1. Thinking Like an Economist
Chapter 2

2. Every field of study has its own terminology
Mathematics
axioms
integrals
vector spaces
Psychology
ego id
cognitive dissonance
Law
torts
venues
Promissory estoppel

3. Every field of study has its own terminology
Economics
Opportunity cost
Elasticity
Supply
Consumer Surplus
Comparative advantage
Deadweight loss
Demand

4. Economics trains you to. . . .
Think in terms of alternatives.
Evaluate the cost of individual and social choices.
Examine and understand how certain events and issues are related. 2

5. The Economist as a Scientist
The economic way of thinking . . .
Involves thinking analytically and objectively.
Makes use of the scientific method. 3

6. Observation, Theory and More Observation!
The Scientific Method
Uses abstract models to help explain how a complex, real world operates.
Develops theories, collects, and analyzes data to prove the theories.
Observation, Theory and More Observation! 4

7. The Role of Assumptions
Economists make assumptions in order to make the world easier to understand.
The art in scientific thinking is deciding which assumptions to make.
Economists use different assumptions to answer different questions.

8. The Economic Way of Thinking
Includes developing abstract models from theories and the analysis of the models.
Uses two approaches:
Descriptive (reporting facts, etc.)
Analytical (abstract reasoning) 5

9. Economic Models The Circular Flow Model
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 Model
The Production Possibilities Frontier

10. The Circular-Flow Model
The circular-flow model is a simple way to visually show the economic transactions that occur between households and firms in the economy. 6

11. The Circular-Flow Diagram
Spending
Revenue
Market for
Goods
and Services
Goods & Services sold
Goods & Services bought
Firms
Households
Wages, rent, and profit
Income
Labor, land, and capital
Inputs for production
Market for
Factors
of Production 7

12. Figure 1 The Circular Flow
Firms sell
Households buy
MARKETS
FOR
GOODS AND SERVICES
Revenue
Spending
Goods
and services
sold
Goods and
services
bought
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
Factors of
production
Labor, land,
and capital
Wages, rent,
and profit
Income
= Flow of inputs
and outputs
= Flow of dollars
Copyright © South-Western

13. 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 7

14. The Circular-Flow Diagram
Markets for Goods & Services
Firms sell
Households buy
Markets for Factors of Production
Households sell
Firms buy 7

15. The Circular-Flow Diagram
Factors of Production
Inputs used to produce goods and services
Land, labor, and capital 7

16. The Production Possibilities Frontier
The production possibilities frontier is a graph showing the various combinations of output that the economy can possibly produce given the available factors of production and technology. 14

17. The Production Possibilities Frontier
Quantity of
Computers
Produced D
3,000 C
2,200 A
2,000
Production
possibilities
frontier B
1,000
300
600
700
1,000
Quantity of
Cars Produced 15

18. Concepts Illustrated by the Production Possibilities Frontier
Efficiency
Tradeoffs
Opportunity Cost
Economic Growth 21

19. The Production Possibilities Frontier
Quantity
of Computers
Produced
4,000
An outward shift in the production possibilities frontier
3,000 E
2,100
750
2,000 A
700
1,000
Quantity of
Cars Produced 15

20. Microeconomics and Macroeconomics
Microeconomics focuses on the individual parts of the economy.
How households and firms make decisions and how they interact in specific markets
Macroeconomics looks at the economy as a whole.
How the markets, as a whole, interact at the national level. 13

21. Two Roles of Economists
When they are trying to explain the world, they are scientists.
When they are trying to change the world, they are policymakers. 30

22. Positive versus Normative Analysis
Positive statements are statements that describe the world as it is.
Called descriptive analysis
Normative statements are statements about how the world should be.
Called prescriptive analysis 31

23. Positive or Normative Statements?
An increase in the minimum wage will cause a decrease in employment among the least-skilled.
Positive ? 32

24. Positive or Normative Statements?
Higher federal budget deficits will cause interest rates to increase.
Positive ? ? 32

25. Positive or Normative Statements?
The income gains from a higher minimum wage are worth more than any slight reductions in employment.
Positive ? ? 32

26. Positive or Normative Statements?
State governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor.
Positive ? 32

27. Economists in Washington . . .
. . . serve as advisers in the policymaking process of the three branches of government:
Legislative
Executive
Judicial 33

28. Economists in Washington
Some government agencies that collect economic data and make economic policy:
Department of Commerce
Bureau of Labor Statistics
Congressional Budget Office
Federal Reserve Board 33

29. Why Economists Disagree
They may disagree on theories about how the world works.
They may hold different values and, thus, different normative views. 35

30. Table 2 Ten Propositions about Which Most Economists Agree

31. Summary
Economists try to address their subjects with a scientist’s objectivity.
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.

32. Summary
The field of economics is divided into two subfields: microeconomics and macroeconomics.
Microeconomists study decisionmaking by households and firms in the marketplace.
Macroeconomists study the forces and trends that affect the economy as a whole.

33. Summary Economics relies on both positive and normative analysis.
Positive statements is an assertion about how the world “is”。
normative statements is an assertion about how the world “ought to be”.
When economists make normative statements, they are acting more as policy advisors than scientists.

34. Summary
Economists who advise policymakers may offer conflicting advice either because of differences in scientific judgments or because of differences in values
At other times, economists are united in the advice they offer, but policymakers may choose to ignore it.

35. Graphical Review

36. Figure 2A-1 (a) Pie Chart Individuals (23%) Private Insurers (32%)
Other (4%)
1996 Value (in
Government (41%)
billions of dollars)
(b) Bar Graph
General
Electric
$140
($126 billion)
120
Exxon
($99 billion)
100
($68 billion) 80
IBM
General 60
Motors
($39 billion) 40 20
output per hour of labor,
(c) Time-Series Graph
Productivity Index (farm
1977 = 100)
160
140
120
100 80 60 40
Figure 2A-1 20
1950
1960
1970
1980
1990 4 43

37. Figure 2A-2 Grade Point Average 4.0 3.5 Albert E. 3.0 (25, 3.5) 2.5
Alfred E.
2.0
(5, 2.0)
1.5
1.0
0.5 5 10 15 20 25 30 35 40
Study
Time
(hours per week)
Figure 2A-2 5 44

38. Figure 2A-3 Price of Novels $11 (5, $10) 10 (9, $9) 9 (13, $8) 8
(17, $7) 7
(21, $6) 6 5
(25, $5)
Demand, D 4 1 3 2 1 5 10 15 20 25 30
Quantity
of Novels
Figure 2A-3
Purchased 6 45

39. Figure 2A-4 Price of Novels $11 10 (13, $8) 9 (16, $8) 8
When income increases,
(10, $8)
the demand curve 7
shifts to the right. 6
When income D 5 3
decreases, the
(income = D D
(income = 1 2
demand curve 4
$20,000)
(income =
$40,000)
shifts to the left.
$30,000) 3 2 1 5 10 13 15 16 20 25 30
Quantity
of Novels
Figure 2A-4
Purchased 7 46

40. Figure 2A-5 Price of Novels $11 10 9 (13, $8) 8 7 6 2 8 5 2 2 (21, $6)
Demand, D 1 4 3 2 1 5 10 13 15 20 21 25 30
Quantity
of Novels
Figure 2A-5
Purchased 8 47

41. Risk of
Cancer
Number of Lighters in House
Figure 2A-6 9 48

42. Figure 2A-7 Violent Crimes (per 1,000 people) Police Officers
Police Officers
(per 1,000 people)
Figure 2A-7 10 49