Thinking Like an Economist

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Thinking Like an Economist

Every field of study has its own terminology
Mathematics
integrals 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 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 thinking analytically and o !ectively. Makes use of the scientific method.

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The Scientific Method: Observation, Theor , and More Observation "ses a stract models to help explain how a complex# real world operates. $evelops theories# collects# and analy%es data to evaluate the theories.

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The !o"e of Ass#m$tions 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 &uestions.

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Economic Mode"s Economists use models to simplify reality in order to improve our understanding of the world Two of the most asic economic models include'
The (ircular )low $iagram The Production Possi ilities )rontier

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O#r %irst Mode": The Circ#"ar&%"o' (iagram The circular-flow diagram is a visual model of the economy that shows how dollars flow through markets among households and firms.

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%ig#re ) The Circ#"ar %"o'

MA!1ETS %O! *OO(S AN( SE!2ICES -%irms se"" *oods -Ho#seho"ds b# and services so"d !even#e

S$ending *oods and services bo#ght

%I!MS -.rod#ce and se"" goods and services -Hire and #se factors of $rod#ction

HO0SEHOL(S -/# and cons#me goods and services -O'n and se"" factors of $rod#ction

%actors of $rod#ction ,ages, rent, and $rofit

Labor, "and, MA!1ETS and ca$ita" %O! %ACTO!S O% .!O(0CTION -Ho#seho"ds se"" -%irms b# Income + %"o' of in$#ts and o#t$#ts + %"o' of do""ars

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O#r %irst Mode": The Circ#"ar&%"o' (iagram )irms

Produce and sell goods and services *ire and use factors of production

*ouseholds
+uy and consume goods and services ,wn and sell factors of production

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O#r %irst Mode": The Circ#"ar&%"o' (iagram Markets for -oods and .ervices
)irms sell *ouseholds uy

Markets for )actors of Production

*ouseholds sell )irms uy

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O#r %irst Mode": The Circ#"ar&%"o' (iagram )actors of Production

Inputs used to produce goods and services Land# la or# and capital

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O#r Second Mode": The .rod#ction .ossibi"ities %rontier The production possibilities frontier is a graph that shows the com inations of output that the economy can possi ly produce given the availa le factors of production and the availa le production technology.

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%ig#re 3 The .rod#ction .ossibi"ities %rontier

uantity o! Computers "ro#uce#

6,444 3,344 3,444 C

A .rod#ction $ossibi"ities frontier

),444

644

544 744

),444

uantity o! Cars "ro#uce# Copyright2003 Southwestern/Thomson Learning

O#r Second Mode": The .rod#ction .ossibi"ities %rontier (oncepts Illustrated y the Production Possi ilities )rontier
Efficiency Tradeoffs ,pportunity (ost Economic -rowth

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%ig#re 6 A Shift in the .rod#ction .ossibi"ities %rontier

uantity o! Computers "ro#uce# 9,444

6,444 E A

3,)44 3,444

744 784

),444

uantity o! Cars "ro#uce#

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Microeconomics and Macroeconomics

Microeconomics focuses on the individual parts

of the economy.
*ow households 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 .OLIC: A(2ISO!

0hen economists are trying to explain the world# they are scientists. 0hen economists are trying to change the world# they are policy advisor.

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.OSITI2E 2E!S0S NO!MATI2E ANAL:SIS

Positive statements are statements that attempt to

descri e the world as it is.

(alled descriptive analysis Normative statements are statements a out how

the world should e.

(alled prescriptive analysis

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.OSITI2E 2E!S0S NO!MATI2E ANAL:SIS

Positive or 1ormative .tatements2
3n increase in the minimum wage will cause a decrease in employment among the least/skilled. P,.ITI4E

*igher federal udget deficits will cause interest rates to increase. P,.ITI4E

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.OSITI2E 2E!S0S NO!MATI2E ANAL:SIS

Positive or 1ormative .tatements2
The income gains from a higher minimum wage are worth more than any slight reductions in employment. 1,5M3TI4E .tate governments should e allowed to collect from to acco companies the costs of treating smoking/related illnesses among the poor. 1,5M3TI4E

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Economists in ,ashington . . . serve as advisers in the policymaking process of the three ranches of government'
Legislative Executive 6udicial

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Economists in ,ashington .ome government agencies that collect economic data and make economic policy'
$epartment of (ommerce
http'77www.commerce.gov

+ureau of La or .tatistics
http'77www. ls.gov

(ongressional +udget ,ffice

http'77www.c o.gov

)ederal 5eserve +oard

http'77www.federalreserve.gov
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,H: ECONOMISTS (ISA*!EE

They may disagree a out the validity of alternative positive theories a out how the world works. They may have different values and# therefore# different normative views a out what policy should try to accomplish.

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Tab"e 3 Ten .ro$ositions abo#t ,hich Most Economists Agree

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S#mmar
Economists try to address their su !ects with a scientist8s o !ectivity.
They make appropriate assumptions and uild simplified models in order to understand the world around them. Two simple economic models are the circular/flow diagram and the production possi ilities frontier.

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S#mmar
Economics is divided into two su fields'
Microeconomists study decisionmaking y households and firms in the marketplace. Macroeconomists study the forces and trends that affect the economy as a whole

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S#mmar
3 positive statement is an assertion a out how the world is. 3 normative statement is an assertion a out how the world ought to e. 0hen economists make normative statements# they are acting more as policy advisors than scientists.

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S#mmar
Economists who advise policymakers offer conflicting advice either ecause of differences in scientific !udgments or ecause of differences in values. 3t other times# economists are united in the advice they offer# ut policymakers may choose to ignore it.

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