1. Copyright © 2004 South-Western/Thomson Learning Thinking Like an Economist Every field of study has its own terminology Mathematics Integral, derivative, vector space, cosine, hypotenuse Psychology Cognitive dissonance, coping, determinism, ego, id Law Plaintiff, deposition, appeal, verdict, subpoena Economics Supply, demand, opportunity cost, elasticity, surplus, shortage, welfare, comparative advantage, deadweight loss

2. Copyright © 2004 South-Western/Thomson Learning Thinking Like an Economist Economics trains you to.... Think in terms of alternatives. Evaluate the cost of individual and social choices. Examine/understand how events and issues are related.

3. Copyright © 2004 South-Western/Thomson Learning The Scientific Method: Observation, Theory, and More Observation Uses abstract models to help explain how a complex, real world operates. Develops theories, collects, and analyzes data to evaluate the theories. Economists make assumptions in order to make the world easier to understand.

4. Copyright © 2004 South-Western/Thomson Learning Economic Models 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

5. Copyright © 2004 South-Western/Thomson Learning Our First Model: The Circular-Flow Diagram The circular-flow diagram is a visual model of the economy that shows how dollars flow through markets among households and firms. Factors of Production Inputs used to produce goods and services Land, labor, capital and entrepreneurship

6. Figure 1 The Circular Flow 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

7. Copyright © 2004 South-Western/Thomson Learning Our First Model: The Circular-Flow Diagram Markets for Goods and Services Firms sell Households buy Markets for Factors of Production Households sell Firms buy

8. Copyright © 2004 South-Western/Thomson Learning Our Second Model: 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.

9. Figure 2 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

10. 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

11. Copyright © 2004 South-Western/Thomson Learning Facts Regarding Value As more of a particular item is consumed in a given time period… The value of the next unit will eventually fall. Value is based on benefits received. Diminishing marginal value Need to see this in Demand Rolos, Washer & Dryer, Automobiles, Houses

12. Copyright © 2004 South-Western/Thomson Learning Facts Regarding Cost As more of a particular item is produced in a given time period… The cost of the next unit will eventually rise. Cost is based on what is given up. Rising marginal opportunity cost Need to see this in Supply Work, Vacations, Wheat or Oranges, China & India

13. 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

14. Copyright © 2004 South-Western/Thomson Learning The Power of Economics Economists try to explain the world (science). Positive economic analysis: observe and describe, scientific, objective, builds understanding Economists try to change the world (policy). Normative economic analysis: prescribe what should be, policy recommendation, subjective, improve/change. See HW1 for Positive/Normative Practice

15. Copyright © 2004 South-Western/Thomson Learning Positive or Normative Statements? An increase in the minimum wage will cause a decrease in employment among the least-skilled. The federal minimum wage should not be raised. POSITIVE VERSUS NORMATIVE ANALYSIS ? ?

16. Copyright © 2004 South-Western/Thomson Learning Positive or Normative Statements? Higher federal budget deficits will cause interest rates to increase. The federal government should be required to run a balanced budget. POSITIVE VERSUS NORMATIVE ANALYSIS ? ?

17. 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 normative views about what policies to pursue and what policies should try to accomplish. But all economists agree on two things…..

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

19. Copyright © 2004 South-Western/Thomson Learning Summary Economists use models to help describe the world in economic terms. They make appropriate assumptions and build simplified models in order to understand the world around them. Two simple economic models are the circular-flow diagram and the production possibilities frontier.

20. Copyright © 2004 South-Western/Thomson Learning Summary Economics is divided into two subfields: Microeconomists study decision-making by households and firms in the market settings. Macroeconomists study the forces and trends that affect the economy as a whole.

21. Copyright © 2004 South-Western/Thomson Learning Summary Positive economic analysis is a description about how the world is (science, observation). Normative economic analysis is a prescription of how the world should be (policy recommendation). Good normative policy prescriptions must be based on sound and thorough positive economic analysis.