1. Economic Thinking Economics as a social Science The scientific method
Observation, Theory, and Testing
Assumptions and ceteris paribus
Avoiding flaws in logical thinking
Ergo hoc post proper hoc
Fallacy of Composition/Division
Microeconomics vs. Macroeconomics

2. Economics Models and Issues an Introduction
The art of making models = making them simple and effective
Example: production possibilities frontier (PPF)
-efficiency, tradeoffs, opportunity costs, law of increasing costs, economic growth.
Example: circular flow – what, how and for whom questions.
overall economy, role of economic agents, output and income, product and factor markets

3. Figure 8 Illustrating Constant Opportunity Cost
Opportunity Cost of going from 0 units of
Pizza to 1 unit of pizza
Production Possibilities Frontier
Pizza
Soda
Opportunity Cost of going from 1 unit of
Pizza to 2 units of pizza
Opportunity Cost of going from 2
units of Pizza to 3 units of pizza

4. Figure 7 Illustrating Increasing Opportunity Cost
Production Possibilities Frontier
Pizza
Soda
Opportunity Cost of going from 0 units of
Pizza to 1 unit of pizza
Opportunity Cost of going from 1 unit of
Pizza to 2 units of pizza
Opportunity Cost of going from 2
units of Pizza to 3 units of pizza

5. 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

6. The Power of Trade Voluntary versus involuntary exchange
An intuitive approach to gains in trade
Using an economic model to demonstrate the gains from trade

7. Voluntary Exchange
All parties to a voluntary exchange must be made better off
Allow for specialization and division of labor
Increase interdependence
Promote cooperation rather than conflict

8. An intuitive Approach to Gains From Trade
Self-sufficiency
Pros: independence
Cons: loss of efficiency, variety in consumption and production
Trade with Yakima?
Trade with other states?
Trade with other nations?

9. Gains from Trade: An Economic Model
Good model building: prove the point and make it simple
Assumptions = things held true during the analysis = simplification
Assumptions can be changed later to explore their implications

10. The Model Assumptions: Two individuals – rancher and a farmer
Two goods – meat and potatoes
Each work eight hours a day
Farmer takes 60min/oz meat and 15min/oz potatoes
Rancher takes 20min/oz of meat and 10min/oz of potatoes

11. Comparative advantage
Absolute advantage
Rancher than farmer is more efficient and producing both meat and potatoes
Comparative advantage
The farmer is comparatively better at producing potatoes than the rancher.
Comparative advantage and opportunity cost
The person with the lower opportunity cost has a comparative advantage
Someone always has a comparative advantage in the production of a least one thing

12. PPF and Production in a Simple Economy
How much can be produced?
Need to know:
Total time divided by time/output = total output, or
output/time multiplied by total time = total output

13. Table 1 The Production Opportunities of the Farmer and Rancher
Farmer (8 hours = 480/min)/ (60 min/oz of meat) = 8 oz of meat
Rancher (480min/20min/oz of meat)=24 oz of meat
Copyright © South-Western

14. Figure 1 The Production Possibilities Curve
(a) The Farmer ’
s Production Possibilities Frontier
Meat (ounces)
If there is no trade,
the farmer chooses
this production and
consumption. 8 32 A 4 16
Potatoes (ounces)
Copyright©2003 Southwestern/Thomson Learning

15. Figure 1 The Production Possibilities Curve
(b) The Rancher ’
s Production Possibilities Frontier
Meat (ounces) 48 24
If there is no trade,
the rancher chooses
this production and
consumption. B 12 24
Potatoes (ounces)
Copyright©2003 Southwestern/Thomson Learning

16. Slope of the PPF
In math, slope = Δy/Δx but in this case meat is on the y-axis and potatoes are on the x-axis, so it become ΔM/ΔP
E.g. Rancher ΔM/ΔP = -24/48 =-1/2 , but it is help to think of this as -1/2/1. Why? +1P → -½ M
E.g. Farmer ΔM/ΔP =- 8/32 =-1/4 , but it is help to think of this as 1/4/1. Why? +1P → -1/4 M
To get 1 P the rancher gives up 1/2M and the farmer gives up 1/4M
Slope = opportunity cost (an example of making math meaningful to real world situations)

17. Reverse directions Conclusions:
Rancher to get 1M → -2P
Farmer to get 1M → -4P
Conclusions:
Rancher has a comparative advantage in producing meat (1M costs 2P or 1P costs 1/2M)
Farmer has a comparative advantage in producing potatoes (1P costs 1/4M or 1M costs 4P)
The rancher should specialize in producing meat and the farmer should specialization in producing potatoes.

18. Gains to Trade Marginal versus Complete Approach Marginal adjustment
Farmer -1M → +4P
Rancher +1M → -2P
Total M P, or
Rancher -1P → +1/2M
Farmer +1P → -1/4M
Total P /4M
Either way specializing and trading means either more meat or potatoes

19. The Total Approach
Mankiw explains gains a bit differently and perhaps in a more complicated way
Farmer only produces potatoes and rancher produces a combination of meat and potatoes
Trade takes place with equal amounts for each
New totals lie outside the old PPF and represents a point on a consumption possibilities frontier
Let’s see how he does it….

20. Table 2 The Gains from Trade: A Summary
Copyright © South-Western

21. Figure 2 How Trade Expands the Set of Consumption Opportunities
(b) The Rancher ’
s Production and Consumption
Meat (ounces)
Rancher's
production
with trade 48 24
Rancher's
consumption
with trade 12 18 13 27
Rancher's
production and
consumption
without trade B* 12 24 B
Potatoes (ounces)
Copyright © South-Western

22. Figure 2 How Trade Expands the Set of Consumption Opportunities
(a) The Farmer ’
s Production and Consumption
Meat (ounces)
Farmer's
consumption
with trade
Farmer's
production and
consumption
without trade 8 32 A* 5 17 4 16 A
Farmer's
production
with trade
Potatoes (ounces)
Copyright©2003 Southwestern/Thomson Learning

23. Distribution of Gains to Trade
Voluntary exchange results in gains to trade, but who gets the gains?
Positive analysis = gains exist so efficiency improvements can occur
Normative analysis = who should get the gains
Normative analysis involves value judgments and therefore must be made by others

24. History of Trade Tribal to feudal times
Adam Smith (1776) and David Ricardo (1817)
The costs of not trading (e.g. lamb example)
Distribution impacts: consumers win but some producers and workers lose
The cost of protectionism
Cost of Protectionism