Chapter 2 Notes – Thinking Like an Economist (Mankiw, 10th Edition)

Economists have two roles:

  • Scientists: explain how the world works.

  • Policy advisers: aim to improve the world.

The Scientific Method in Economics

  • Involves observation, theory development, and further evaluation.

  • Economists rely on natural experiments as laboratory experiments are not feasible.

Assumptions and Models

  • Economists use simplifying assumptions to study complex realities.

  • They employ models to reveal what is truly important.

  • All models are provisional and subject to revision.

The Circular-Flow Diagram

  • A visual model of the economy, showing how dollars flow through markets.

  • Features two decision makers:

    • Firms

    • Households

  • Involves two types of markets:

    • Market for goods and services (firms sell, households buy)

    • Market for factors of production (hous
      eholds sell inputs, firms buy)

The Production Possibilities Frontier (PPF)

  • A graph showing various output combinations an economy can produce.

  • Illustrates:

    • Trade-offs: More of one good requires sacrificing another.

    • Opportunity cost: The slope of the PPF represents the opportunity cost of one good in terms of the other.

  • Points on the PPF are efficient, points inside are inefficient, and points outside are not feasible.

  • Economic growth shifts the PPF outward due to additional resources or improved technology.

  • The shape of the PPF:

    • Straight-line PPF: Indicates constant opportunity cost.

    • Bowed-outward PPF: Indicates increasing opportunity cost, typically due to specialized resources and differing worker skills.

Microeconomics vs Macroeconomics

  • Microeconomics: Study of how households and firms make decisions and interact in markets.

  • Macroeconomics: Study of economy-wide phenomena (e.g., inflation, unemployment, economic growth).

The Economist as Policy Adviser

  • Economists use two types of statements:

    • Positive statements: Describe how the world is; testable with evidence.

    • Example: \text{
      “Minimum-wage laws cause unemployment.”}

    • Normative statements: Prescribe how the world should be; involve value judgments.

    • Example: \text{
      “The government should raise the minimum wage.”}

Economists in Washington

  • Advise various government bodies (e.g., Council of Economic Advisers, Department of the Treasury, Federal Reserve).

  • Their advice may not always be followed due to political considerations.

Why Economists Disagree

  • Disagreements often stem from:

    • Differing scientific judgments about the validity of theories or parameter sizes.

    • Varying values or political philosophies.

  • Despite disagreements, there is broad consensus on many propositions:

    • Tariffs and import quotas usually reduce general economic welfare. (93\% agreement)

    • A minimum wage increases unemployment among young and unskilled workers. (79\% agreement)

Formulas

  • Opportunity cost formula: OC_{\text{good1}} = \frac{\text{change in good2}}{\text{change in good1}}.