1. Chapter 2 Thinking Like an Economist Ratna K. Shrestha

2. Overview  The Economist as a Scientist  The Economist as a Policy-Maker  Where Economists Disagree and where Economists Agree

3. Economics Trains us to Think – in terms of alternatives. – and understand the cost of individual and social choices. – and provide us with insights into how certain events and issues are related.

4. Thinking Like an Economist  The economic way of thinking requires one to think analytically and objectively.  The economic way of thinking is like the Scientific Method.

5. Scientific Method  Scientific Method uses abstract models to help understand how a complex real-world operates.  e.g., biologist use plastic replica of human body to study anatomy.  The Scientific Method develops theory, collects and analyzes data to prove the theory.

6. Economic Way of Thinking Includes  the development of abstract models from theories and the analysis of the models using two approaches: –descriptive: reporting facts, etc. –analytical: abstract reasoning  As do other scientists, economists make assumptions in developing models. To study international trade for example, we may assume two countries and two goods.

7. The Circular-Flow Model  The economy consists of millions of people involved in many activities.  The circular-flow model provides a simple way of describing all the economic transactions that occur in a Market Economy.  It emphasizes decentralization in that economic decisions are made by Households and Businesses in Product and Resource Markets.

8. The Circular-Flow Model Households Businesses Resource Markets Product Markets

9. Diagram: The Circular-Flow Model Households Businesses Product Markets Flow of Resources Supply Resources Demand Resources Resource Markets

10. Diagram: The Circular-Flow Model Households Businesses Product Markets Flow of Supply Resources Demand Resources Land Labor Capital Resource Markets

11. Diagram: The Circular-Flow Model Households Businesses Product Markets Flow of Goods and Services Supply Goods & Services Demand Goods & Services Resource Markets

12. The Circular-Flow Model Households Businesses Product Markets The Flow of Dollars $ Spending $ Revenue Resource Markets

13. Diagram: The Circular-Flow Model Households Businesses Product Markets The Flow of Dollars $ Revenue $ Expenses $ Income $ Spending Resource Markets

14. Diagram: The Circular-Flow Model Households Businesses Product Markets The Flow of Dollars $ Revenue $ Expenses $ Income Rent Wages Profit $ Spending Resource Markets

15. Diagram: The Circular-Flow Model Households Businesses Product Markets $ $ $ $ Dollar Flow Real Flow Resource Markets

16. The Circular-Flow Diagram Households u Buy and consume goods and services u Own and sell factors of production Firms u Produce and sell goods and services u Hire and use factors of production

17. A Second Economic Model: Production Possibilities Frontier (PPF)…is a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and technology.

18. Production Possibilities Frontier Computers Cars 0

19. Production Possibilities Frontier Computers 700 A Cars 0 2000

20. Production Possibilities Frontier Computers 3000 700 A Cars E 0 2000

21. Production Possibilities Frontier Computers 3000 1000 700 A Cars E F 0 2000

22. Production Possibilities Frontier Computers 3000 1000 700 A Cars E F 0 2000

23. Concepts Illustrated by the PPF  Efficiency  Tradeoffs  Opportunity Cost  Economic Growth

24. Efficient Resource Use Production Possibilities Frontier Computers 3000 1000 2000 700 A Cars E F 0 B? 1000 300

25. Production Possibilities Frontier Computers 3000 1000 2000 700 A Cars E F 0 1000 900 C Tradeoffs

26. Production Possibilities Frontier Computers 3000 1000 2000 700 A Cars E F 0 1000 900 C Opportunity Cost of next 200 cars is 1000 computers. Opportunity cost of 1 car is 5 computers Opportunity Cost

27. 4,000 The PPF Quantity of Computers Produced Quantity of Cars Produced 3,000 2,000 A 700 01,000 E 2,100 750 Improvement in technology in the production of Computers

28. Economic Growth Production Possibilities Frontier Computers 3000 1000 2000 700 Cars 0 1000 300 Improvement in technology in the production of both

29. Microeconomics and Macroeconomics  Microeconomics focuses on “the individual parts of the economy.” –e.g. individual markets –e.g. price increase in the housing market  Macroeconomics looks at the “economy as a whole.” –e.g. aggregate of markets –e.g. average price increase for all goods –e.g. unemployment

30. 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 Policy-makers.

31. Positive versus Normative Analysis  Positive: Statements or assertions dealing with matters of fact or questions about how things are (descriptive analysis).  Normative: Statements that reflect individual opinions about how the world should be (prescriptive analysis).

32. Positive or Normative Statements?  An increase in the minimum wage will cause a decrease in employment among the least skilled.  Higher federal budget deficits will cause interest rates to increase.  The income gains from a higher minimum wage are worth more than any slight reduction in employment.  Provincial governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor.

33. –Two main benefits from studying economics: 1. Understanding 2. Expanded career opportunities 1. Understanding –Economic ideas is all around you. You cannot ignore them. –As you progress with you study of economics, you’ll gain a deeper understanding of what is going on around you. WHY ECONOMICS IS WORTH STUDYING?

34. 2. Expanded Career Opportunities –Most students of economics don’t become economists. – But knowledge of economics is vital is many fields such as banking, finance, business, management, insurance, real estate, law, government, journalism, health care and the arts. –Economics graduates are not the highest- paid professional, but they are close to the top. WHY ECONOMICS IS WORTH STUDYING?

35. The Costs of Studying Economics – The main cost of studying economics is forgone leisure time. – Most students find that economics is difficult and that it takes time to master. – The trick is practice, or learning by doing. Benefits Versus Costs –Weigh up your benefits and costs! WHY ECONOMICS IS WORTH STUDYING?

36. Economists in Government  Department of Finance: formulate tax policy.  Industry Canada: design competition policy.  Foreign Affairs: assist with trade agreements.  Human Resources Development Canada: formulate labor market policies.  Bank of Canada: implement monetary policy.  Environment Canada: design environment laws.

37. Economists in the Private Sector  C.D. Howe Institute — suggest policy options.  Fraser Institute — suggest policy options.  Provide forecasts for companies.  Assist firms manage resources efficiently.  Assist with investment decisions.

38. Do Economists Always Agree With Each Other? Three reasons why they don’t:  Disagree about the validity of alternative positive theories  Each have different values, thus different normative views

39. Examples of When Economists (Majority) Do Agree  A ceiling on rents reduces the quantity and quality of housing available.  Tariffs and import quotas usually reduce general economic welfare.  Tax cuts has a significant stimulative impact on a less than fully employed economy.