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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 • Our first economic model…. • The Production Possibilities Frontier Copyright © 2004 South-Western/Thomson Learning The Production Possibilities Frontier • The production possibilities frontier (PPF) 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? An Aging America and the PPF • The average age of Americans will rise significantly as the elderly make up a larger and larger share of the total population: • Suppose the US economy can produce two goods, medical care and food. • Draw a PPF and a possible production point representing the original situation before the average age of the US population has begun to increase. • Now draw another possible point representing the change that may occur as the population ages. Copyright © 2004 South-Western/Thomson Learning An Aging America and the PPF 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 Practice Worksheet 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 Practice Worksheet Copyright © 2004 South-Western/Thomson Learning POSITIVE VERSUS NORMATIVE ANALYSIS • Positive or Normative? • U.S. spending on healthcare is rising faster than Gross Domestic Product (GDP). ? ? • The U.S. should spend less on healthcare. Copyright © 2004 South-Western/Thomson Learning POSITIVE VERSUS NORMATIVE ANALYSIS • Positive or Normative? • Enacting price controls on prescription drugs will result in fewer new/innovative drugs being developed. ? ? • The U.S should not enact price regulations to control the cost of prescription drugs. 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 normative views about what policies to pursue and what policies 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 positive economic analysis. • And…… Copyright © 2004 South-Western/Thomson Learning