Week 1: Nature of Mathematical Economics

• Course Outline Overview

• Lecturers, Tutorial Sessions
• Topics
• IA
• Main Exams

Slide 1
 Session Overview
Overview
• This session is meant to introduce students to basic
mathematical concepts and approaches in solving economic
problems.
Objectives
• Understand the difference between mathematical and non-
mathematical economics
• Understand what economic models entail.

Slide 2
 Session Outline
The key topics to be covered in the session are as follows:
• Mathematical vs Nonmathematical Economics
• Mathematical Economics versus Econometrics
• Economic Models

Slide 3
 Reading List
• Chiang, A. C., “Fundamental Methods of Mathematical
Economics”, McGraw Hill Book Co., New York, 1984.-
• Chapter 1: Nature of Mathematical Economics
• Chapter 2: Economic Models

Slide 4
Topic One

MATHEMATICAL VERSUS NON

MATHEMATICAL ECONOMICS
Slide 5
 Mathematical and Nonmathematical
Economics
• Mathematical economics is not a distinct branch of
economics as is the case of public finance, international
trade etc.
• It is an approach to economic analysis where economists
use mathematical symbols in the statement of economic
problems and use known mathematical theorems to aid in
reasoning.
• Mathematical economics is also described to go beyond
simple geometry which presents the visual aspect of
analysis.
• Since mathematical economics is merely an approach, it does not
differ from non-mathematical approach to economics in any
fundamental way. Slide 6
 Mathematical and Nonmathematical
Economics
• The purpose of any theoretical analysis, regardless of the approach is
to be able to derive a set of conclusions from a given set of
assumptions.
• The main difference between mathematical and non mathematical
economics is that in mathematical economics, the assumptions and
conclusions are formally stated in mathematical symbols and
equations rather than in words and sentences as in the case of
nonmathematical economics.
• Inasmuch it matters little which approach is chosen, it is perhaps beyond
dispute that symbols are more convenient to use in deductive reasoning
than words and sentences.
• Symbols and equations are also more conducive to conciseness and
preciseness of statements.
• The mathematical approach also forces analysts to make their assumptions
explicit at every stage of reasoning.
 How does Mathematics provide tools for
Economics?
• Formulation of economics models
• Analyses and derivation (eg. how one variable changes
in response to another – relationships and sensitivities)
• Optimisation ( determining best outcome from a set of
constraints)
• Equilibrium analyses (in various markets)
• Statistical and econometric analyses- (empirical
verification of economic theories)
• Dynamic Models ( differential equations to study
behaviour over time)
Slide 8
 Differences- Approach
• Mathematical Economics:
• Utilizes mathematical symbols, equations, and models to represent
economic theories and problems.
• Allows for rigorous formulation, generalization, and derivation,
enabling precise predictions and clarity in assumptions and results.
• Often employs tools like calculus, algebra, optimization techniques,
and statistics.
• Non-Mathematical Economics:
• Relies on verbal logic, descriptive narratives, and graphical analysis.
• Tends to be more qualitative, with emphasis on conceptual clarity,
historical context, or institutional details.
• Can be more easily accessible for those without a mathematical
background
Slide 9
Differences- Nature of the Analyses
• Mathematical Economics:
• Tends to be more abstract and general, capturing the essence of
economic problems in symbolic form.
• Provides clear-cut conclusions given a set of assumptions.
• Enables analysis of complex scenarios that might be hard to
decipher without mathematical tools.
• Non-Mathematical Economics:
• Provides a more intuitive understanding, often with richer context.
• Can delve deeply into specific real-world scenarios, institutional
details, or historical contexts.
• May provide a more holistic view, incorporating sociological,
psychological, or historical considerations.
Slide 10
 Differences- type of questions asked
• Mathematical Economics:
• Typically addresses questions that require optimization, general
equilibrium analysis, or those that involve dynamic changes.
• Useful for scenarios where quantitative predictions or sensitivity
analyses are essential.
• Non-Mathematical Economics:
• Often explores questions related to institutional economics,
economic history, or behavioral economics where context,
narratives, or individual/institutional behaviors are central.
• Might be more suited for issues where qualitative insights or
understanding the broader picture is more important than precise
quantification.
Slide 11
 Strengths and Limitations
• Mathematical Economics:
• Strengths: Precision, ability to handle complexity, clear
generalization, and predictive power.
• Limitations: Can be overly abstract, might miss out on
nuanced real-world details, and requires strong mathematical
skills to comprehend.
• Non-Mathematical Economics:
• Strengths: Accessibility, rich contextual details, and ability to
address questions outside the purview of mathematical
models.
• Limitations: Potential for ambiguity, might lack the rigor and
precision of mathematical analyses.
Slide 12
Topic Two

MATHEMATICAL ECONOMICS VS
ECONOMETRICS
Slide 13
 Mathematical Economics Versus
Econometrics
• Mathematical economics and econometrics are both
essential subfields of economics that use
mathematical tools and techniques
• but they serve different purposes and focus on
distinct aspects of economic analysis
 Mathematical Economics Versus
Econometrics
1. Primary Objective:
• Mathematical Economics:
• Aims to represent economic theories and ideas using
mathematical formulations and models.
• Concerned with constructing and analyzing abstract models to
understand and explain economic behavior and phenomena.
• Econometrics:
• Focuses on testing economic theories by confronting them
with empirical data.
• Concerned with the application of statistical methods to
economic data to estimate economic relationships and test
hypotheses.
 Mathematical Economics Versus
Econometrics
2. Methodology:
• Mathematical Economics:
• Uses mathematical symbols and equations to formulate
theories.
• Employs tools like calculus, algebra, and optimization
techniques to analyze economic problems and derive
conclusions.
• Econometrics:
• Uses statistical techniques to estimate economic
relationships.
• Employs regression analysis, time series analysis, and
other statistical methods to analyze real-world data.
 Mathematical Economics Versus
Econometrics
• 3. Nature of Analysis:
• Mathematical Economics:
• Tends to be more abstract, dealing with theoretical
constructs.
• Helps in making predictions based on theoretical models.
• Econometrics:
• Grounded in real-world data.
• Helps in validating or refuting theoretical predictions by
comparing them with actual observations.
 Mathematical Economics Versus
Econometrics
• 4. Key Tools and Techniques:
• Mathematical Economics:
• Differential and integral calculus.
• Linear algebra.
• Optimization techniques.
• Econometrics:
• Regression analysis (OLS, logistic regression, etc.).
• Hypothesis testing.
• Time series analysis.
 Mathematical Economics Versus
Econometrics
• 5. Applications:
• Mathematical Economics:
• Used to build and analyze models that explain economic
behaviors, like how firms decide on output levels or how
consumers make choices.
• Econometrics:
• Used in forecasting (e.g., predicting future GDP or
unemployment rates).
• Helps policymakers and businesses make informed
decisions based on past data.
 Mathematical Economics Versus
Econometrics
• 6.Limitations:
• Mathematical Economics:
• Theories and models can sometimes be too abstract or
simplified, failing to capture real-world complexities.
• Econometrics:
• Relies heavily on the quality and availability of data.
• Vulnerable to issues like omitted variable bias,
multicollinearity, and endogeneity, which can affect the
accuracy of estimations.
Topic Three

ECONOMIC MODELS

Slide 21
 Economic Models
• Like any theory, economic theory is an abstraction from
the real world.
• The complexity of the real economy makes is impossible to
understand or study all the interrelationships at once.
• The practical thing to do therefore is to pick out what
appeals to our reason to be the primary factors and the
relationships relevant to the problem we wish to study
and focus our attention on such factors or relationships
alone – this is what an economic model basically does.
• An economic model is a deliberately simplified analytical
framework used to enhance our understanding of the
actual economy.
 Economic Models
• Economic models are simplified, abstract representations of
the real-world economic environment.
• They are designed to help analysts and policymakers
understand complex economic interactions and predict
potential outcomes.
• These models can be expressed in various ways, including
mathematically, graphically, or verbally.
• The primary purpose of an economic model is to break
down intricate real-world scenarios into a more
comprehensible format, allowing for better analysis,
understanding, and decision-making.
 Examples of Economic Models
1. Microeconomic Models:
– Demand and supply
– Production possibility frontier
– Monopoly
– Game theory models
2. Macroeconomic models
– Solow Growth models
– Philips Curve
– IS-LM Curves
3. Financial Economics Models
4. International Economics Models
5. Development and Growth Models
6. Behavioural Economics Models.
 Ingredients of an Economic Model
• Variables
• Parameters
• Assumptions (all firms are identical; profit maximizing, only
two goods etc)
• Constraints (eg. Budget constraints)
• Equations/ Relations
• Exogenous shocks

Slide 25
 Variables, Constants and Parameters

• A variable is something whose magnitude can change

ie. Something that can take on different values.
• Examples of variables frequently used in economics
include price, revenue, cost, national income,
consumption, investment, imports, exports etc.
• Since each variable can assume various values, it must
be represented by a symbol instead of a specific
number.
• For example: we may represent price by P, profit by
revenue by R, cost by C and national income by Y..
• When we write P=3 or C= 8, we are ‘freezing’ these variables
at specific values. Slide 26
 Variables, Constants and Parameters
• When properly constructed, an economic model can be solved to give us the
solution values of a certain set of variables such as the market clearing level of
price or the profit maximizing output level.
• Such variables whose values are provided within the model are known as
endogenous variables.

• Sometimes, the model may also contain certain variables that are assumed to
be determined by external forces outside the model whose values are accepted
as given data . These variables are called exogenous variables.

• It should be noted however that, a variable which is endogenous in one

economic model may be exogenous in another economic model.

• For example: In an analysis of the market determination of rice price (P), the
variable P is definitely endogenous. However, in the framework of a theory of
consumer expenditure, P would become an exogenous variable since P is
Slide 27
instead a datum for the individual consumer.
 Variables, Constants and Parameters

• Variables usually appear in combination with fixed numbers or

constants as in the expressions 9P or 0.2Y.
• A constant is defined as a magnitude that does not change. When a
constant is joined to a variable, it is called the coefficient of that
variable.

• Sometimes, the coefficient may be symbolic rather than numerical. For

instance the symbol a can stand for a given constant and used in the
expression such as aP instead of 7P in a model in order to attain a
higher level of generality.

• The symbol a is a special case- it is supposed to represent a constant

but yet it is a variable.

Slide 28
 Variables, Constants and Parameters

• Due to its special feature, it is given a distinctive name parametric

constant or simply a parameter.

• It must be emphasized that even though parameters can take on

different values in a model, they are treated as datum in the model . In
this regard, parameters resemble exogenous variables since they are
both treated as givens in the model.

• As a matter of convention, parametric constants are normally

represented by symbols such as a, b, c or their counterpart Greek
alphabets:

Slide 29
 Equations and Identities
• In economic applications, we may distinguish between three types of
equations namely:
• Definitional equations
• Behavioural equations
• Equilibrium equations

• A definitional equation sets up an identity between two alternate

expressions that have exactly the same meaning. For such an equation ,
the identical –equality sign (read : identical to) is often employed in
place of the although this is also acceptable.

• Example: Total Profit is defined as the excess of total revenue (R) over
total cost ( C). We can therefore express total profit as :

Slide 30
 Definitional Equations
These are equations that hold true by definition.
• They represent fundamental relationships or definitions within the system and
are always true regardless of the state of the system.
• Example:
• The equation for Gross Domestic Product (GDP) can be considered a
definitional or identity equation.
• In an open economy, GDP is defined as:
• GDP=C+I+G+(X−M)
• Where: C = Consumption I = Investment G = Government Spending X =
Exports, M = Imports

• This equation is true by the very definition of GDP. It's not describing a
behavioral relationship or an equilibrium condition, but rather an accounting
or definitional truth.
Slide 31
 Behavioural Equations
• These equations describe the behaviour of economic agents, such as consumers,
firms, or the government.
• They are typically derived from some underlying theory or principle about how these
agents operate.

• The consumption function is a behavioural equation derived from consumer

behavior theories.
• It might be expressed as:
• C=C0+c(Y−T)
• Where: C = Consumption C0 = Autonomous consumption (consumption when
disposable income is zero) c = Marginal propensity to consume
• Y = Total income T = Taxes

Slide 32
 Behavioural Equations
• These equations establish conditions under which various
economic entities are in balance or equilibrium.
• They indicate where demand equals supply or where some
economic variable has found its "resting point.”
• In a simple market model, the equilibrium condition is where the
quantity demanded equals the quantity supplied.
• This can be expressed as: Qd=Qs
• Or, in terms of specific behavioral functions: Qd(P)=Qs(P)
• Where: Qd​= Quantity demanded
• Qs = Quantity supplied
• P = Price
Slide 33
 Session Problem Sets
• What is the main difference between mathematical
and nonmathematical economics?
• State 4 advantages of mathematical economics over
non-mathematical economics.
• Differentiate between Variables, Constants and
Parameters.
• What are the main types of Equations? List and briefly
explain.

Slide 34