micro econ chap02
TRANSCRIPT
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2Thinking Like anEconomist
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Copyright 2004 South-Western/Thomson Learning
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
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: Observation,Theory, and More Observation Uses abstract models to help explain how a
complex, real world operates.
Develops theories, collects, and analyzesdata to 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 decidingwhich assumptions to make.
Economists use different assumptions toanswer different questions.
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Economic Models
Economists use models to simplify realityin order to improve our understanding ofthe world
Two of the most basic economic modelsinclude: The Circular Flow Diagram
The Production Possibilities Frontier
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Our First Model: The Circular-FlowDiagram The circular-flow diagram is a visual model
of the economy that shows how dollars flowthrough markets 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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Our First Model: The Circular-FlowDiagram 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
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Our First Model: The Circular-FlowDiagram Markets for Goods and Services
Firms sell Households buy
Markets for Factors of Production Households sell Firms buy
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Our First Model: The Circular-FlowDiagram Factors of Production
Inputs used to produce goods and services Land, labor, and capital
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Our Second Model: The ProductionPossibilities Frontier The production possibilities frontier is a
graph that shows the combinations ofoutput that the economy can possibly
produce given the available factors ofproduction and the available productiontechnology.
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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
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Our Second Model: The ProductionPossibilities Frontier Concepts Illustrated by the Production
Possibilities Frontier Efficiency
Tradeoffs Opportunity Cost Economic Growth
i 3 A Shif i h d i ibili i
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Figure 3 A Shift in the Production PossibilitiesFrontier
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E
Quantity of
Cars Produced
2,000
700
2,100
750
0
4,000
3,000
1,000
Quantity of Computers
Produced
A
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Microeconomics andMacroeconomics 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.
Economy-wide phenomena, including inflation,unemployment, and economic growth
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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.
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Positive versus normative analysis
Positive statements are statements thatattempt to describe the world as it is. Called descriptive analysis
Normative statements are statementsabout how the world should be. Called prescriptive analysis
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Positive versus normativeanalysis Positive or Normative Statements?
An increase in the minimum wage will cause adecrease in employment among the least-
skilled. POSITIVE
Higher federal budget deficits will causeinterest rates to increase. POSITIVE
?
?
?
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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.NORMATIVE
State governments should be allowed to collectfrom tobacco companies the costs of treatingsmoking-related illnesses among the poor.
NORMATIVE
?
?
Positive versus normativeanalysis
?
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Economists in Washington
. . . serve as advisers in the policymakingprocess of the three branches ofgovernment:
Legislative Executive Judicial
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WHY ECONOMISTSDISAGREE They may disagree about the validity of
alternative positive theories about how theworld works.
They may have different values and,therefore, different normative views about
what policy should try to accomplish.
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Table 2 Ten Propositions about Which MostEconomists Agree
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Summary
Economics is divided into two subfields: Microeconomists study decision-making by
households and firms in the marketplace.
Macroeconomists study the forces and trendsthat affect the economy as a whole
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Summary
A positive statement is an assertion abouthow the world is.
A normative statement is an assertionabout how the world ought to be.
When economists make normativestatements, they are acting more as policy
advisors than scientists.
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Summary
Economists who advise policymakers offerconflicting advice either because ofdifferences in 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.