Thinking Like an Economist

Chapter 2

Every field of study has its own terminology

Every field of study has its own terminology

Economics trains you to. . . .

u Think in terms of alternatives.

u Evaluate the cost of individual and social choices.

u Examine and understand how certain events and issues are related.

The Economist as a Scientist

The economic way of thinking . . .

u Involves thinking analytically and objectively.

u Makes use of the scientific method.

The Scientific Method

u Uses abstract models to help explain how a complex, real world operates.

u Develops theories, collects, and analyzes data to prove the theories.

The Role of Assumptions

u Economists make assumptions in order to make the world easier to understand.

u The art in scientific thinking is deciding which assumptions to make.

u Economists use different assumptions to answer different questions.

The Economic Way of Thinking

uIncludes developing abstract models from theories and the analysis of the models.

uUses two approaches:

Economic Models

u Economists use models to simplify reality in order to improve our understanding of the world

u Two of the most basic economic models include:

The Circular-Flow Model

The circular-flow model is a simple way to visually show the economic transactions that occur between households and firms in the economy.

The Circular-Flow Diagram

The Circular-Flow Diagram

The Circular-Flow Diagram

The Circular-Flow Diagram

Factors of Production

u Inputs used to produce goods and services

u Land, labor, and capital

The Production Possibilities Frontier

The production possibilities frontier is a graph showing the various combinations of output that the economy can possibly produce given the available factors of production and technology.

The Production Possibilities Frontier

The Production Possibilities Frontier

Concepts Illustrated by the Production Possibilities Frontier

u Efficiency

u Tradeoffs

u Opportunity Cost

u Economic Growth

The Production
Possibilities Frontier

Microeconomics and Macroeconomics

u Microeconomics focuses on the individual parts of the economy.

u How households and firms make decisions and how they interact in specific markets

u Macroeconomics looks at the economy as a whole.

u How the markets, as a whole, interact at the national level.

Two Roles of Economists

uWhen they are trying to explain the world, they are scientists.

uWhen they are trying to change the world, they are policymakers.

Positive versus Normative Analysis

u Positive statements are statements that describe the world as it is.

u Called descriptive analysis

u Normative statements are statements about how the world should be.

u Called prescriptive analysis

Positive or Normative Statements?

An increase in the minimum wage will cause a decrease in employment among the least-skilled.

Positive or Normative Statements?

Higher federal budget deficits will cause interest rates to increase.

Positive or Normative Statements?

The income gains from a higher minimum wage are worth more than any slight reductions in employment.

Positive or Normative Statements?

State governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor.

Economists in Washington . . .

. . . serve as advisers in the policymaking process of the three branches of government:

u Legislative

u Executive

u Judicial

Why Economists Disagree

u They may disagree on theories about how the world works.

u They may hold different values and, thus, different normative views.

Examples of What Most Economists Agree On

u A ceiling on rents reduces the quantity and quality of housing available.

u Tariffs and import quotas usually reduce general economic welfare.

Summary

uIn order to address subjects with objectivity, economics makes use of the scientific method.

uThe field of economics is divided into two subfields: microeconomics and macroeconomics.

Summary

u Economics relies on both positive and normative analysis. Positive statements assert how the world “is” while normative statements assert how the world “should be.”

u Economists may offer conflicting advice due to differences in scientific judgments or to differences in values.

The Circular-Flow Diagram

The Production Possibilities Frontier

The Production Possibilities Frontier

The Production
Possibilities Frontier