CHAPTER

Thinking Like An Economist

Economics
PRINCIPLES OF

N. Gregory Mankiw

2011
© 2011 South-Western, a part of Cengage Learning, all rights reserved update
In this chapter,
look for the answers to these questions:
 What are economists’ two roles? How do they differ?
 What are models? How do economists use them?
 What are the elements of the Circular-Flow Diagram?
What concepts does the diagram illustrate?
 What is the difference between microeconomics and
macroeconomics? Between positive and normative?

2
 The Economist as Scientist
 Economists play two roles:
1. Scientists: try to explain the world
2. Policy advisors: try to improve it
 In the first, economists use the scientific method, the dispassionate
development & testing of theories about how the world works.
 In the second, economists make recommendations to the rulers of a
country to help manage the economy.

THINKING LIKE AN ECONOMIST 3

The Economist as Policy Advisor

4
5
ACTIVE LEARNING
Answers
a. Prices rise when the government increases the quantity of money.
Positive – describes a relationship, could use data to confirm or
refute.
b. The government should print less money.
Normative – this is a value judgment, cannot be confirmed or
refuted.

6
ACTIVE LEARNING
Answers
c. A tax cut is needed to stimulate the economy.
Normative – another value judgment.
d. An increase in the price of burritos will cause an increase in consumer
demand for video rentals.
Positive – describes a relationship.
Note that a statement need not be true to be positive.

7
 Why Economists Disagree
 Economists often give conflicting policy advice.
 Sometimes they do not believe the positive
statements make any sense (even if they are
shown to be “true”).
 They may have different values, morals, and
beliefs about what is right and wrong, therefore,
different normative views about what policy
should try to accomplish.
 Yet, there are many propositions about which
most economists agree.
THINKING LIKE AN ECONOMIST 8
 Assumptions & Models
 Assumptions simplify the complex world,
make it easier to understand

 Example: To study international trade, assume two countries & two goods.
Unrealistic, but simple to learn & gives useful insights about the real world.
 Model: a very simple representation of
a more complicated reality. Economists use models to study economic issues.

THINKING LIKE AN ECONOMIST 9

 Our First Model:
The Circular-Flow Diagram

THINKING LIKE AN ECONOMIST 10

 Factors of Production
 Factors of production: the resources (inputs) the economy
uses to produce goods & services (outputs), including
 labor (workers)
 land (Natural Resources)
 capital (buildings & machines used in production)
 Enter premiership (Businessman and Entrepreneur)
 Knowledge (education/skills are the most important)
(because knowledge

11
FIGURE 1: The Circular-Flow Diagram

Households:
Households:
Own
Own thethe factors
factors of
of production,
production,
sell/rent
sell/rent them
them to
to firms
firms for
for income
income
Buy
Buy and
and consume
consume goods
goods & & services
services

Firms Households

Firms:
Firms:
Buy/hire
Buy/hire factors
factors of
of production,
production,

use
use them
them to to produce
produce goods
goods
and
and services
services
THINKING
Sell
Sell goods
LIKE AN&
goods services
&ECONOMIST
services 12
FIGURE 1: The Circular-Flow Diagram

Revenue Spending
Markets for
G&S Goods &
G&S
sold Services bought

Firms Households

Factors of Labor, land,

production Markets for capital
Factors of
Wages, rent, Production Income
profit
THINKING LIKE AN ECONOMIST 13
 Microeconomics and Macroeconomics

THINKING LIKE AN ECONOMIST 14