CH 2: Thinking like an economist

Scientific method

the dispassionate development of and testing of theories about how the world works

Circular flow diagram

• visual model of the economy

• - shows how dollars flow through the economy

Factors of production

inputs (labor, land, capital)

Production possibilities frontier (PPF)

a graph that shows the various combinations of output the economy can possibly produce given the available factors of production and production technology

Efficient

the economy is getting all it can from the scarce resources available

Inefficient

the economy is producing less than it could from the resources available

Unattainable

cannot be reached on the ppf

Microeconomics

study of how households and firms make decisions and interact in specific markets

Macroeconomics

study of the overall economy (inflation, unemployment, & economic growth

Normative statement

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

Positive statement

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

Economists play 2 roles

1: scientists - try to explain the world

2: policy advisors - try to improve it

Why are economic models used?

they are tools used to simplify our understanding of the world. assumptions are made.

circular flow diagram: who are the two decision makers?

firms and households

ircular flow diagram: what are the two interacting markets?

• markets for goods and services

• markets for factors of production

firms

• hire and use factors of production

• produce and sell goods and services

households

• own and sell the factors of production

• buy and consume goods and services

markets for goods and services

• goods and services are bought and sold

• sellers - firms

• buyers - households

markets for factors of production

• inputs are bought and sold

• sellers - households

• buyers - firms

straight line PPF

means constant opportunity cost

bowed outward PPF

increasing opportunity cost

when is the PPF bowed outward?

• different workers have different skills

• there are different opportunity costs of producing one good in terms of the other

• there is some other resource with varying opportunity costs

why would economists give conflicting advice?

may have different values or judgements