the hypothesis 5. Test the theory by comparing its predictions against real-world events. 6. If the evidence supports the theory, then no further actions is necessary (at the moment!). If the evidence rejects the theory, then a. conclude the theory is incorrect. b. conclude the data is inadequate.

19 Economics and Electing the President

20 The work of Ray Fair Ray Fair’s Website: http://fairmodel.econ.yale.edu/ http://fairmodel.econ.yale.edu/ The specific site on presidential elections. http://fairmodel.econ.yale.edu/vote201 2/index2.htmhttp://fairmodel.econ.yale.edu/vote201 2/index2.htm The review of the 2008 election. http://fairmodel.econ.yale.edu/vote200 8/index2.htm http://fairmodel.econ.yale.edu/vote200 8/index2.htm His model and the data on each election (before 2008) http://fairmodel.econ.yale.edu/RAYFAI R/PDF/2006CHTM.HTMhttp://fairmodel.econ.yale.edu/RAYFAI R/PDF/2006CHTM.HTM

21 Economic Growth and the United States Presidency: Can You Evaluate the Players Without a Scorecard? David J. Berri Department of Applied Economics California State University – Bakersfield Bakersfield, California 93311 661-654-2027 dberri@csub.edu James Peach P. O. Box 30001/ MSC 3CQ Department of Economics New Mexico State University Las Cruces, NM 88003 505-646-2113 jpeach@nmsu.edu

22 Abstract In several academic papers and a book, Ray Fair (1978, 1996, 2002) has demonstrated a link between the state of the macroeconomy and the outcome of the Presidential Election in the United States. Beginning with the 1916 election, Fair’s model, based on such factors as economic growth, inflation, and incumbency, was able to accurately predict the winner in virtually every election. The purpose of this research is to take the Fair model back to the 19th century. The question we address is as follows: Can a version of Fair’s model accurately predict in an environment where economic data was not made available to the voter?

23 Louis Bean (1948) How to Predict Elections “Business depressions played a powerful role in throwing the Republicans out of office in 1874, after 1908, and in 1932, and they had exactly the same influence in ousting Democrats after the panic of 1858 and during the economic setbacks of 1894 and 1920.” “Harding in 1920, McKinley in 1896, and Cleveland in 1884 were also depression-made presidents. Had the deciding electoral vote been cast for the candidate who had the majority of the popular vote in 1876, Tilden too, would have been a depression-made President.”

24 The work of Ray Fair Fair, Ray C. 1978. “The Effect of Economic Events on Votes for President.” The Review of Economics and Statistics (Vol. LX, No. 2):159-173 May 1978. Fair, Ray C. 1978. “The Effect of Economic Events on Votes for President: 1980 Results.” The Review of Economics and Statistics (Vol. 64, No. 2):322-25 May 1978. Fair, Ray. C. 1996. “Econometrics and Presidential Elections.” Journal of Economic Perspectives (Vol. 10, No 3):89-102 (Summer 1996). Fair, Ray C. 2002. “The Effect of Economic Events on Votes for President: 2000 Update.” http://fairmodel.econ.yale.edu/RAYFAIR/PDF/2002DHTM Downloaded Feb 2, 2006.http://fairmodel.econ.yale.edu/RAYFAIR/PDF/2002DHTM Fair, Ray C. 2002. Predicting Presidential Elections and other things. Stanford: Stanford Business Books.

25 A Fair Model VOTE= a 1 + a 2 GROWTH+ a 3 INFLATION + a 4 PARTY + a 5 PERSON + a 6 DURATION + a 7 GOODNEWS + ε

26 Defining the variables employed http://fairmodel.econ.yale.edu/RAYFAIR/PDF/2002DHTM.HTM VOTE = Incumbent share of the two-party presidential vote. GROWTH = annual growth rate of real per capita GDP in the first three quarters of the election year. INFLATION = absolute value of the growth rate of the GDP deflator in the first 15 quarters of the administration (annual rate) except for 1920, 1944, and 1948, where the values are zero.

27 Defining the variables employed http://fairmodel.econ.yale.edu/RAYFAIR/PDF/2002DHTM.HTM PARTY = 1 if Democrats are in power, = -1 if Republicans are in power PERSON = 1 if the president is running, = 0 otherwise DURATION = 0 if the incumbent party has been in power for one term, 1 if the incumbent party has been in power for two consecutive terms, 1.25 if the incumbent party has been in power for three consecutive terms, 1.50 for four consecutive terms, and so on. WAR = 1 for the elections of 1920, 1944, and 1948 and 0 otherwise GOODNEWS = number of quarters in the first 15 quarters of the administration in which the growth rate of real per capita GDP is greater than 3.2 percent at an annual rate except for 1920, 1944, and 1948, where the values are zero.

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29 Summarizing Fair: 1916- 2000 Only incorrect in three elections: 1960, 1964, 1992. Average absolute error: 1.5 Results are driven by economic variables with no consideration of a candidate’s appearance, debating talents, advertisements, or general campaign skills.

30 Taking Fair back to 1824 New measures of growth and inflation are needed. Louis Johnston and Samuel H. Williamson, "The Annual Real and Nominal GDP for the United States, 1789 - Present." Economic History Services, April 2002, URL : http://www.eh.net/hmit/gdp/ http://www.eh.net/hmit/gdp/ This data has been updated. Updated data did not change our general findings.

31 The Models to be Estimated Model 1Original Fair Model (1916-2000) Model 2 Fair Model with new measures of GROWTH and INFLATION (1916-2000) Model 3 Fair Model with new measures of GROWTH and INFLATION, no GOODNEWS (1916-2000) Model 4 Fair Model with new measures of GROWTH and INFLATION, no GOODNEWS (1916-2004) Model 5 Fair Model with new measures of GROWTH and INFLATION, no GOODNEWS (1824-1912) Model 6 Fair Model with new measures of GROWTH and INFLATION, no GOODNEWS (1824-2004)

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34 Why does the Fair model fair poorly before 1916? Economic data did not exist. U.S. economy not integrated. Federal government was not held responsible for the macroeconomy. Non-economic issues were more important in the 19 th century.

35 Econometrics and Presidential Elections Larry M. Bartels

36 Overview of the Fair Model One of the most interesting aspects of Fair's essay is the unusually frank and detailed description it provides of the enormous amount of exploratory research underlying published analyses of aggregate election outcomes. What is the relevant sample period? Which economic variables matter? Measured over what time span? What does one do with third party votes, war years, or an unelected incumbent? In fewer than a dozen pages, Fair raises and resolves many such questions, as any data analyst must. In the process, he makes clear how much of what Leamer (1978) has referred to as “specification uncertainty” plagues this (or any other) statistical analysis of presidential election outcomes.

37 Choosing a Model ….(Fair’s) choice of model specification seems to have been guided by goodness-of-fit considerations rather than by a priori political or economic considerations. His data set begins in 1916 because “some experimentation... using observations prior to 1916" produced results that “were not as good.” Gerald Ford is sometimes counted as an incumbent and sometimes not, depending upon which treatment “improves the fit of the equation.” Revised economic data produced significant changes in several key coefficients, prompting renewed searching “to see which set of economic variables led to the best fit,” and so on.

38 What have we learned? What most electoral scholars really care about is what the relationship between economic conditions and election outcomes tells us about voting behavior and democratic accountability. On that score, what have we learned, and what have we yet to learn? The clearest and most significant implication of aggregate election analyses is that objective economic conditions -- not clever television ads, debate performances, or the other ephemera of day-to-day campaigning -- are the single most important influence upon an incumbent president's prospects for reelection. Despite a good deal of uncertainty regarding the exact form of the relationship, the relevant time horizon, and the relative importance of specific economic indicators, there can be no doubt that presidential elections are, in significant part, referenda on the state of the economy.

39 My own thoughts on why the economy drives elections…… Three voters in the election… Republicans (vote Republican) Democrates (vote Democrat) Independents The only free agents are independents. These are voters who care so little, they don’t join a party. And these are the voters that matter. Why the economy? It is the one issue that matters to the independent.

40 Politics and football…  Some football coaches believe the run sets up the pass. Others think the pass sets up the run. Fans, though, don’t care. You win, you keep your job. You lose, you lose your job.  Applied to politics… some people believe in smaller government and low taxes. Others believe in more government to solve problems.  Independents, though, don’t care. The economy does well, you keep your job. If not, your fired. What the politician believes is simply not relevant.


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