Transcript Thinking Like an Economist

Thinking Like an Economist
Two basic economic models
Thinking Like an Economist
• Economics trains you to. . . .
▫ Think in terms of alternatives.
▫ Evaluate the cost of individual and
social choices.
▫ Examine and understand how
certain events and issues are
related.
• Economists use models to simplify reality in
Economic Models
order to improve our understanding of the world
• Two of the most basic economic models include:
▫ The Circular Flow Diagram
▫ The Production Possibilities Frontier
Figure 1 The Circular Flow
Revenue
Goods
and services
sold
MARKETS
FOR
GOODS AND SERVICES
•Firms sell
•Households buy
Wages, rent,
and profit
Goods and
services
bought
HOUSEHOLDS
•Buy and consume
goods and services
•Own and sell factors
of production
FIRMS
•Produce and sell
goods and services
•Hire and use factors
of production
Factors of
production
Spending
MARKETS
FOR
FACTORS OF PRODUCTION
•Households sell
•Firms buy
Labor, land,
and capital
Income
= Flow of inputs
and outputs
= Flow of dollars
Copyright © 2004 South-Western
The Production Possibilities Frontier
A
B
C
D
E
Pizza
0
1
2
3
4
Robots
10
9
7
4
0
Importance of Production Possibility
Frontier
• Concepts Illustrated by the Production
Possibilities Frontier
▫
▫
▫
▫
Efficiency
Tradeoffs
Opportunity Cost
Economic Growth
• The model implies productive efficiency and
allocative efficiency (or ceterus paribus)
▫ Okun’s Law: for every 1% of extra unemployment
over 5%, there is 2% of potential GDP lost
Production Possibilities II
• The curve illustrates the law of increasing costs
▫ The more pizza produced, the less robots are
produced
▫ Because not all resources are alike, some are
better suited to the production of one product to
another so numbers might be different
▫ The curve is bowed because resources are not
completely adaptable to other uses