Thinking like an economist

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Thinking Like an Economist

Every field of study has its own terminology
Mathematics
integrals ❖

Thinking Like an Economist Every field of study has its own terminology
axioms ❖ vector spaces
Psychology
ego ❖ id ❖ cognitive dissonance
Law
promissory ❖ estoppel ❖ torts ❖ venues
Economics
supply ❖ opportunity cost ❖ elasticity ❖ consumer surplus ❖ demand ❖ comparative advantage ❖ deadweight loss

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Thinking Like an Economist

Economics trains you to. . . .
Think in

Thinking Like an Economist Economics trains you to. . . . Think
terms of alternatives.
Evaluate the cost of individual and social choices.
Examine and understand how certain events and issues are related.

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THE ECONOMIST AS A SCIENTIST

The economic way of thinking . . .
Involves

THE ECONOMIST AS A SCIENTIST The economic way of thinking . .
thinking analytically and objectively.
Makes use of the scientific method.

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The Scientific Method: Observation, Theory, and More Observation

Uses abstract models to help

The Scientific Method: Observation, Theory, and More Observation Uses abstract models to
explain how a complex, real world operates.
Develops theories, collects, and analyzes data to evaluate the theories.

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The Role of Assumptions

Economists make assumptions in order to make the

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.

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Economic Models

Economists use models to simplify reality in order to improve

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

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Our First Model: The Circular-Flow Diagram

The circular-flow diagram is a visual model

Our First Model: The Circular-Flow Diagram The circular-flow diagram is a visual
of the economy that shows how dollars flow through markets among households and firms.

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Figure 1 The Circular Flow

Copyright © 2004 South-Western

Spending

Revenue

Income


= Flow of inputs

Figure 1 The Circular Flow Copyright © 2004 South-Western Spending Revenue Income


and outputs


= Flow of dollars













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Our First Model: The Circular-Flow Diagram

Firms
Produce and sell goods and services

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

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Our First Model: The Circular-Flow Diagram

Markets for Goods and Services
Firms sell

Our First Model: The Circular-Flow Diagram Markets for Goods and Services Firms
Households buy
Markets for Factors of Production
Households sell
Firms buy

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Our First Model: The Circular-Flow Diagram

Factors of Production
Inputs used to produce

Our First Model: The Circular-Flow Diagram Factors of Production Inputs used to
goods and services
Land, labor, and capital

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Our Second Model: The Production Possibilities Frontier

The production possibilities frontier is a

Our Second Model: The Production Possibilities Frontier The production possibilities frontier is
graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology.

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Figure 2 The Production Possibilities Frontier

Copyright©2003 Southwestern/Thomson Learning

Quantity of

Cars Produced

0

3,000

1,000

Quantity of

Computers

Produced

Figure 2 The Production Possibilities Frontier Copyright©2003 Southwestern/Thomson Learning Quantity of Cars

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Our Second Model: The Production Possibilities Frontier

Concepts Illustrated by the Production Possibilities

Our Second Model: The Production Possibilities Frontier Concepts Illustrated by the Production
Frontier
Efficiency
Tradeoffs
Opportunity Cost
Economic Growth

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Figure 3 A Shift in the Production Possibilities Frontier

Copyright © 2004 South-Western

Quantity

Figure 3 A Shift in the Production Possibilities Frontier Copyright © 2004
of

Cars Produced

0

Quantity of

Computers

Produced

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Microeconomics and Macroeconomics

Microeconomics focuses on the individual parts of the economy.
How households

Microeconomics and Macroeconomics Microeconomics focuses on the individual parts of the economy.
and firms make decisions and how they interact in specific markets
Macroeconomics looks at the economy as a whole.
Economy-wide phenomena, including inflation, unemployment, and economic growth

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THE ECONOMIST AS POLICY ADVISOR

When economists are trying to explain the world,

THE ECONOMIST AS POLICY ADVISOR When economists are trying to explain the
they are scientists.
When economists are trying to change the world, they are policy advisor.

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POSITIVE VERSUS NORMATIVE ANALYSIS

Positive statements are statements that attempt to describe the

POSITIVE VERSUS NORMATIVE ANALYSIS Positive statements are statements that attempt to describe
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

Positive or Normative Statements? An increase in the minimum wage will cause
a decrease in employment among the least-skilled.
POSITIVE
Higher federal budget deficits will cause interest rates to increase.
POSITIVE

?

?

POSITIVE VERSUS NORMATIVE ANALYSIS

?

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Positive or Normative Statements?
The income gains from a higher minimum wage

Positive or Normative Statements? The income gains from a higher minimum wage
are worth more than any slight reductions in employment.
NORMATIVE
State governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor.
NORMATIVE

?

?

POSITIVE VERSUS NORMATIVE ANALYSIS

?

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Economists in Washington

. . . serve as advisers in the policymaking process

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

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Economists in Washington

Some government agencies that collect economic data and make economic

Economists in Washington Some government agencies that collect economic data and make
policy:
Department of Commerce
http://www.commerce.gov
Bureau of Labor Statistics
http://www.bls.gov
Congressional Budget Office
http://www.cbo.gov
Federal Reserve Board
http://www.federalreserve.gov

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WHY ECONOMISTS DISAGREE

They may disagree about the validity of alternative positive theories

WHY ECONOMISTS DISAGREE They may disagree about the validity of alternative positive
about how the world works.
They may have different values and, therefore, different normative views about what policy should try to accomplish.

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Table 2 Ten Propositions about Which Most Economists Agree

Copyright © 2004 South-Western

Table 2 Ten Propositions about Which Most Economists Agree Copyright © 2004 South-Western

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Summary

Economists try to address their subjects with a scientist’s objectivity.
They make appropriate

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

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Summary

Economics is divided into two subfields:
Microeconomists study decisionmaking by households and firms

Summary Economics is divided into two subfields: Microeconomists study decisionmaking by households
in the marketplace.
Macroeconomists study the forces and trends that affect the economy as a whole

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Summary

A positive statement is an assertion about how the world is.
A normative

Summary A positive statement is an assertion about how the world is.
statement is an assertion about how the world ought to be.
When economists make normative statements, they are acting more as policy advisors than scientists.
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