Name ______________________________________________ LECTURE NOTES

Principles of Microeconomics – Dr. Sauer

Chapter 2: Understanding How Economists Think I. An Economist as a Scientist Economists approach the study of the economy with ________________________________. - observe the world - devise theories and formulate hypotheses - collect data - test hypotheses Like all scientists, economists make appropriate ________________ and build _______________ models in order to understand the world around them. The economist’s “lab” is the _____________. - can’t design experiments for the whole economy - can study the results of random events and policy changes The economy is a _____________________. - constantly changing - true in the past may not be true in the future. There is an _________________ that can help you to understand the economy, even if you can’t predict its future.

II. An Economist as a Policy Adviser When economists are trying to ______________ the world, they are ______________. When they are trying to help ______________ it, they are __________________. Why is unemployment higher for teenagers than for older workers? What should the government do to improve the economic well-being of teenagers? To help clarify the two roles that economists play, let's examine the use of language. Because scientists and policy advisers have __________________, they use language in different ways. - objective vs subjective The cost of Metro’s tuition is too high. Metro’s tuition has increased since last year. 1. Ask yourself “Is the claim positive or normative?” A ___________________ statement is a claim about what is, was, or will be. - objective (no value judgment/approval/disapproval). - can be ______________. - can be ______________. - can be a prediction. A ___________________ statement is a claim expressing a value judgment. - subjective (value judgment). - cannot be verified.

Examples: ___The cost of Metro’s tuition is too high. ___Metro’s tuition has increased since last year. ___Many economists believe that international trade is an opportunity for an economy. ___The US trade deficit is a problem. ___The US exports more than it imports. 2. Once you have determined if a claim is positive or normative: If it is positive: - What _________________ is there to support the claim? - How _________________ is the evidence? - Are there ______________ ways of interpreting the evidence? If it is normative: - Is the normative claim ___________ on any positive claims? - Are those positive claims supported by _____________ evidence? How do economists affect policy? ~ Federal, State, and Local governments directly _______________ economists. ~ Their research and writings often affect policy _________________. ~ Sometimes their advice is _______________. Making economic policy in a representative democracy is a messy process. - economic advice is only one part of the information considered by policymakers

Sometimes Economists Disagree ~ disagree about the __________________ of alternative positive theories Ex: a change in the tax code that would eliminate a tax on income and create a tax on consumption - some think this would increase household savings - others think it would have little effect on saving behavior ~ have different ______________ and therefore different __________________ prescriptions Ex: Suppose that Peter and Paula both take the same amount of water from the town well. To pay for maintaining the well, the town taxes its residents. - Peter has income of $50,000 and is taxed $5,000, which is 10% of his income. - Paula has income of $10,000 and is taxed $2,000, which is 20% of her income. Is this policy fair? - If not, who pays too much and who pays too little? - Does it matter whether Paula's low income is due to a medical disability or to her decision to pursue a career in acting? - Does it matter whether Peter's high income is due to a large inheritance or to his willingness to work long hours at a dreary job? These are difficult questions on which people are likely to ______________________.

III. Circular Flow Diagram {____________ economic models have assumptions. Models ______________ include every feature of the real world.} Assumptions: -2 types of economic actors - firms do all production - households own all factors - 2 types of markets

What could be added to this model to make it more like the real world (and more complex)?

Even though the model is simple and “missing” many features of the real world, how well does it capture the essence of the flow of money and goods and services in the economy?

IV. The Production Possibilities Frontier (PPF) represents the _____________________________ that an economy can produce with a ___________ level of resources and a given level of technology Assumptions: - 2 goods - fixed level of factors - fixed level of technology
quantity of military goods

quantity of consumer goods

MG
A B

F

Points on the PPF are ____________________________. This means - all resources are employed - resources aren’t being used wastefully Points inside the PPF are _________________________. - unemployed, underemployed, or wasted resources Points outside the PPF are _____________________________.

E

C

D

CG
{Society’s preferences will determine the level of economic output.} 1. Efficiency implies that an economy ___________________________ of one good ________________________________________ of another. Ex: If the economy is currently producing at B and wants to move to C, then it must forgo the production of some military goods in order to produce more consumer goods. 2. Inefficiency implies that an economy ______________ produce more of one good without producing less of another. Ex: If the economy is currently producing at E, if it fully and efficiently uses all available resources, it can produce B or C without giving up any consumer goods or military goods.

3. Opportunity cost and the PPF:
MG
175
150 A B

If the economy is producing at point C and moves to point B:
F

____ units of consumer goods must be sacrificed to gain ____ units of military goods. __________________________ is whatever must be given up to get something. The _________________ opportunity cost of the additional 70 military goods is ______________.
CG

80

E

C

D 75 100 110

The opportunity cost of one additional unit of military goods is:

Calculate the total and per unit opportunity cost of moving from point B to point D.

Calculate the total and per unit opportunity cost of moving from point E to point B.

4. Changes in the PPF What happens if the level of resources or technology changes? Ex: - increase in resources - increase in general technology Ex: - increase in resources used in the production of good Y only - increase in technology for producing good Y only
quantity of good Y

quantity of good Y

quantity of good X

quantity of good X

PPFs can have two shapes:

bowed out or straight line Bowed out PPFs reflect that ______ all inputs _________________ into the outputs.

Straight line PPFs happen when the inputs _______________________ into the outputs.
Y

Y

10

20

30

40

X

10

20

30

40

X

- ______________ opportunity costs as you move from left to right

- ______________ opportunity costs as you move from left to right

__________________________________________________________________________________ Summary: Economists try to address their subject with a scientist’s objectivity. Sometimes economists are called upon to be policy advisers. A positive statement is an assertion about how the world is. A normative statement is an assertion about how the world ought to be. One simple model of the economy as a whole is the circular-flow diagram. The Production Possibilities Frontier can be used to illustrate efficiency, inefficiency, and unobtainable outcomes for a nation’s output.

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