Ch 02 Thinking Like an Economist

Chapter 2: Thinking Like an Economist

Introduction

• Economists play two distinct roles:

  • Scientists: Aim to explain how the world works.

  • Policy Advisors: Seek to improve the economy and provide policy recommendations.

Role of Economists

Economists as Scientists

• Use the scientific method:

  • Develop and test theories about economic phenomena.

  • Theories are supported or rejected based on collected data.

Economists as Policy Advisors

• Formulate policy recommendations based on economic analysis.

Economic Models

• Economists create models:

  • Simplified representations of complex realities.

  • Models help in understanding and analyzing economic issues.

  • Example: Utilizing assumptions to simplify international trade analysis.

The Circular-Flow Diagram

• A visual model showcasing how the economy operates:

  • Illustrates the flow of dollars through different market interactions.

• Key Elements:

  • Households: Own factors of production, sell/rent them to firms, consume goods and services.

  • Firms: Buy factors of production to produce goods and services, then sell these goods and services.

• The diagram also distinguishes between two markets:

  • Market for Goods and Services

  • Market for Factors of Production

The Production Possibilities Frontier (PPF)

• A graph that outlines the combinations of outputs an economy can produce:

  • Depicts the maximum possible output given resources and technology.

  • Opportunity Cost: The slope of the PPF represents the trade-offs between different goods produced.

Example: PPF with Airplanes and Soybeans

• Assumes a fixed quantity of resources and technology:

  • Only two goods are produced: airplanes and soybeans.

  • Possible production combinations range from only one good to various mixes.

  • To increase airplane production, some soybean output must be sacrificed.

Efficiency and Inefficiency on the PPF

• Points on the PPF (A-E): Efficient use of resources.

• Points under the PPF (e.g. G): Inefficient (underutilized resources).

• Points above the PPF (e.g. F): Not achievable with current resources and technology.

Moving Along the PPF

• Represents shifting resources from one good to another:

  • Society faces trade-offs: Gaining more of one good entails sacrificing some of another.

  • The slope illustrates the opportunity cost of production shifts.

Economic Growth and the PPF

• Economic growth causes an outward shift of the PPF:

  • Possible through additional resources or technological advancement.

  • Leads to increased capacity for producing both goods.

Shape of the PPF

• Straight Line: Indicates constant opportunity cost.

• Bowed Outward: Suggests increasing opportunity costs as production of one good rises at the expense of another.

Factors for Bowed-Outward PPF

• Reflects differences in worker skills and varying opportunity costs.

• Different resources might be more suited for various types of production.

Microeconomics vs. Macroeconomics

• Microeconomics: Focuses on individual households and firms and their market interactions.

• Macroeconomics: Examines economy-wide phenomena such as inflation, unemployment, and overall economic growth.

Positive vs. Normative Statements

• Positive Statements: Descriptive and based on facts (e.g. "Minimum-wage laws cause unemployment").

• Normative Statements: Prescriptive and based on personal beliefs (e.g. "The government should raise the minimum wage").

• Conflict arises in economic advice due to differing scientific judgments and values.

Consensus Among Economists

• Some propositions enjoy significant agreement among economists:

  • Effects of rent control, tariffs, outsourcing, agricultural subsidies, etc.

Conclusion

• Summary of economist roles and models:

  • Essential to understand micro and macroeconomic principles.

  • Recognition of the differing nature of positive and normative analysis in economic advice.