Chapter 2 - Thinking Like an Economist

scientific method

dispassionate development and testing of theories about how the world works

how do economists use the scientific method?

use historical events to draw insights about economic theories rather than conducting controlled experiments (it cannot be done)

how are assumptions useful for economists?

they simplify the complexity of the world to make analysis manageable, yielding valuable insights despite being unrealistic

economic model

An explanation of how an economic phenomenon operates, based on simplifying assumptions

circular-flow diagram

a visual model of the economy that shows how dollars flows through markets

who are the decision makers in a circular-flow diagram?

households and firms

factors of production

inputs necessary for production (of goods and services) like land, labour, and capital which households own and sell

what are the two markets in a circular-flow diagram?

markets for goods and services and markets for factors of production

in a goods and services market…

households buy goods and services, firms produce and sell goods and services

in the market for factors of production…

Households own and sell factors of production, firms buy and use factors of production for goods and services

production possibilities frontier (PPF)

A graph that represents all possible combinations of goods an economy can produce with limited factors of production

where on the PPF is production not feasible?

Points that lie outside the frontier, as they require more resources than are available

where on the PPF is production efficient?

Points that lie on the frontier, where the economy is maximizing its production capabilities with available resources

where on the PPF is production inefficient?

Points that lie inside the frontier, indicating that resources are not being fully utilized

increasing one good’s production results in…

a decrease in the production of another good due to limited resources (opportunity cost)

the slope of the PPF represents…

the opportunity cost of one good in terms of the other (the rate at which one good must be sacrificed to produce more of the other good)

what does a straight line PPF mean?

opportunity cost of a good is constant regardless of output

what does a bowed out PPF mean?

opportunity cost of producing a good increases as more of it is produced

what does a shift outward in the PPF mean?

economic growth, meaning increased capabilities to produce goods

factors influencing economic growth

Technological advancements, population increases which enable more combinations of goods than before

positive statements

statements that describe the world as it is (economic conditions)

normative statements

express opinions on how the world (economic conditions) SHOULD be, often involving judgments