EC 111 1st Edition Lecture 2Previous LectureI. What Economics is All AboutII. How People Make Decisions (10 Principles of Economics)Current LectureI. Assumptions and ModelsII. The Circular-Flow DiagramIII. Factors of ProductionIV. The Production Possibility FrontierV. Microeconomics and MacroeconomicsAssumptions and Models- Assumptions simplify the complex world and make it easier to understando Example: to study international trade, assume two countries are consuming and selling two goods. Unrealistic, but simple to learn and gives useful insights about the real world- Model: a highly simplified representation of a more complicated reality. Economists use models to study economicsThe Circular-Flow Diagram- The Circular-Flow Diagram: a visual model of the economy, shows how dollars flow through markets among households and firmso Households and firms are the two actors in the diagramo The markets for goods and services and the market for factors of production are the two markets in the diagram- Households give labor, land, and capitol to the market for factors of production- Households receive income from the market for factors of production- Households give money to the market for goods and services- Households receive goods and services from the market from goods and services- Firms provide wages, rent, interest, and profit to the market for factors of production- Firms receive factors of production from the market for factors of production- Firms receive revenue from the market for goods and services- Firms provide goods and services to the market for goods and servicesThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.- We leave government, foreign countries, banking systems for nowFactors of Production- Factors of Production: the resources the economy uses to produce goods and services including:o Laboro Lando Capital (buildings, and machinery used in productiono Entrepreneurs- Households:o Own factors of production and sell and rent them to firms for income (labor, skills ect.)o Buy and consume goods in services with their income- Firms:o Buy and hire factors of production and use them to produce goods and serviceso Sell goods and services for revenueThe Production Possibility Frontier- The Production Possibility Frontier (PPF): a graph that shows the combos of two goods the economy can possibly produce given the available resources and available technologyo Answers the question what’s the maximum we can do?- Recall: opportunity cost (what must be given up to obtain something)- Moving along the PPF involves shifting resources from production of one good to another- Society faces tradeoff. How much of the goods are we sacrificing?- Slope of the PPF tells the opportunity cost of one good in terms of the other- The PPF can be straight-lined or bow-shaped. Depends on what happens to the opportunity cost as economy shifts resources from one industry to anothero If opportunity cost is constant, the PPF forms a straight line Same resources used for producing both goodso If Opportunity cost of a good rises as economy produces more of one good, then the PPF is bow shaped Resources are specialized for the production of one good and are not easily adaptable  Opportunity cost increases as you move along the curve- With additional resources or improvement in technology the economy can produce more goods (economic growth)o Shifts the PPF outwards- The PPF is shaped differently when workers have different skills. This is because workers have different skills which causes different opportunity costs in creating one good in terms of the other- Some other resource, or mix of resources have varying opportunity costs because land is suited for different purposes- The PPF shows all combinations of two goods the economy can possibly produce given resourcesand technology- PPF illustrates the concepts of tradeoffs and opportunity cost, efficiency and inefficiency, unemployment and economic growth- Bow-shaped PPF illustrates increasing opportunity cost and straight shows constant opportunity costMicroeconomics and Macroeconomics- Microeconomics: study of how households and firms make decisions and how they interact- Macroeconomics: study of economy-wide phenomena including inflation, unemployment, and economic growth- As scientists economists make:o Positive Statements: attempt to describe the world as it is- As policy makers economists make:o Normative Statements: attempt to prescribe the world as it should be (value