02 thinking like an economist

8/10/2019 02 Thinking Like an Economist

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Copyright 2004 South-Western/Thomson Learning

2Thinking Like anEconomist


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Thinking Like an Economist

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


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Thinking Like an Economist

Economics trains you to. . . . Think in terms of alternatives. Evaluate the cost of individual and social choices.

Examine and understand how certain events andissues are related.


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The Scientific Method: Observation, Theory,and More Observation

Uses abstract models to help explain how acomplex, real world operates.

Develops theories, collects, and analyzes datato evaluate the theories.


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The Role of Assumptions

Economists make assumptions in order tomake the world easier to understand.

The art in scientific thinking is deciding whichassumptions to make.

Economists use different assumptions toanswer different questions.


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Our First Model: The Circular-Flow Diagram

The circular-flow diagram is a visual model of theeconomy that shows how dollars flow throughmarkets among households and firms.


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Figure 1 The Circular Flow

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Spending

Goods and services bought

Revenue

Goods and services sold

Labor, land, and capital

Income

= Flow of inputsand outputs

= Flow of dollars

Factors of production

Wages, rent, and profit

FIRMS Produce and sell goods and services

Hire and use factors of production

Buy and consume goods and services

Own and sell factors of production

HOUSEHOLDS

Households sell Firms buy

MARKETS FOR

FACTORS OF PRODUCTION

Firms sell Households buy

MARKETS FOR

GOODS AND SERVICES


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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




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 ProductionPossibilities Frontier

The production possibilities frontier is a graph thatshows the combinations of output that theeconomy can possibly produce given the

available factors of production and the available production technology.


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Figure 2 The Production Possibilities Frontier

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Production possibilities frontier

A

B

C

Quantity of Cars Produced

2,200

600

1,000

300 0 700

2,000

3,000

1,000

Quantity of Computers

Produced

D



Our Second Model: The ProductionPossibilities Frontier

Concepts Illustrated by the ProductionPossibilities Frontier Efficiency

Tradeoffs Opportunity Cost Economic Growth


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Figure 3 A Shift in the Production Possibilities Frontier


E

Quantity of Cars Produced

2,000

700

2,100

750 0

4,000

3,000

1,000

Quantity of Computers

Produced

A



Microeconomics and Macroeconomics

Microeconomics focuses on the individual partsof the economy. How households and firms make decisions and how

they interact in specific markets Macroeconomics looks at the economy as a

whole.

Economy-wide phenomena, including inflation,unemployment, and economic growth



THE ECONOMIST AS POLICY ADVISOR

When economists are trying to explain theworld, they are scientists.

When economists are trying to change theworld, they are policy advisor.



POSITIVE VERSUS NORMATIVE ANALYSIS

Positive statements are statements that attempt todescribe the world as it is. Called descriptive analysis

Normative statements are statements about howthe 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.

POSITIVE

Higher federal budget deficits will cause interest

rates to increase.POSITIVE

?

?


?



Positive or Normative Statements? The income gains from a higher minimum wage are

worth more than any slight reductions in

employment. NORMATIVE

State governments should be allowed to collectfrom tobacco companies the costs of treatingsmoking-related illnesses among the poor.

NORMATIVE

?

?


?



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 about the validity ofalternative positive theories about how theworld works.

They may have different values and, therefore,different normative views about what policy

should try to accomplish.

Table 2 Ten Propositions about Which Most


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Table 2 Ten Propositions about Which MostEconomists Agree




Summary

Economists try to address their subjects with ascientists objectivity. They make appropriate assumptions and build

simplified models in order to understand the worldaround them.

Two simple economic models are the circular-flowdiagram and the production possibilities frontier.



Summary

Economics is divided into two subfields: Microeconomists study decisionmaking by

households and firms in the marketplace.

Macroeconomists study the forces and trends thataffect the economy as a whole


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Summary

Economists who advise policymakers offerconflicting advice either because of differencesin scientific judgments or because of

differences in values. At other times, economists are united in the

advice they offer, but policymakers may choose

to ignore it.

02 thinking like an economist

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