CHAPTER 2- Thinking Like an EconomistWhat 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 worksDevise theoriesUse ‘observations’ to verify or refute the theoriesMost 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:HouseholdsFirmsTwo types of market:The market for goods and services.The market for Factors of ProductionResources the economy uses to produce goods & servicesLabor, land, capital (buildings & machines used in production)Our Second Economic ModelA 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.Ex: guns vs butterOur Second Economic ModelA 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.Ex: guns vs butterproduction possibilities frontiera graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technologyHighlights 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:it is not possible to produce more of one good without producing less than another.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.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: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 negativeSuccessive one unit increases in butter, the slope decreasesIf we alternatively think about the magnitudes of the negative slopes: those magnitudes increaseThese properties are implications of the production possibilities curve being bowed out from the origin in the graph.Our conclusion about the slope of our production possibilities curve tells us:Getting an additional unit of butter always causes us to give up some guns.The amount of guns we have to give up to get an additional unit of butter INCREASES as the amount of butter we have goes up.The opportunity cost of butter rises as the economy produces more butter.The opportunity cost of guns rises as the economy produces 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 in marketsMacroeconomics: the study of the large.How the overall economy behaves.the study of economy-wide phenomena, including inflation, unemployment, and economic growthThe Economist as a Policy AdvisorCouncil of Economic AdvisersAdvise the president & write the annual Economic Report of the Pres.Department of TreasuryDepartment of LaborDepartment of JusticeCongressional Budget OfficeThe Federal ReserveEconomists sometimes disagree about public policyDifferences normally fall into one of two categories:Differences about how the economy operates (Positive Econ)Differences reflect based on using different dataDifferences about how to evaluate the consequences of policies (Normative Econ)Differences reflect based on different values.Positive statementsclaims that attempt to describe the world as it isNormative statementsclaims that attempt to prescribe how the world should beThe Two Branches of Economics 09/11/2012CHAPTER 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 worksDevise theoriesUse ‘observations’ to verify or refute the theoriesMost 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 depictparticular 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
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