Where does Economics fit in a business school?

1
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

2
To understand where economics and business fit in
this trilogy (and why they dont belong in the
same place) lets 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?

3
Now that weve talked about art and technology,
were close to the most critical point that needs
to be made. Lets think about what scientists do
that distinguishes their work from art or
technology. (A big question and while this isnt
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 isnt real it isnt
  science).
• Scientists, however, arent just bookkeepers,
  they also formulate and test theories

4
The notion of a theory is so abused, lets be
clear about the meaning. This best understood by
asking what it means to accept(notice I didnt
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 isnt about building
  anything practical
• Even if the law of gravity didnt help us
  launch rockets, it would still be a very good
  theory.

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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 dont 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 doesnt have to be
  useful!
• Before the entire class storms the Deans Office,
  I should quickly add that I dont think that will
  be the case. In fact, theres lots of good stuff
  that economics can contribute directly to the
  bottom line. But thats just a sidebar. The
  goal here is to make theory, not money.

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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.

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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.

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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, lets consider the
  following exercise

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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.

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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 its 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 Its not because we think people are
  shallow and materialistic.

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Why Do Students Demand Grades?

• They Dont. Employers and grad schools are the
  real users of grades, and so the demand for
  grades is actually a derived demand--the
  students demand for grades is actually derived
  from the employers demand. (In much the same way
  that GMs demand for steel is really derived from
  the demand for cars.)

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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.)

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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.

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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.

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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, Id use an absolute scale.
• If I believe students work harder when in
  competition against each other and that employers
  are interested in relative rankings, Id use a
  relative scale.

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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.

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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 cant really understand how interest rates
  are set if you dont 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.