Thinking Like an Economist
Introduction to Economics PowerPoint Slides
Prepared by: V. Andreea CHIRITESCU, Eastern Illinois UniversityTextbook: N. Gregory Mankiw, Principles of Economics, Eighth Edition
Chapter: Thinking Like an Economist
© 2018 Cengage Learning®
The Economist as a Scientist, Part 1: Economics Defined
Economics is classified as a social science focused on the study of how individuals and societies use scarce resources to satisfy unlimited wants.
Economists engage in scientific work which includes:
Developing theories: Creating models of economic behavior to explain how economies function.
Collecting and analyzing data: Gathering empirical evidence to support or refute economic theories and models.
Testing theories through the scientific method: Utilizing observable and testable predictions about economic phenomena to validate theories.
The Economist as a Scientist, Part 2: Scientific Method Applied to Economics
Involves a systematic and objective approach to understanding economic phenomena.
Key Steps:
Observation of economic phenomena: Noting patterns, trends, and outliers in economic activity.
Formulation of theories: Developing hypotheses to explain observed data.
Further observation to validate or refute theories: Conducting experiments or seeking additional data to confirm hypothesis.
Limitations:
Direct experimentation is often impractical in economics; reliance on historical events for insights is common. Experiments like those in the natural sciences, such as chemistry or biology, are less feasible due to the myriad of variables at play in economic systems.
The Economist as a Scientist, Part 3: Role of Assumptions
Assumptions play a critical role in simplifying complex economic systems, making it easier to analyze outcomes.
Art of Scientific Thinking: Choosing appropriate assumptions is essential for different types of inquiries, such as assessing short-run (immediate effects) versus long-run (sustained effects) outcomes.
The Economist as a Scientist, Part 4: Economic Models
Economic models are simplified representations utilizing diagrams and equations to illustrate economic realities.
Models help identify significant factors in economic analysis by omitting non-essential details, thus focusing on the most impactful variables.
Models are constructed based on specific assumptions to reflect aspects of reality and make predictions about future economic behavior.
The Economist as a Scientist, Part 5: Circular-Flow Diagram
A circular-flow diagram is a visual representation that illustrates how money flows in an economy between various actors.
Key Components:
Decision Makers: Households (consumers) and Firms (producers) interact with each other and the markets.
Markets:
Goods and Services Market: Where firms sell their products to households.
Factors of Production Market: Where households sell resources or labor to firms.
The Economist as a Scientist, Part 6: Role of Firms and Households
Firms:
Produce goods and services and utilize production factors. Decision-making in firms focuses on maximizing profit through efficient resource allocation.
Households:
Own production factors and consume goods and services. Households make decisions based on utility maximization, striving to derive the most benefit from their consumption choices.
The Economist as a Scientist, Part 7: Market Interaction
Markets for Goods and Services:
Firms sell to households based on demand, which is influenced by price and income levels.
Markets for Factors of Production:
Households sell their labor and other resources to firms, which in turn affects wages and employment levels.
Figure 1: Circular Flow Representation
Description: Visual model displaying interactions between households and firms in economic markets.
Outer arrows indicate the flow of money (income to households, payments to firms), while inner arrows illustrate the flow of goods and services and inputs, demonstrating the interdependence of these economic actors.
The Economist as a Scientist, Part 8: Production Possibilities Frontier (PPF)
The PPF graphically represents potential output combinations for an economy given its available resources and technology, illustrating the concept of opportunity costs.
Figure 2: PPF Illustration:
Demonstrates maximum feasible production levels of different goods (e.g., cars vs. computers). Points on the frontier reflect production efficiency, while those inside indicate inefficiencies. The slope signifies opportunity costs associated with producing one good over the other, making it essential to consider trade-offs.
The Economist as a Scientist, Part 9: Efficient vs. Inefficient Production
Efficient Production:
Achieving maximum output with current resources (points on the PPF). Understanding trade-offs is vital; for instance, increasing the production of one product may necessitate reduced output of another.
The Economist as a Scientist, Part 10: Inefficient Production Explained
Points within the PPF symbolize underutilized resources, indicating potential increases in total production if efficiency is improved by better resource allocation.
The Economist as a Scientist, Part 11: Bowed-Outward PPF
Opportunity costs may vary based on current production levels; specialized resources lead to different opportunity costs when switching outputs, which is graphically represented by the bowed shape of the PPF.
The Economist as a Scientist, Part 12: Technological Advances
Technological advances shift the PPF outward, indicating potential economic growth and increased production capacities, allowing for more efficient resource use.
Figure 3: Shifts in the PPF:
Illustrates the impact of innovations on the economic production capabilities.
The Economist as a Scientist, Part 13: Microeconomics vs. Macroeconomics
Microeconomics:
Focuses on individual households and firm decision-making processes, analyzing how these decisions influence supply and demand in specific markets.
Macroeconomics:
Examines aggregate economic phenomena, such as gross domestic product (GDP), inflation, and unemployment rates, assessing the overall health of an economy.
The Economist as Policy Adviser, Part 1: Positive vs. Normative Statements
Positive Statements:
Describe the world as it is and can be tested empirically (e.g., "Minimum-wage laws cause unemployment").
Normative Statements:
Prescribe what the world ought to be (e.g., "The government should raise the minimum wage"), influenced by personal beliefs and value judgments.
The Economist as Policy Adviser, Part 2: Roles in Economic Governance
Economists play advisory roles within governmental bodies such as the Council of Economic Advisers, where their insights inform policies.
They produce annual economic reports that assess current developments and recommend policies to mitigate economic issues.
The Economist as Policy Adviser, Part 3: Key Economic Institutions
Various institutions where economists provide insights include:
Office of Management and Budget
Department of the Treasury
Department of Labor
Department of Justice
Congressional Budget Office
Federal Reserve.
The Economist as Policy Adviser, Part 4: Challenges in Policy Application
Economic advice can face challenges as it may be overlooked or modified for political considerations. Influences on decision-making include public opinion, possible political repercussions, and the need to communicate complex economic concepts clearly to policymakers and the public.
Why Economists Disagree, Part 1: Disagreement in Economics
Roots of disagreement in the field often stem from differing positive theories and varying values or goals among economists concerning what policies is best for economic progress.
Why Economists Disagree, Part 2: Judgment Variance
Economists may arrive at differing conclusions due to scientific judgments about the relevance of certain theories and how variables are measured and interpreted, leading to different policy recommendations.
Why Economists Disagree, Part 3: Case Study: Peter and Paula
Different individual incomes can lead to differing perspectives on tax burdens and the fairness of taxation, showcasing how societal values and economic conditions influence economic views and policy stances.
Why Economists Disagree, Part 4: Perception vs. Reality
Example: Rent control laws, while intended to assist those in need, can lead to negative effects on housing quality and availability, demonstrating the unintended consequences of well-meaning policies. Moreover, a general consensus exists among economists that trade barriers, such as tariffs, hinder economic welfare.
ASK THE EXPERTS: Ticket Resale Expert Insight
Discussion revolves around the impact of laws limiting ticket resale on audience accessibility, weighing benefits of regulation against market freedom.
Table 1: Consensus Among Economists, Part 1 Key Propositions (with percentages of agreement):
Rent ceilings reduce housing quality and quantity (93%).
Tariffs and quotas lower economic welfare (93%).
Flexible exchange rates are beneficial (90%).
Fiscal policy impacts low-employment economies (90%).
Outsourcing should not be restricted (90%).
Growth improves well-being (88%).
Agricultural subsidies should be eliminated (85%).
Proper fiscal policy boosts capital formation (85%).
State subsidies to sports franchises should be eliminated (85%).
Balanced federal budgets should be cyclical, not yearly (85%).
Table 1: Consensus Among Economists, Part 2 Continued Propositions:
Social Security funds will face unsustainable gaps in 50 years (85%).
Cash payments benefit recipients more than in-kind transfers (84%).
Large federal deficits negatively affect the economy (83%).
Income redistribution is a legitimate government role (83%).
Money supply growth primarily causes inflation (83%).
Ban on genetically modified crops is unnecessary (82%).
Minimum wage raises unemployment for inexperienced workers (79%).
Welfare should be restructured (79%).
Market solutions for pollution are preferable (78%).
Ethanol subsidies should be reduced (78%).
Graphing: A Brief Review, Part 1: Purpose of Graphs
Provide visual clarity to complex economic ideas that may be difficult to articulate in verbal or equation form.
Types of Graphs:
Pie charts
Bar graphs
Time-series graphs
Figure A-1: Types of Graphs Examples:
Pie chart illustrating sources of national income.
Bar graph comparing average income across different countries.
Time-series graph indicating productivity trends over time, allowing for analysis of historical changes in economic performance.
Graphing: A Brief Review, Part 2: Graphs of Two Variables
Use coordinate systems to demonstrate relationships between two variables.
Types include scatterplots illustrating ordered pairs, highlighting correlations and potential predictive relationships.
Figure A-2: Coordinate System Usage Analysis:
For instance, GPA plotted against study time illustrates a positive correlation, indicating that increased study time generally leads to higher grades.
Graphing: A Brief Review, Part 3: Demand Curve
Represents the relationship between the price of a good and the quantity demanded by consumers at different income levels, reflecting consumer behavior and market dynamics.
Table A-1: Novels Purchased by Emma Data Overview:
Illustrates how many novels Emma buys at different prices and income levels, forming distinct demand curves (D1, D2, and D3) based on her income categories.
Graphing: A Brief Review, Part 4: Relationships in Variables
Negatively related variables: Graphs slope downward, demonstrating inverse relationships.
Positively related variables: Graphs slope upward, indicating direct relationships.
Movement along curves signifies changes in variables; shifts in curves represent external changes affecting the economic interplay.
Figure A-3: Demand Curve Representation
Observation illustrates a downward slope indicating that as the price of novels increases, the quantity demanded decreases, a fundamental concept in understanding demand.
Figure A-4: Shifting Demand Curves
Income Correlation: Higher income levels result in rightward shifts of demand curves, indicating increased purchasing power for novels, demonstrating how consumer income directly impacts demand.
Graphing: A Brief Review, Part 5: Understanding Slope
The slope represents the ratio of vertical change to horizontal change, indicative of the relationship strength between variables.
Graphing: A Brief Review, Part 6: Slope Variations
Slope can be flat, steep, negative, zero, or infinite, reflecting different relationships between the variables based on data representation in graphs.
Figure A-5: Calculating Slope of Demand Curve Example Calculation:
Slope is calculated by examining changes in coordinates when moving along the demand curve, illustrating how price and quantity demanded influence each other, fundamental to grasping market behavior.
Graphing: A Brief Review, Part 7: Causal Relationships
Importance of correctly identifying causal relationships in economic data, highlighting the issue of omitted variable bias that can lead to misleading interpretations of economic phenomena.
Figure A-6: Omitted Variable Impacts
An analysis of various graph data may reveal a correlation between cigarette lighter ownership and cancer instances but neglects the influence of smoking habits, underscoring the necessity of comprehensive data analysis for accurate economic conclusions.
Graphing: A Brief Review: Reverse Causality
Importance of discerning causality directions, where causation can be misattributed, emphasizing careful evaluation of temporal sequences in economic data.
Figure A-7: Reverse Causality Example Analysis:
Highlights the relationship between police presence and crime rates, stressing the need for thorough analysis to understand whether police presence lowers crime or a higher crime rate leads to increased police deployment, illustrating how careful consideration of economic data can prevent erroneous conclusions.