Chapter 2: Thinking Like an Economist Theory

The Scientific Method for Social Sciences

(1) Observation (Observe)

(2) Research/Literature Review (Research)

(3) Develop a Theory (Theory)

(4) Form Hypotheses (Hypotheses)

(5) Collect Data

(6) Analyze Data

(7) Support/Refute Hypothesis (Accept/Reject Hypothesis)

(8) Refine Theory and Communicate Results (Communicate Results)

What do economists do?

(1) the dispassionate development and testing of theories about how the world works (theories)

(2) devise theories, collect data, analyze the data to verify or refute their theories (statistics)

(3) economists pay close attention to the natural experiments offered by history (history)

Assumptions

(1) assumptions can simplify the complex world and make it easier to understand

(2) the creative part in scientific thinking is deciding which assumptions to make

What are economic models?

(1) economic models are diagrams and equations that are built with assumptions

(2) an economic model is used to simplify and demonstrate important parts together

The Art of Economic Modelling

(1) the art of economics is knowing when to find the right model at the right time

What are the 2 major economic models?

(1) the circular-flow diagram

(2) the production possibilities frontier (PPF)

What is the circular flow diagram?

(1) how value: goods and services, labor and resources, money, flows in the economy; how value flows in the economy

What are the 2 types of decision makers in the circular flow diagram?

(1) firms and households

What are the 2 types of markets in the circular flow diagram?

(1) markets for goods and services

(2) markets for the factors of production

What are firms?

(1) firms produce goods and services

(2) in order to produce goods and services they need input (labor, capital, land, entrepreneurship)

What are households?

(1) households own the inputs (labor, land, capital, entrepreneurship)

(2) households consume all the goods and services produced by firms

Factors of Production

(1) these are your inputs

(2) labor, land, capital, entrepreneurship

(3) inputs are services that people do (labor, entrepreneurship), inputs are things that people own (land, capital)

What roles do households and firms play in the markets for goods and services?

(1) households are buyers, firms are sellers

(2) households buy the output of goods and services that firms produce

What roles do households and firms play in the markets for the factors of production?

(1) households are sellers, firms are buyers

(2) firms buy the inputs of labor that households produce; to produce goods and services

(3) households provide the inputs that firms use to produce goods and services

Draw the Circular Flow Diagram.

What is the production possibilities frontier?

(1) illustrates all the possible combinations of output that an economy can produce given its (1) factors of production (inputs) and (2) technology

(2) this is a graph that shows the various combinations of output the economy can possibly produce given the available (1) factors of production and the (2) production technology that firms use to turn these inputs into output; (1) manpower and (2) tech power

(3) talks about the economy's productive capacity, production limits and trade-offs

What are the 4 core rules of the production possibilities frontier?

(1) two goods only

(2) fixed resources

(3) fixed technology

(4) full use of resources

What does movements along the PPF tell us?

(1) shows the maximum possible combinations of output between two goods

(2) producing more of one good requires producing less of the other

3 Fundamental Economic Concepts Illustrated by the PPF

(1) trade-offs

(2) scarcity

(3) opportunity cost

What do the endpoints on the PPF tell us?

(1) x and y intercept endpoints shows specialization to one good only meaning all resources and production are devoted to that single good only

(2) maximum production of one good, and zero production of the other

What is the shape of the PPF?

(1) bowed outward, concave down

What does the slope represent on the PPF?

(1) the opportunity cost (expressed in units of the other good)

What is the concavity of the PPF? How does the slope behave?

(1) the curve is decreasing at a decreasing rate, the curve is increasing at a decreasing rate

(2) given the absolute value, the slope is getting bigger as it goes down

What do points on the frontier of the PPF tell us?

(1) more efficient outcomes

(2) the maximum efficient use of resources

(3) the economy is producing as much as possible

(4) peak efficiency

(5) the economy is getting the most it can from scarce resources

What do points inside the frontier of the PPF tell us?

(1) less efficient outcomes

(2) may be feasible, but inefficient use of resources

(3) the economy’s resources are underused or misallocated

(4) inefficiency

(5) resources are idle, wasted, or misallocated

(6) causes may root from unemployment, poor coordination, economic downturns

What do points outside the frontier of the PPF tell us?

(1) not feasible

(2) the economy lacks sufficient resources and technology

An increase in ____ and ____ causes the PPF to shift ____.

(1) resources

(2) technology

(3) outward

A ____ of resources and technology causes the PPF to shift inward.

(1) increase

An decrease in ____ and ____ causes the PPF to shift ____.

A ____ of resources and technology causes the PPF to shift inward.

(1) decrease

What is the shape of the Increasing Cost Production Possibilities Frontier? Why does it have that shape?

(1) bowed out because, it is specialized into one, different resources different skills, like meat and cars

(2) a bowed-out PPF shows increasing opportunity cost because resources are specialized and not equally efficient in producing all goods

What is the shape of the Constant Cost Production Possibilities Frontier? Why does it have that shape?

(1) linear because, not specialized into one, same resources same skills, like meat and potatoes, tables and chairs

(2) a constant production possibilities frontier shows constant opportunity cost, meaning the economy gives up the same amount of one good to produce each additional unit of another good

Microeconomics

(1) the study of how households and firms make decisions and how they interact in specific markets

Macroeconomics

(1) the study of the overall economy

Microeconomics or Macroeconomics: The effects of rent control on housing in New York City

Microeconomics

Microeconomics or Macroeconomics: The effects of education on workers' earnings

Microeconomics

Microeconomics or Macroeconomics: The effects of borrowing by the federal government

Macroeconomics

Microeconomics or Macroeconomics: The changes in the economy's unemployment rate over time

Macroeconomics

Microeconomics or Macroeconomics: Alternative policies to promote growth in national living standards

Macroeconomics

Two Faces of the Economist

(1) as a scientist

(2) as a policy adviser

The Economist as a Scientist

(1) when economists try to explain the world

The Economist as a Policy Adviser

(1) when economists are giving guidance on how to improve the world

Positive Analysis

(1) descriptive, claims that attempt to describe the world as it is

(2) economics is: economics tries to explain how the economy works

(3) scientist

Positive or Normative Statement? “Minimum wage laws cause unemployment”

Positive

Normative Analysis

(1) prescriptive, claims that attempt to prescribe how the world should be

(2) economists use economics to: economists want to learn how to improve the economy

(3) policy adviser

Positive or Normative Statement? “The government should raise the minimum wage”

(1) Normative

Give the two reasons why economists might disagree?

(1) disagree on theories (positive theories)

(2) disagree on values (normative views)