Transcript Thinking Like an Economist

Chapter 2
Thinking Like an
Economist
Ratna K. Shrestha
Overview
The Economist as a Scientist
 The Economist as a Policy-Maker
 Where Economists Disagree and where
Economists Agree

Economics Trains us to Think
– in terms of alternatives.
– and understand the cost of individual and
social choices.
– and provide us with insights into how
certain events and issues are related.
Thinking Like an Economist
 The
economic way of thinking requires one to
think analytically and objectively.
 The
economic way of thinking is like the
Scientific Method.
Scientific Method
 Scientific
Method uses abstract
models to help understand how
a complex real-world operates.
 e.g., biologist use plastic replica
of human body to study
anatomy.
 The Scientific Method develops
theory, collects and analyzes
data to prove the theory.
Economic Way of Thinking Includes
 the development of abstract models from
theories and the analysis of the models using
two approaches:
– descriptive: reporting facts, etc.
– analytical: abstract reasoning
 As do other scientists, economists make
assumptions in developing models. To study
international trade for example, we may assume
two countries and two goods.
The Circular-Flow Model
The economy consists of millions of people
involved in many activities.
 The circular-flow model provides a simple
way of describing all the economic
transactions that occur in a Market
Economy.


It emphasizes decentralization in that
economic decisions are made by
Households and Businesses in Product and
Resource Markets.
The Circular-Flow Model
Product Markets
Households
Businesses
Resource Markets
Diagram: The Circular-Flow Model
Product Markets
Households
Flow of
Resources
Businesses
Supply
Resources
Demand
Resources
Resource Markets
Diagram: The Circular-Flow Model
Product Markets
Households
Supply
Resources
Flow of
Land
Labor
Capital
Businesses
Resource Markets
Demand
Resources
Diagram: The Circular-Flow Model
Demand
Goods &
Services
Product Markets
Supply
Goods &
Services
Flow of Goods
and Services
Households
Businesses
Resource Markets
The Circular-Flow Model
Product Markets
The Flow of Dollars
Households
Businesses
Resource Markets
Diagram: The Circular-Flow Model
Product Markets
The Flow of Dollars
Households
Businesses
Resource Markets
Diagram: The Circular-Flow Model
Product Markets
The Flow of Dollars
Households
Rent
Wages
Profit
Businesses
Resource Markets
Diagram: The Circular-Flow Model
Product Markets
$
$
Dollar Flow
Real Flow
Households
Businesses
$
$
Resource Markets
The Circular-Flow Diagram
Firms

Produce and sell goods and services

Hire and use factors of production
Households

Buy and consume goods and services

Own and sell factors of production
A Second Economic Model:
Production Possibilities Frontier
(PPF)…is a graph that shows the various
combinations of output that the economy
can possibly produce given the available
factors of production and technology.
Production Possibilities Frontier
0
Cars
Production Possibilities Frontier
A
2000
0
700
Cars
Production Possibilities Frontier
E
3000
A
2000
0
700
Cars
Production Possibilities Frontier
E
3000
A
2000
F
0
700
1000
Cars
Production Possibilities Frontier
E
3000
A
2000
F
0
700
1000
Cars
Concepts Illustrated by the PPF
 Efficiency
 Tradeoffs
 Opportunity
Cost
 Economic Growth
Production Possibilities Frontier
Efficient
Resource Use
E
3000
A
2000
B?
1000
F
0
300
700
1000
Cars
Production Possibilities Frontier
E
Tradeoffs
3000
A
2000
C
1000
F
0
700
900
1000
Cars
Production Possibilities Frontier
E
3000
2000
Opportunity Cost of next 200 cars
is 1000 computers. Opportunity
cost of 1 car is 5 computers
A
C
1000
Opportunity
Cost
F
0
700
900
1000
Cars
Quantity
of Computers
Produced
The PPF
4,000
Improvement in
technology in the
production of
Computers
3,000
2,100
2,000
E
A
Quantity of
Cars Produced
0
700 750
1,000
Production Possibilities Frontier
Economic Growth
3000
Improvement in
technology in the
production of
both
2000
1000
0
300
700
1000
Cars
Microeconomics and Macroeconomics
focuses on “the individual
parts of the economy.”
– e.g. individual markets
– e.g. price increase in the housing market
 Macroeconomics looks at the “economy as a
whole.”
– e.g. aggregate of markets
– e.g. average price increase for all goods
– e.g. unemployment
 Microeconomics
Two Roles of Economists
When they are trying to
explain the world, they are
Scientists.
When they are trying to
change the world they are
Policy-makers.
Positive versus Normative Analysis

Positive: Statements or assertions dealing
with matters of fact or questions about how
things are (descriptive analysis).

Normative: Statements that reflect individual
opinions about how the world should be
(prescriptive analysis).
Positive or Normative Statements?
 An
increase in the minimum wage will cause a
decrease in employment among the least
skilled.
 Higher federal budget deficits will cause
interest rates to increase.
 The income gains from a higher minimum
wage are worth more than any slight reduction
in employment.
 Provincial governments should be allowed to
collect from tobacco companies the costs of
treating smoking-related illnesses among the
poor.
WHY ECONOMICS IS WORTH
STUDYING?
1.
– Two main benefits from studying economics:
1. Understanding
2. Expanded career opportunities
Understanding
– Economic ideas is all around you. You
cannot ignore them.
– As you progress with you study of
economics, you’ll gain a deeper
understanding of what is going on around
you.
WHY ECONOMICS IS WORTH
STUDYING?
2. Expanded Career Opportunities
– Most students of economics don’t become
economists.
– But knowledge of economics is vital is
many fields such as banking, finance,
business, management, insurance, real
estate, law, government, journalism, health
care and the arts.
– Economics graduates are not the highestpaid professional, but they are close to the
top.
WHY ECONOMICS IS WORTH
STUDYING?
The Costs of Studying Economics
– The main cost of studying economics is
forgone leisure time.
– Most students find that economics is
difficult and that it takes time to master.
– The trick is practice, or learning by doing.
Benefits Versus Costs
–Weigh up your benefits and costs!
Economists in Government
 Department
of Finance: formulate tax policy.
 Industry Canada: design competition policy.
 Foreign Affairs: assist with trade agreements.
 Human Resources Development Canada:
formulate labor market policies.
 Bank of Canada: implement monetary policy.
 Environment Canada: design environment
laws.
Economists in the Private Sector
Howe Institute — suggest policy
options.
 Fraser Institute — suggest policy options.
 Provide forecasts for companies.
 Assist firms manage resources efficiently.
 Assist with investment decisions.
 C.D.
Do Economists Always Agree With Each
Other? Three reasons why they don’t:
 Disagree about the validity of alternative
positive theories
 Each have different values, thus different
normative views
Examples of When Economists
(Majority) Do Agree
A
ceiling on rents reduces the quantity and
quality of housing available.
 Tariffs
and import quotas usually reduce
general economic welfare.
 Tax
cuts has a significant stimulative impact
on a less than fully employed economy.