Thinking Like an
Economist
Chapter 2
Copyright ? 2001 by Harcourt,Inc.
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Every field of study has its
own terminology
Mathematics
axioms
integrals
vector spaces Psychologyego
id
cognitive
dissonanceLawtorts
venues
Promissory
estoppel
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Every field of study has its
own terminology
Economics
Supply
Demand
Elasticity
Consumer
SurplusComparative advantage
Opportunity
cost
Deadweight
loss
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Economics trains you to.,,,
?Think in terms of alternatives.
?Evaluate the cost of individual and
social choices.
?Examine and understand how certain
events and issues are related.
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The Economist as a Scientist
The economic way of thinking,,,
?Involves thinking analytically and
objectively.
?Makes use of the scientific method.
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The Scientific Method
?Uses abstract models to help explain
how a complex,real world operates.
?Develops theories,collects,and
analyzes data to prove the theories.
Observation,Theory and More Observation!
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The Role of Assumptions
? Economists make assumptions in order
to make the world easier to understand.
? The art in scientific thinking is deciding
which assumptions to make.
? Economists use different assumptions to
answer different questions.
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The Economic Way of Thinking
?Includes developing abstract models
from theories and the analysis of the
models.
?Uses two approaches:
?Descriptive (reporting facts,etc.)
?Analytical (abstract reasoning)
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Economic Models
? Economists use models to simplify reality
in order to improve our understanding of the
world
? Two of the most basic economic models
include:
?The Circular Flow Model
?The Production Possibilities Frontier
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The Circular-Flow Model
The circular-flow model is a
simple way to visually show the
economic transactions that occur
between households and firms in
the economy.
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The Circular-Flow Diagram
Firms Households
Market for
Factors
of Production
Market for
Goods
and Services
SpendingRevenue
Wages,rent,
and profit
Income
Goods &
Services sold Goods & Services
bought
Labor,land,
and capital
Inputs for
production
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The Circular-Flow Diagram
Households
? Buy and consume goods and services
? Own and sell factors of production
Firms
? Produce and sell goods and services
? Hire and use factors of production
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The Circular-Flow Diagram
Markets for Factors of Production
? Households sell
? Firms buy
Markets for Goods & Services
? Firms sell
? Households buy
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The Circular-Flow Diagram
Factors of Production
? Inputs used to produce goods and
services
? Land,labor,and capital
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The Production Possibilities
Frontier
The production possibilities frontier is a
graph showing the various combinations
of output that the economy can possibly
produce given the available factors of
production and technology.
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The Production Possibilities
Frontier
Quantity of
Computers
Produced
Quantity of
Cars Produced
3,000
0 1,000
2,000
700
1,000
300
A
B
2,200
600
C
D
Harcourt,Inc,items and derived items copyright ? 2001 by Harcourt,Inc.
The Production Possibilities
Frontier
Quantity of
Computers
Produced
Quantity of
Cars Produced
3,000
1,000
2,000
2,200
A
7006003000 1,000
B
C
D
Production
possibilities
frontier
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Concepts Illustrated by the
Production Possibilities Frontier
?Efficiency
?Tradeoffs
?Opportunity Cost
?Economic Growth
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4,000
The Production
Possibilities Frontier
Quantity
of Computers
Produced
Quantity of
Cars Produced
3,000
2,000 A
7000 1,000
E2,100
750
An outward shift
in the production
possibilities
frontier
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Microeconomics and
Macroeconomics
?Microeconomics focuses on the individual
parts of the economy.
? How households and firms make decisions
and how they interact in specific markets
?Macroeconomics looks at the economy as
a whole.
? How the markets,as a whole,interact at the
national level.
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Two Roles of Economists
?When they are trying to explain the
world,they are scientists.
?When they are trying to change the
world,they are policymakers.
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Positive versus Normative
Analysis
?Positive statements are statements
that describe the world as it is.
?Called descriptive analysis
?Normative statements are statements
about how the world should be.
?Called prescriptive analysis
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Positive or Normative
Statements?
An increase in the minimum wage
will cause a decrease in employment
among the least-skilled.
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Positive or Normative
Statements?
Higher federal budget deficits will
cause interest rates to increase.
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Positive or Normative
Statements?
The income gains from a higher
minimum wage are worth more than
any slight reductions in employment.
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Positive or Normative
Statements?
State governments should be allowed to
collect from tobacco companies the
costs of treating smoking-related
illnesses among the poor.
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Economists in Washington,,,
.,, serve as advisers in the
policymaking process of the three
branches of government:
? Legislative
? Executive
? Judicial
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Why Economists Disagree
?They may disagree on theories
about how the world works.
?They may hold different values
and,thus,different normative
views.
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Examples of What Most
Economists Agree On
?A ceiling on rents reduces the
quantity and quality of housing
available.
?Tariffs and import quotas usually
reduce general economic welfare.
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Summary
?In order to address subjects with
objectivity,economics makes use of the
scientific method,
?The field of economics is divided into
two subfields,microeconomics and
macroeconomics.
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Summary
?Economics relies on both positive
and normative analysis,Positive
statements assert how the world,is”
while normative statements assert
how the world,should be.”
?Economists may offer conflicting
advice due to differences in scientific
judgments or to differences in
values.
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Graphical
Review
Harcourt,Inc,items and derived items copyright ? 2001 by Harcourt,Inc.
The Circular-Flow Diagram
Firms Households
Market for
Factors
of Production
Market for
Goods
and Services
SpendingRevenue
Wages,rent,
and profit
Income
Labor,land,
and capital
Inputs for
production
Goods &
Services sold Goods & Services
bought
Harcourt,Inc,items and derived items copyright ? 2001 by Harcourt,Inc.
The Production Possibilities
Frontier
Quantity of
Computers
Produced
Quantity of
Cars Produced
3,000
0 1,000
2,000
700
1,000
300
A
B
2,200
600
C
D
Harcourt,Inc,items and derived items copyright ? 2001 by Harcourt,Inc.
The Production Possibilities
Frontier
Quantity of
Computers
Produced
Quantity of
Cars Produced
3,000
1,000
2,000
2,200
A
7006003000 1,000
B
C
D
Production
possibilities
frontier
Harcourt,Inc,items and derived items copyright ? 2001 by Harcourt,Inc.
The Production
Possibilities Frontier
4,000
Quantity
of Computers
Produced
Quantity of
Cars Produced
3,000
2,000 A
7000 1,000
E2,100
750
An outward shift
in the production
possibilities
frontier