Where does Economics fit in a business
school?
Almost every discipline that is taught at a
modern university can be described as fitting in
one of three categories:
Art and Humanities
Science
Technology
Think about where business and economics belong
Hint: Not in the same place
To understand where economics and business fit in
this trilogy (and why they don’t belong in the same
place) let’s take a few moments and consider what
distinguishes the three.
How does the creation or study of art differ
from the pursuit of science of technology?
What makes the development or study of
technology a unique intellectual pursuit? (Hint:
a good way to frame this question is to ask (1)
what do we mean by technology? and (2) how
do we judge whether technology is a “success”?
Now that we’ve talked about art and technology, we’re close to the most
critical point that needs to be made. Let’s think about what scientists do
that distinguishes their work from art or technology. (A big question and
while this isn’t a class in the philosophy of science, one worth considering
at least for a few minutes.
First, the focus of all science is what can be
observed (perhaps indirectly and with great
difficulty, but if isn’t “real” it isn’t science).
Scientists, however, aren’t just bookkeepers,
they also formulate and test “theories”
The notion of a theory is so abused, let’s be clear about the
meaning. This best understood by asking what it means to
accept(notice I didn’t say prove) a theory. A theory is not rejected if
If it is logical (next slide please)
It is consistent with what is observed.
We believe the law of gravity because apples really do fall down, not up. We
believe that law of demand because when the relative price of oil goes up, people
really do buy less oil.
Helps us lead understand a wide range of phenomena.
The law of gravity also explains the position of the planets and, there is a
pursuasive argument that the law of demand also explains the choice of marriage
partners.
So ultimately the distinction between science and technology is that science is
all about observing and building theories to better understand what we
observe. Science isn’t about building anything practical
Even if the “law” of gravity didn’t help us launch rockets, it would still be a very
good theory.
So, where does economics and
business fit?
This must meant the business schools like engineering
schools and maybe some other locations on campus are
in the technology part of the university. They are all
about the creation of useful tools.
[Notice, by the way that “tools” don’t have to have a physical
dimension. An accounting system or a business plan can be
good tools but lousy paper weights.]
Economics is a science. It doesn’t have to be useful!
Before the entire class storms the Dean’s Office, I should
quickly add that I don’t think that will be the case. In fact,
there’s lots of good stuff that economics can contribute
directly to the bottom line. But that’s just a sidebar. The
goal here is to make theory, not money.
Why You Are Here: #1
The obvious reason is that, many of the tools that are part of the
practical training are based on economic theory. Learning the
theories will help you build better tools
In fact, our Dean, who is an economist, is sometimes fond of
reminding his colleagues that economics “is the mother
discipline”.
For example, in finance you will learn all about the “efficient market
hypothesis” which is an amazingly important tool for investment analysis
that really makes sense only if you understand the law of demand and
supply.
As an analogy, think about how important it is for a good
engineer to understand certain aspects of physics, or a physician
to understand biology.
Why You Are Here: #2
A less obvious reason is that economics relies on
some specific tools--especially mathematics and
statistics--that are used in other classes. This is a
good opportunity to sharpen your skills.
In other words, econ is to Business School what
boot camp is to the Marine Corp.
Just as in boot camp, you will endure sleepless nights of
seemingly pointless activity designed by an arrogant,
humorless sociopath, all with the goal of toughening you
for the grim years of combat that lie ahead.
Why You Are Here: #3
I think most compelling reason is that
economics examines the world in a very
particular way. And this approach can be useful
to non economists. This is a big claim and
rather than try and express it as an abstraction,
let’s consider the following exercise
An Example of How Economists
Think: Why Give Grades?
Grades are expensive and complicated. Large amounts
of resources are devoted to the giving and getting. An
economic analysis is often begun by asking why
resources are used in a particular way.
This question is way to broad and so the next step will
be to break it down into smaller questions.
Grades are a relationship, thus an economic approach
to the puzzle begins by asking
why do professors supply them and
why do students demand them.
Why Do Professors Supply Grades?
Money: By offering tests and promising grades, the class
becomes more valuable to the student (why?) and so
the student is willing to pay more.
Non Pecuniary Rewards (Utility): Most Profs enjoy their
subject, think it’s important and want their students to
learn (or at least stay awake during part of the lecture).
Grades motivate the student to learn.
But think about why most economists would begin
with the pecuniary motive.
Hint: It’s not because we think people are shallow and
materialistic.
Why Do Students Demand Grades?
They Don’t. Employers and grad schools are
the real users of grades, and so the demand for
grades is actually a derived demand--the student’s
demand for grades is actually derived from the
employers demand. (In much the same way that
GM’s demand for steel is really derived from the
demand for cars.)
Why do employers and grad schools
demand grades?
Two Possible Theories
Grades are an absolute measure of knowledge.
(Consistent with the HUMAN CAPITAL
theory of education.)
Grades are a relative measure of knowledge
and other important characteristics.
(Consistent with the
SIGNALING/SORTING theory of
education.)
Does This Constitute a Theory of Grades?
Sure. The “theory” we have just described has two
important characteristics.
It is logically consistent and more important
Give explanations that can, at least in principle, be
refuted.
Even It Is a Theory, What Good Is It?
Theories are just good.
There seems to be something about the human mind
that likes the order and connections that obtain from
a good theory. Most of us could live long and
healthy lives without ever having heard about the
theory of evolution. But most of us also crave a
better understanding of our surroundings and find a
really good theory (one that is both simple and fits
the evidence) very satisfying.
Even It Is a Theory, What Good Is It?
Theories can be a good guide to policy.
There are two basic grading policies: You can be graded on
an absolute scale (e.g.,everybody who scores a 90 or better
gets an A), or on a relative scale (the top 20% of the class gets
an A)
If I believe that students work harder when in competition against an
absolute scale and that employers are interested in the absolute level
of achievement, I’d use an absolute scale.
If I believe students work harder when in competition against each
other and that employers are interested in relative rankings, I’d use a
relative scale.
Take-Aways: What characterizes an
“economic way of thinkings”?
Economics tends to be a science of the ordinary in that most
economists are attracted to problems and patterns of behavior
that are common to many people.
In one way or another an economic problem tends to focus on
decisions that affect the allocation of resources, either for
consumption or further production.
Whenever possible economists like to break up a big
complicated problem into small more managable problems.
Economists assume that behavior is purposeful and almost all
economic analysis begins by asking who is making the decision
and what the decision maker is trying to achieve.
Economists tend to focus on self-interest and pecuniary motives
because we believe that these kinds of things matter to almost
everybody and we want our theories to be as broad as possible.
A Final Note on How Economists See the World:
Macroeconomics and Microeconomics
Macroeconomics: The Study of Aggregate behavior and the flows
between producers and consumers
GDP, Price Levels, Interest Rates
Microeconomics: The study of individual producers, consumers
and markets.
Pricing, internal organization of firms, strategic interaction between firms
The first part of this class is microeconomics. This are at least
two good reasons for this
Micro is the foundation for macro (for example, you can’t really
understand how interest rates are set if you don’t understand supply and
demand.
Micro is where one really learns “the economic view of the world”, which
I believe is a remarkably useful analytical framework.