Thinking Like an

Economist

Chapter 2

Copyright © 2001 by Harcourt, Inc.

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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.
 The Economic Way of Thinking

 Includes developing abstract models

from theories and the analysis of the
models.
 Uses two approaches:


Descriptive (reporting facts,
etc.)

Analytical (abstract reasoning)
 Two Roles of Economists

 When they are trying to explain the

world, they are scientists.
 When they are trying to change the
world, they are policymakers.
The Economist as a Scientist

The economic way of thinking . . .

 Involves thinking analytically and
objectively.
 Makes use of the scientific method.
 The Scientific Method

 Develops theories, collects, and analyzes

data to prove the theories.
 Uses abstract models to help explain how
a complex, real world operates.

Observation, Theory and More Observation!

 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 Model

 The Production Possibilities Frontier
The Circular-Flow Model

The circular-flow model is a simple

way to visually show the economic
transactions that occur between
households and firms in the
economy.
 The Circular-Flow Diagram
Revenue Spending

Goods & Goods &

Services sold Services
bought
Market for Goods and Services
Firms
Households
Market for Factors of Production

Inputs for Labor, land,

production and capital

Wages, rent, Income

and profit
The Production Possibilities Frontier

The production possibilities frontier is a

graph showing the various
combinations of output that the
economy can possibly produce given
the available factors of production and
technology.
 The Production Possibilities Frontier

Quantity of
Computers
Produced
3,000 D

2,200
C
2,000 A

B
1,000

0 300 600 700 1,000 Quantity of

Cars Produced
Microeconomics and Macroeconomics

 Microeconomics focuses on the individual

parts of the economy.
 How households and firms make decisions
and how they interact in specific markets
 Macroeconomics looks at the economy as
a whole.
 How the markets, as a whole, interact at the
national level.

Economists in Washington . . .

. . . serve as advisers in the

policymaking process of the three
branches of government:
 Legislative
 Executive
 Judicial
 Positive versus Normative Analysis
 Positive statements are statements
that describe the world as it is.
 Called descriptive analysis
 Economists as scientists make positive
statements
 Normative statements are statements
about how the world should be.
 Called prescriptive analysis
 Economists as policymakers make
normative statements
 Why Economists Disagree

 They may disagree on theories

about how the world works.

 They may hold different values

and, thus, different normative
views.
Examples of What Most Economists
Agree On

 A ceiling on rents reduces the

quantity and quality of housing
available.

 Tariffs and import quotas usually

reduce general economic welfare.
ECONOMIC ANALYSIS
EASY AS 1..., 2..., 3...
1. Where are you before any changes? Mark a beginning point
based on the scenario. (A) Tell how you knew where to start.

2. What was the change? What happened in the scenario? Did

production of one good increase? Did we go to war? Restate it
simply here.

3. What was the result of the change?

Short Run Where are we now? What was the immediate impact
on the two variables? Which way on the line did we move? Are
we inside the line?
 Show the result with a new point. (B)

Long Run What happened to the location of the production

possibilities frontier? Did it move in or out?
 If it moved show the new location with a new line and arrows
indicating the direction of change.
 Tell what changed to cause this movement (this must be a change in
a resource or technology).
 PRODUCTION POSSIBILITIES CURVE
Scenario: While at full-employment new
developments in computer technology cause 1. Begin:
many business to invest in new computer
systems.
Capital Goods 2. Change:

3. Result of Change:
• Short run:

• Long run:

0 Consumer Goods
 While at full-employment new
developments in computer
technology cause many 1. Begin: A , because at
business to invest in new full-employment
computer systems.

2. Change: US
Capital Goods

companies increase
B purchase and
Ca2
production of capital
goods.

3. Result of Change: Move

Ca1 A to B
• Short run: Consumer
goods decrease and
Capital goods increase
• Long run: Production
Co2 Co1 Possibilities Curve
Consumer Goods shifts outward due to
more capital.