Chapter 2 Thinking like an economist The Economist as Scientist The Scientific Method Observation Theory and More Observation o Conducting experiments is difficult in economics therefore economists pay close attention to the natural experiments offered by history The Role of Assumptions o Assumptions can simplify the complex world and make it easier to understand Economic Models o All models simplify reality to improve our understanding of it Our First Model The Circular Flow Diagram o Circular flow diagram a visual model of the economy that shows how dollars flow through markets among households and firms Decisions are made by households and firms Firms produce goods services using inputs such as labor land and capital inputs aka factors of production Households own the factors of production and consume all the goods and services that the firms produce Markets for goods and services households are buyers firms are sellers Markets for the factors of production households are sellers firms are buyers Inner loop represents flow of inputs and outputs while the outer loop represents the flow of dollars Our Second Model The Production Possibilities Frontier 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 o An economy is efficient if the point is on rather than inside the production possibilities frontier o Shows the opportunity cost Microeconomics and Macroeconomics o Microeconomics is the study of how households and firms make decisions and how they interact in specific markets o Macroeconomics is the study of economy wide phenomena The Economist as a Policy Adviser Positive statements claims that attempt to describe the world as it is Normative statements claims that attempt to prescribe how the world should be Why Economists Disagree Economists may disagree about the validity of alternative positive theories about how the world works Economists may have different values and therefore different normative views about what policy should try to accomplish Economists agree more than most people think
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