Chapter 2 Thinking Like an Economist

• Economist


  Plays two roles: 1) Scientist - tries to explain the world, 2) Policy advisor - tries to improve it
• Scientific method


  Dispassionate development and testing of theories about how the world works
• Assumptions


  Simplify the complex world, make it easier to understand
• Model


  A highly simplified representation of a more complicated reality. Economists use this to study economic issues.
• Circular-flow diagram


  A visual model of the economy, shows how dollars flow through markets among households and firms
• Actors in the circular-flow diagram

  • Households
  • Firms
• Markets in the circular-flow diagram

  • Market for goods and services
  • Market for factors of production
• Factors of production


  The resources the economy uses to produce goods & services, including labor, land, and capital
• Production Possibilities Frontier (PPF)


  A graph that shows the combinations of two goods the economy can possibly produce given the available resources and the available technology
• PPF example


  • Two goods: computers and wheat, One resource: labor (measured in hours), Economy has 50,000 labor hours per month available for production
• Points on the PPF are possible and efficient (all resources are fully utilized)
• Points under the PPF are possible but not efficient (some resources underutilized)
• Points above the PPF are not possible
• Opportunity cost


  What must be given up to obtain an item
• The slope of the PPF tells you the opportunity cost of one good in terms of the other
• Economic growth


  Shifts the PPF outward
• Bow-shaped PPF


  Opportunity cost of a good rises as the economy produces more of the good
• If opportunity cost remains constant, the PPF is a straight line
• If opportunity cost rises as the economy produces more of a good, the PPF is bow-shaped
• Production Possibility Frontier (PPF)

  • Bow-shaped
  • Illustrates tradeoff and opportunity cost
  • Illustrates efficiency and inefficiency
  • Illustrates unemployment
  • Illustrates economic growth
• The PPF is bow-shaped when different workers have different skills and different opportunity costs of producing one good in terms of the other
• The PPF would also be bow-shaped when there is some other resource, or mix of resources with varying opportunity costs
• Microeconomics


  The study of how households and firms make decisions and how they interact in markets
• Macroeconomics


  The study of economy-wide phenomena, including inflation, unemployment, and economic growth
• Microeconomics and macroeconomics are closely intertwined, yet distinct - they address different questions
• Positive statements


  Attempt to describe the world as it is
• Normative statements


  Attempt to prescribe how the world should be
• Positive statements can be confirmed or refuted, normative statements cannot
• Who studies economics

  • Ronald Reagan, President of the United States

  Barbara Boxer, U.S. Senator

  Sandra Day-O'Connor, Former Supreme Court Justice

  Anthony Zinni, Former General, U.S. Marine Corps

  Kofi Annan, Former Secretary General, United Nations

  Meg Witman, Chief Executive Officer, eBay

  Steve Ballmer, Chief Executive Officer, Microsoft

  Arnold Schwarzenegger, Governor of California, Actor

  Ben Stein, Political Speechwriter, Actor, Game Show Host

  Mick Jagger, Singer for the Rolling Stones

  John Elway, NFL Quarterback

  Tiger Woods, Golfer

  Diane von Furstenburg, Fashion Designer