Thinking Like an Economist
Chapter 2
Outline
The Economist as Scientist
The Economist as Policy Adviser
Why Economists disagree
Every field of study has its own terminology
Mathematics
integrals? axioms? vector spaces
Psychology
ego? id? cognitive dissonance
Law
promissory? estoppel? torts? venues
Economics
supply? opportunity cost? elasticity?
consumer surplus? demand? comparative
advantage? deadweight loss
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.
The economic way of thinking,,,
Involves thinking analytically and
objectively.
Makes use of the scientific method,
Uses abstract models to help explain how
a complex,real world operates.
Develops theories,collects and analyzes
data to evaluate the theories.
The Economic Way of Thinking
Yingyi Qian (2002)
Perspective
Reference or Benchmark
Analytic Tools
The Economic Perspective
About the Individual Behavior
Self-interest economic agent
Scarcity
Opportunity Cost
Tradeoff
The Economic Perspective
About Multi-Person Decisionmaking
Equilibrium
Efficiency
Win-Win
Reference/Benchmark
General Equilibrium (Arrow-Debreu)
Coase Theorem
Modigliani-Miller Theorem
Monetary Neutrality Theorem
Economic Analytic Tools:
Economic Models
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)
The Scientific Method:
Observation
Theory
And More Observation
The Scientific Method
Theoretical Analysis,Explain how real
world operates
Logic
Proof
Empirical Analysis,Analyze data to test
the theory
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.
The Economic Models
Economists use models to simplify reality
in order to improve our understanding of
the world.
Economic models omit many details to
allow us to see what is truly important.
All models are built with assumptions
Two of the Most Basic Models
The Circular-Flow Model
The Production Possibilities Frontier
Our First Model,
The Circular-Flow Diagram
The circular-flow diagram is a visual
model of the economy that shows how
dollars flow through markets among
households and firms.
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
Our First Model,
The Circular-Flow Diagram
Firms
– Produce and sell goods and services
– Hire and use factors of production
Households
– Buy and consume goods and services
– Own and sell factors of production
Our First Model,
The Circular-Flow Diagram
Markets for Goods and Services
– Firms sell
– Households buy
Markets for Factors of Production
– Households sell
– Firms buy
Factors of Production
– Inputs used to produce goods and services
– Land,labor,and capital
Our Second Model,The Production
Possibilities Frontier
The production possibilities frontier is a
graph that shows the combinations of
output that the economy can possibly
produce given the available factors of
production and the available production
technology.
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
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
Concepts Illustrated by the
Production Possibilities Frontier
Efficiency
Tradeoffs
Opportunity Cost
Economic Growth
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
Correlation vs,Causality
Economists usually illustrate the causality
between two events using a graph with
two variables in the coordinate system.
Ceteris Paribus,we claim that there is
causality between variables if variable A
cause variable B,and name A as the cause,
B the effect.
Warning
We call it correlation between variables if
there are some reliable statistical relationship
between variable A and variable B.
Sometimes we treat correlation as causality
BUT …
Correlation vs,CausalityWarning
Correlation maybe means causality
Correlation maybe means nothing
Omitted variable
Reverse causality
Correlation vs,CausalityWarning
Correlation means
causality
Correlation vs,CausalityWarning
A
B
Price of
Apples
Quantity
of Apples
Correlation does not mean
causality (omitted variables)
The graph does not take into
account of the number of
cigarettes smoked
Correlation vs,CausalityWarning
Risk of
Cancer
Number of
Lighters
More police cause
more crimes?
More crimes need
more police?
Correlation vs,CausalityWarning
Violent
Crimes
Police
officers
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.
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.
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
Positive or Normative Statements?
An increase in the minimum wage will
cause a decrease in employment among
the least-skilled.
Government ought to raise the minimum
wage
Positive or Normative Statements?
Higher budget deficits will cause
interest rates to increase.
Government should enhance the
market demand by implementing
deficit policies
Economists in Government,USA
The White House
– National Economic Advisor
– Council of Economic Advisors
Other Federal Agencies
– Treasury Department
– The Federal Reserve System
– The Justice Department (Anti-Trust Division)
– Commissions (SEC,FCC,FTC,etc)
– Congressional Budget Office
Economists in Government,China
党中央
中央财经领导小组办公室
国务院
各部委（发改委、财政部、人民银行、银监会证监会、保监会、劳动和社会保障部等）
研究机构（国务院政策研究室、国务院发展研究中心等）
半政府（中国社会科学院）
Why Economists Disagree
They may disagree on theories
about how the world works.
They may hold different values and,
thus,different normative views,
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.
Power of Economics
“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 intellectual influences,are usually the
slaves of some defunct economists.” (John
Maynard Keynes,1935)
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.
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.
Chapter 2
Outline
The Economist as Scientist
The Economist as Policy Adviser
Why Economists disagree
Every field of study has its own terminology
Mathematics
integrals? axioms? vector spaces
Psychology
ego? id? cognitive dissonance
Law
promissory? estoppel? torts? venues
Economics
supply? opportunity cost? elasticity?
consumer surplus? demand? comparative
advantage? deadweight loss
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.
The economic way of thinking,,,
Involves thinking analytically and
objectively.
Makes use of the scientific method,
Uses abstract models to help explain how
a complex,real world operates.
Develops theories,collects and analyzes
data to evaluate the theories.
The Economic Way of Thinking
Yingyi Qian (2002)
Perspective
Reference or Benchmark
Analytic Tools
The Economic Perspective
About the Individual Behavior
Self-interest economic agent
Scarcity
Opportunity Cost
Tradeoff
The Economic Perspective
About Multi-Person Decisionmaking
Equilibrium
Efficiency
Win-Win
Reference/Benchmark
General Equilibrium (Arrow-Debreu)
Coase Theorem
Modigliani-Miller Theorem
Monetary Neutrality Theorem
Economic Analytic Tools:
Economic Models
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)
The Scientific Method:
Observation
Theory
And More Observation
The Scientific Method
Theoretical Analysis,Explain how real
world operates
Logic
Proof
Empirical Analysis,Analyze data to test
the theory
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.
The Economic Models
Economists use models to simplify reality
in order to improve our understanding of
the world.
Economic models omit many details to
allow us to see what is truly important.
All models are built with assumptions
Two of the Most Basic Models
The Circular-Flow Model
The Production Possibilities Frontier
Our First Model,
The Circular-Flow Diagram
The circular-flow diagram is a visual
model of the economy that shows how
dollars flow through markets among
households and firms.
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
Our First Model,
The Circular-Flow Diagram
Firms
– Produce and sell goods and services
– Hire and use factors of production
Households
– Buy and consume goods and services
– Own and sell factors of production
Our First Model,
The Circular-Flow Diagram
Markets for Goods and Services
– Firms sell
– Households buy
Markets for Factors of Production
– Households sell
– Firms buy
Factors of Production
– Inputs used to produce goods and services
– Land,labor,and capital
Our Second Model,The Production
Possibilities Frontier
The production possibilities frontier is a
graph that shows the combinations of
output that the economy can possibly
produce given the available factors of
production and the available production
technology.
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
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
Concepts Illustrated by the
Production Possibilities Frontier
Efficiency
Tradeoffs
Opportunity Cost
Economic Growth
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
Correlation vs,Causality
Economists usually illustrate the causality
between two events using a graph with
two variables in the coordinate system.
Ceteris Paribus,we claim that there is
causality between variables if variable A
cause variable B,and name A as the cause,
B the effect.
Warning
We call it correlation between variables if
there are some reliable statistical relationship
between variable A and variable B.
Sometimes we treat correlation as causality
BUT …
Correlation vs,CausalityWarning
Correlation maybe means causality
Correlation maybe means nothing
Omitted variable
Reverse causality
Correlation vs,CausalityWarning
Correlation means
causality
Correlation vs,CausalityWarning
A
B
Price of
Apples
Quantity
of Apples
Correlation does not mean
causality (omitted variables)
The graph does not take into
account of the number of
cigarettes smoked
Correlation vs,CausalityWarning
Risk of
Cancer
Number of
Lighters
More police cause
more crimes?
More crimes need
more police?
Correlation vs,CausalityWarning
Violent
Crimes
Police
officers
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.
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.
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
Positive or Normative Statements?
An increase in the minimum wage will
cause a decrease in employment among
the least-skilled.
Government ought to raise the minimum
wage
Positive or Normative Statements?
Higher budget deficits will cause
interest rates to increase.
Government should enhance the
market demand by implementing
deficit policies
Economists in Government,USA
The White House
– National Economic Advisor
– Council of Economic Advisors
Other Federal Agencies
– Treasury Department
– The Federal Reserve System
– The Justice Department (Anti-Trust Division)
– Commissions (SEC,FCC,FTC,etc)
– Congressional Budget Office
Economists in Government,China
党中央
中央财经领导小组办公室
国务院
各部委（发改委、财政部、人民银行、银监会证监会、保监会、劳动和社会保障部等）
研究机构（国务院政策研究室、国务院发展研究中心等）
半政府（中国社会科学院）
Why Economists Disagree
They may disagree on theories
about how the world works.
They may hold different values and,
thus,different normative views,
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.
Power of Economics
“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 intellectual influences,are usually the
slaves of some defunct economists.” (John
Maynard Keynes,1935)
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.
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.
