Chapter 2: What Is an Economy, and How Do Economists Study It?

Vocabulary-style flashcards covering core concepts from the notes: scientific method in economics, data types, assumptions, PPF, circular-flow, micro vs macro, positive vs normative economics, and the five foundations of economic thinking.

Economists' use of the scientific method

Observe phenomena, develop theories, gather data, and test whether empirical evidence supports theoretical predictions.

Observational data

Data collected without controlled experiments, used due to practical and ethical constraints.

Natural experiments

Real-world situations that approximate randomized experiments to study causal effects.

Assumptions (in economics)

Simplifications that reduce complexity to clarify analysis; may include models with two countries and two goods.

Price stickiness

Short-run assumption that prices are fixed rather than flexible.

Flexible prices

Long-run assumption that prices adjust and are not fixed.

Economic models

Visual or mathematical tools (diagrams and equations) that clarify relationships and predict outcomes.

Circular-Flow Diagram

A model showing how money and goods flow between households and firms; households supply factors of production and earn income, which they spend on firms' goods and services.

Production Possibilities Frontier (PPF)

A curve showing the maximum output combinations of two goods given fixed resources and technology; highlights trade-offs and opportunity costs.

Efficiency (PPF)

Points on the PPF reflect full utilization of resources.

Opportunity cost (PPF)

The slope of the PPF; the amount of one good that must be given up to produce more of the other.

Bowed-outward shape (PPF)

A typical PPF shape indicating increasing opportunity costs as resources are reallocated.

Shifts in the PPF (outward/inward)

Outward shift: technology or resource growth; Inward shift: disasters or reduced resources.

Microeconomics

Focuses on decisions of households and firms and interactions in specific markets.

Macroeconomics

Examines economy-wide aggregates such as GDP, inflation, unemployment, and growth.

Positive economics

Descriptions of what is; testable with data.

Normative economics

Judgments or prescriptions about what ought to be; value-based.

Households (circular flow)

Provide labor and capital; receive wages, rent, and interest.

Firms (circular flow)

Produce goods/services; pay incomes; receive revenue from sales.

Expanded circular-flow model (government/foreign sector)

Includes government taxes/spending, the financial sector, and foreign trade.

Incentives (Five Foundations)

Factors that motivate and influence economic decisions.

Trade-offs (Five Foundations)

Choices that require giving up alternatives.

Marginal thinking (Five Foundations)

Evaluating the additional costs and benefits of small, incremental changes.

Trade creates value (Five Foundations)

The idea that trade allows gains from specialization and exchange.

Two-good, two-country model

A basic framework using two goods in two countries to illustrate trade and opportunity costs.