Transcript Thinking Like An Economist

Economic Models
• Economics trains you to. . . .
• Think in terms of alternatives.
• Evaluate the cost of individual and social choices.
• Understand how certain events and issues are related.
• Economists use models to simplify reality in order to
improve our understanding of the world
• Two of the most basic economic models include:
• The Circular Flow Diagram
• The Production Possibilities Frontier
Copyright © 2004 South-Western/Thomson Learning
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 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
• Government?
Copyright © 2004 South-Western/Thomson Learning
The Production Possibilities Frontier
• The production possibilities frontier is a graph that
shows the combinations of output that the
economy can possibly produce given the available
factors of production and the available production
technology.
Copyright © 2004 South-Western/Thomson Learning
The Production Possibilities Frontier
Quantity of
Computers
Produced
3,000
D
C
2,200
2,000
A
Production
possibilities
frontier
B
1,000
0
300
600 700
1,000
Quantity of
Cars Produced
Copyright©2003 Southwestern/Thomson Learning
Our Second Model: The Production
Possibilities Frontier
• Concepts Illustrated by the Production
Possibilities Frontier
•
•
•
•
•
Scarcity
Efficiency
Tradeoffs
Opportunity Cost
Economic Growth
Copyright © 2004 South-Western/Thomson Learning
Wheat or Oranges?
Copyright © 2004 South-Western/Thomson Learning
Wheat or Oranges?
Copyright © 2004 South-Western/Thomson Learning
Wheat or Oranges?
Copyright © 2004 South-Western/Thomson Learning
Corn, Food, Ethanol and the PPF
• An economy has only corn and labor as resources.
• Only two goods can be produced, ethanol and food.
• Draw a PPF and a possible initial production point.
• Suppose the government mandates an increase in the
amount of ethanol added to gasoline (clean air, less oil).
• Draw a new production point representing the change that
is likely to occur as society responds to this mandate.
Copyright © 2004 South-Western/Thomson Learning
Microeconomics and Macroeconomics
• Microeconomics focuses on the individual parts of
the economy.
• How households and firms make decisions and how they
interact in specific market settings.
• Macroeconomics looks at the economy as a whole.
• Economy-wide phenomena, including inflation,
unemployment, and economic growth.
See HW1 for Micro/Macro Practice
Copyright © 2004 South-Western/Thomson Learning
The Power of Economics
• Economists try to explain the world (scientists).
• Positive economic analysis describes what is, descriptive
analysis, scientific method, objective.
• Economists try to change the world (policy).
• Normative economic analysis describes what should be,
prescriptive analysis, policy recommendation, subjective.
See HW1 for Positive/Normative Practice
Copyright © 2004 South-Western/Thomson Learning
Positive or Normative Statements?
• Signing the Kyoto Protocol would result in one million
lost U.S. jobs.
?
• Drilling for oil in ANWR would reduce U.S.
dependency on foreign oil and lower the price of gas.
?
Copyright © 2004 South-Western/Thomson Learning
Positive or Normative Statements?
• The U.S should not sign on to the Kyoto Protocol.
?
• The U.S. should drill in ANWR.
?
Copyright © 2004 South-Western/Thomson Learning
ECONOMISTS DISAGREE
• They may disagree about the validity of alternative
positive theories on how the world works.
• They may have different values and, therefore,
different normative views about what policies to
pursue and what policy should try to accomplish.
• But all economists agree on two things…..
Copyright © 2004 South-Western/Thomson Learning
ECONOMISTS AGREE
• Good normative policy prescriptions must be
based on sound and thorough positive economic
analysis.
• And……
Copyright © 2004 South-Western/Thomson Learning