Thinking Like an Economist

Every field of study has its own terminology
Mathematics
Psychology
Law

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

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.

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

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!

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.

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)

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 Model
The Production Possibilities Frontier

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.

The Circular-Flow Diagram
Firms
Households
Market for
Factors
of Production
Market for
Goods
and Services

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

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

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

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.

The Production Possibilities Frontier
Quantity of
Computers
Produced
Quantity of
Cars Produced
3,000
1,000

The Production Possibilities Frontier
Quantity of
Computers
Produced
Quantity of
Cars Produced
3,000
1,000
2,000
2,200
A
700
600
300
0
1,000
B
C
D
Production
possibilities
frontier

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

The Production
Possibilities Frontier
Quantity
of Computers
Produced
Quantity of
Cars Produced
3,000
2,000
A
700
0
1,000
An outward shift in the production possibilities frontier

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.

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.

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

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

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

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

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

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

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

Examples of What Most Economists Agree On
A ceiling on rents reduces the quantity and quality of housing available.
Tariffs and import quotas usually reduce general economic welfare.

Summary
In order to address subjects with objectivity, economics makes use of the scientific method.
The field of economics is divided into two subfields: microeconomics and macroeconomics.

Summary
Economics relies on both positive and normative analysis. Positive statements assert how the world “is” while normative statements assert how the world “should be.”
Economists may offer conflicting advice due to differences in scientific judgments or to differences in values.

The Circular-Flow Diagram

The Production Possibilities Frontier

The Production Possibilities Frontier