UMD ECON 200 - Chapter 2: Thinking like an economist

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Chapter 2: Thinking like an economistThe Economist as Scientist- The Scientific Method: Observation, Theory and More Observationo Conducting experiments is difficult in economics, therefore economists pay close attention to the natural experiments offered by history - The Role of Assumptionso Assumptions can simplify the complex world and make it easier to understand - Economic Modelso All models simplify reality to improve our understanding of it - Our First Model: The Circular-Flow Diagramo 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 Macroeconomicso 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 beWhy 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


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UMD ECON 200 - Chapter 2: Thinking like an economist

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