The Two Branches of Economics 09 11 2012 CHAPTER 2 Thinking Like an Economist What is distinctive about how economists confront a question What does it mean to think like an economist In most of the work that economists do they are either being Social Scientists trying to explain the world Economists use the scientific method the dispassionate development and testing of theories about how the world works Devise theories Use observations to verify or refute the theories Most observations used in economics are data from natural experiments provided by history Use models Policy Advisors trying to improve the world Model a simplified representation of a more complicated reality Economists construct models of the economy in words or equations to depict particular features of the economy Models are usually abstractions as opposed to real objects Try to choose abstractions that share important features of the real object in order to isolate those features and study them closely Our First Economic Model A diagram which illustrates how i money and ii some of the things that are brought with money flow in an economy Two types of decision maker Households Firms Two types of market The market for goods and services The market for Factors of Production Resources the economy uses to produce goods services Labor land capital buildings machines used in production Our Second Economic Model A graph which shows the combinations of two goods that an economy can possibly produce given the available resources and the available A Combination of Goods a quantity of each good that is a quantity of the first good and a quantity of the second good With a given quantity of inputs only certain quantities of goods can be technology produced Ex guns vs butter 09 11 2012 Our Second Economic Model A graph which shows the combinations of two goods that an economy can possibly produce given the available resources and the available technology A Combination of Goods a quantity of each good that is a quantity of the first good and a quantity of the second good With a given quantity of inputs only certain quantities of goods can be produced o Ex guns vs butter o production possibilities frontier 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 Highlights the principle of having to face trade offs negative slope Points on the curve efficient possible Points above production possibilities the curve not possible At a point below production possibilities curve both goods can be produced inefficient Efficiency o it is not possible to produce more of one good without producing less than another o if the economy is getting all it can from the scarce resources it has available WHAT THE GRAPH TELLS YOU For our production possibilities curve the slope is always negative o Moving along a production possibilities frontier involves shifting resources from the production of one god to the other TRADE OFF If we start a point on the PPC and we consider the point where there is one more unit of butter the slope between the two points tells us the following trade off o how many units of guns the society must forgo to get an additional unit of butter OPPORTUNITY COST what must be given up to obtain that item When we calculate the slope of the production possibilities curve using a one unit increase in butter the slope tells you the opportunity cost of one unit of butter Measured in terms forgone guns FOR PRODUCTION POSSIBILITIES CURVE Slope always negative Successive one unit increases in butter the slope decreases o If we alternatively think about the magnitudes of the negative slopes those magnitudes increase o These properties are implications of the production possibilities curve being bowed out from the origin in the Our conclusion about the slope of our production possibilities curve graph tells us o Getting an additional unit of butter always causes us to give o The amount of guns we have to give up to get an additional unit of butter INCREASES as the amount of butter we have o The opportunity cost of butter rises as the economy produces o The opportunity cost of guns rises as the economy produces up some guns goes up more butter more guns WHY IS THIS PPC bowed out from the origin When output is increased the production of the additional output is more difficult Microeconomics the study of the small Specific goods and services industries individuals and firms the study of how households and firms make decisions and how they interact 09 11 2012 the study of economy wide phenomena including inflation unemployment in markets Macroeconomics the study of the large How the overall economy behaves and economic growth The Economist as a Policy Advisor Council of Economic Advisers Department of Labor Department of Justice Congressional Budget Office The Federal Reserve Advise the president write the annual Economic Report of the Pres Department of Treasury Economists sometimes disagree about public policy Differences normally fall into one of two categories Differences about how the economy operates Positive Econ Differences reflect based on using different data Differences about how to evaluate the consequences of policies Normative Econ Differences reflect based on different values Positive statements Normative statements claims that attempt to describe the world as it is claims that attempt to prescribe how the world should be
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