1. Copyright © 2004 South-Western/Thomson Learning Economic Models Economics trains you to.... Think in terms of alternatives. Evaluate the cost of individual and social choices. Understand how certain events and issues are related. Economists use models to simplify reality in order to improve our understanding of the world Two of the most basic economic models include: The Circular Flow Diagram The Production Possibilities Frontier

2. Copyright © 2004 South-Western Spending Goods and services bought Revenue Goods and services sold Labor, land, and capital Income = Flow of inputs and outputs = Flow of dollars Factors of production Wages, rent, and profit FIRMS Produce and sell goods and services Hire and use factors of production Buy and consume goods and services Own and sell factors of production HOUSEHOLDS Households sell Firms buy MARKETS FOR FACTORS OF PRODUCTION Firms sell Households buy MARKETS FOR GOODS AND SERVICES

3. Copyright © 2004 South-Western/Thomson Learning The Circular-Flow Diagram Firms Produce and sell goods and services Hire and use factors of production Households Buy and consume goods and services Own and sell factors of production Government?

4. Copyright © 2004 South-Western/Thomson Learning The Production Possibilities Frontier The production possibilities frontier is 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.

5. The Production Possibilities Frontier Copyright©2003 Southwestern/Thomson Learning Production possibilities frontier A B C Quantity of Cars Produced 2,200 600 1,000 300 0 700 2,000 3,000 1,000 Quantity of Computers Produced D

6. Copyright © 2004 South-Western/Thomson Learning Our Second Model: The Production Possibilities Frontier Concepts Illustrated by the Production Possibilities Frontier Scarcity Efficiency Tradeoffs Opportunity Cost Economic Growth

7. Copyright © 2004 South-Western/Thomson Learning Wheat or Oranges?

8. Copyright © 2004 South-Western/Thomson Learning Wheat or Oranges?

9. Copyright © 2004 South-Western/Thomson Learning Wheat or Oranges?

10. Copyright © 2004 South-Western/Thomson Learning Corn, Food, Ethanol and the PPF An economy has only corn and labor as resources. Only two goods can be produced, ethanol and food. Draw a PPF and a possible initial production point. Suppose the government mandates an increase in the amount of ethanol added to gasoline (clean air, less oil). Draw a new production point representing the change that is likely to occur as society responds to this mandate.

11. Copyright © 2004 South-Western/Thomson Learning Microeconomics and Macroeconomics Microeconomics focuses on the individual parts of the economy. How households and firms make decisions and how they interact in specific market settings. Macroeconomics looks at the economy as a whole. Economy-wide phenomena, including inflation, unemployment, and economic growth. See HW1 for Micro/Macro Practice

12. Copyright © 2004 South-Western/Thomson Learning The Power of Economics Economists try to explain the world (scientists). Positive economic analysis describes what is, descriptive analysis, scientific method, objective. Economists try to change the world (policy). Normative economic analysis describes what should be, prescriptive analysis, policy recommendation, subjective. See HW1 for Positive/Normative Practice

13. Copyright © 2004 South-Western/Thomson Learning Signing the Kyoto Protocol would result in one million lost U.S. jobs. Drilling for oil in ANWR would reduce U.S. dependency on foreign oil and lower the price of gas. ? Positive or Normative Statements? ?

14. Copyright © 2004 South-Western/Thomson Learning The U.S should not sign on to the Kyoto Protocol. The U.S. should drill in ANWR. ? Positive or Normative Statements? ?

15. Copyright © 2004 South-Western/Thomson Learning ECONOMISTS DISAGREE They may disagree about the validity of alternative positive theories on how the world works. They may have different values and, therefore, different normative views about what policies to pursue and what policy should try to accomplish. But all economists agree on two things…..

16. Copyright © 2004 South-Western/Thomson Learning ECONOMISTS AGREE Good normative policy prescriptions must be based on sound and thorough positive economic analysis. And……