Economist as Scientist: Assumptions & Economic Models

The Economist as Scientist

• Economics is the study of how societies allocate scarce resources.
• Economists develop theories and collect and analyze data to test those theories.
• Key to economics is using the scientific method.

Steps of the Scientific Method

• Economists develop and test theories about how world works.
• Experiments are difficult in economics, so economists often study natural experiments offered by history.
• Economists may pay close attention to natural experiments or develop quantitative macro models.

Assumptions

• Economists use assumptions to simplify complex situations, making them understandable.
• It is an art to decide which assumptions to make.
• Economists may use different assumptions to answer questions.
• They will also change assumptions for different time horizons.

Economic models

• Models simplify reality.
• They can be diagrams or equations.
• Use assumptions.
• Often omit many details.
• Are subject to change.

The Circular Flow Diagram

• A visual model of the economy shows how dollars and goods/services flow through markets.
• It simplifies the economy to include individuals and companies. Firms:
  • Produce goods and services.
  • Use factors of production(inputs). Households:
  • Own the factors of production.
  • Consume goods and services.
• Households and companies interact in markets for goods/services and in markets for factors of production.
• In markets for goods and services, households are buyers and firms are sellers.
• In markets for factors of production, households are the sellers and firms are the buyers.

Production Possibilities Frontier

• Production Possibilities Frontier (PPF) graph shows the combinations of output that the economy can produce.
• Relies on the availability of:
• Factors of production
• Production technology
• Any point on or beneath the curve is a possible output combination.
• Points outside of the frontier are not possible, given the economy's resources.
• The slope of the PPF shows the opportunity cost of a car in terms of computers, depending on how much of the two goods the economy is producing.

Efficient Outcomes

• Points of on the PPF are considered efficient. The economy is getting all it can from the resources it has available. Society faces trade-offs, at an efficient point. -The only way to produce more of one good is to produce less of another. Moving from point A to point B, for example, yields 100 more cars at the expense of producing 200 less computers.

Opportunity Costs

• Producing one good means giving up production of another good.
• Point A means the opportunity cost of 100 cars is 200 computers and the opportunity cost of 1 car is 2 computers.
• Opportunity cost is slope of PPF.

Inefficient outcomes

• Points inside of PPF are considered inefficient
• At certain point, the economy is producing less than it could from the resources it has.
• When the source of inefficiency is eliminated, the economy can increase its production of both goods.

The Economists as Policy Advisor

Economists analyze, as scientists.

• Explain causes of economic events. Also, they advise on policy.
• Recommend policy to improve economic outcome.

Positive versus Normative Analysis

• Positive statements are descriptive; they make claims on how the world is.
• Positive statements can be confirmed or refuted with data.
• Normative statements are prescriptive; they make claims about how the world ought to be.
• Evaluation includes both values and facts.

Economists in Washington

• The Council of Economic Advisors advises the president and writes the annual Economic Report of the President.
• Economists also serve as advisors at the Office of Management and Budget, the Department of the Treasury, the Department of Labor, the Department of Justice, the Federal Reserve, and the Congressional Budget Office.

The Reasons Economist's Advice Isn't Always Followed

• The president receives advice from many advisors, including communication advisors, press advisors, legislative affairs advisors, and political advisors.
• The president makes the decision after weighing all the advice.

Why Economists Disagree

• Economists may have different hunches about the validity of alternative theories.
• They can have different judgments regarding the parameters that measure how economic variables are related.
• Because of differing political philosophies, economists often disagree about public policy, offering conflicting advice.

Graphing

• Graphs visually express ideas that are difficult to describe in equations or words.
• Graphs also are a way of finding interesting patterns.
• Graphs of a single variable: pie chart, bar graph, time series graph.
• Graph ordered point pairs to display two variables - x-coordinate (x-axis) for horizontal location; y-coordinate (y-axis) for vertical location.

Variables

• When fine data observations are available, a scatterplot creates a curve.
• As an alternative, points can be connected to create a curve manually.
• When negatively related variables shift, they move in opposite directions, creating a downward-sloping curve.
• When positively related variables shift, they move in the same direction, creating an upward-sloping curve.
• One set of circumstances leads to another.
• One may conclude a causal relationship is present if a connection exist.
  • Omitted variables can create deceptive graphs.
  • Reverse causality can be an issue.

Markets and Competition

• Supply and demand refers to forces that drive market economics
• A market constitutes a group of buyers and sellers for a specific service.
• Buyers: group determines the demand of teh product
• Sellers: group determine supply of the product.

Competition

• A competitive market has many buyers and sellers.
• Each seller impacts the market price.
• Price and quantity are determined as sellers and buyers interact in the marketplace.
• In a perfectly competitive market, a buyer or seller can have influence on the market price

Demand

• Quantity is an amount a buyer is willing and able to purchase at given price.
• According to the law of demand, generally when the price of a good rises, the quantity demanded falls
• When the price falls, the quantity demanded rises.
• Individual demand is an individual demand for a product
• Demand schedule show relationship between price and quantity

Market Demand

• Market demand curve represents the total demands for a product or service
• Market demand varies with price, holding constant what affect purchases.
• A change that increases quantity leads to rightward shift in the demand curve.
• A change that decreases quantity leads to a leftward shift in the demand curve.

Factors that influence buyers

• Incomes of buyers
• Prices of related goods
• Tastes
• Expectations
• Number of buyers
• Normal Products: Income increase leads to increased demand.

Related Goods

• Substitutes: increase in price of leads to increase in demand for other
• Complements: increase in price of decrease in demand for the other

Demand

• Unique and affected by historical or physiological forces, tastes drive buying decisions.
• Expectations like, future changes in price, and number of people in market

Supply

• Quantity supplied refers to good seller is able and willing to sell.
• According to the the law of supply, when the price of a good rises, the quantity supplied also rises
• When the price falls, the quantity supplied falls as well.

Individual/Market Supply

• A single seller's supply for a product make up individual supply
• Supply schedule show relationship between price and quantity. Table, graph relationships

Shifts in the supply curve

• Show how supplied various the price varies, all other consideration held equal
• A change that increases quantity that sellers supply at any price shifts supply to the right.
• A change that decreases quantity is shift to the left.
• Important considerations. input prices, technology, what expects

Supply and demand together

• Equilibrium consists of: quantity that balances with what sellers willing and can sell, forces are balanced
• If there is a price equilibrium, there is balances the quantity supplied and demanded
• Quantities equilibrium will exist when demand and supplied for that equilibrium price.

Surpluses

• Quantity available higher then can demand, sellers try to respond
• Surplus= quantity available higher than can demand
• Shortage= Quanitity demand higher than can supply

Law of supply and demand

• Movement from non-equilibrium to equilibrium, good price adjust to that quantity that willing to supplied and demanded
• Over and under is only for time, and over corrections due to prices fast to move to equilibrium.

Equilibrium

Steps to analyzing change:

• First decide shift due event, second decide in what directions, third shift by change in quanities.

Graphs on equilibrium

• If a summer heat wave the market price will be higher but if summer is bad market goes down
• Overtime will the equilibrium will always find a the right.

Price elasticity of Demand

• The term that often use to measure sensitivity of consumers to changing price

The Variety of Demand Curves

• Elastic demand: price elasticity of demand > 1.
• Inelastic demand: price elasticity of demand < 1.
• Unit elasticity: price elasticity of demand = 1.
• Perfectly inelastic demand: price elasticity of demand = 0; demand curve is vertical.
• Perfectly elastic demand: price elasticity of demand = infinity; demand curve is horizontal.

Total revenue

• Total revenue is measured by:
• the amount paid by buyers and received by sellers of a good:
• The price of the good times the quantity sold (PxQ).
• Total revenue and the demand price elasticity of demand: With elastic demand, price and total revenue move in opposite directions.
• With inelastic demand, price and total revenue move in the same direction.
• With unit elastic demand, when price changes, total revenue remains constant.
• It has a constant slope.
• However, its elasticity changes along the curve.

Income and Cross-Price Elasticity

• Measures the elasticity of a good response based consumers income
• Positive elasticity when income is normal and negative when lower
• Some good can measures to other when price affect
• Substitutes have positive measure
• Completment that when price have negative measure effect.
• Time impacts the elasticity, more lastics in long term instead of short period

Elasticity of Supply

• Supply is the impact volume product respond that affect by price
• Impact in price affect the how well goods resold
• Time will affect if in long run, the elasticity will impact more that just short term
• Curve can be elastic, inelastic and or more for supply

Module 2

Measuring of GDP

• GDP is use measure market value of market
• GDP tried to comprehensitive with economy
• GDP is only find final value to ensure is what end users will expect in products and services
• GDP will always have change due various factors of a nations economy, GDP can have the economy of scale increase due product and higher services, its production will sold and or may time and price affect as welll

Components of GDP

• Is all four components of a GDP: -C + I + G + NX

Cost of good calculation

• Most cost of a goods depends on the durable and nondurable costs to make
• Services impact can be education and rentable
• Gov also put costs to services, for salaries and more

Problems in Measuring and Calculating GDP

• Difficult to know how to accurately measure, various problems with cost of living
• Substitution bias: over time some price rise the other
• The CPI is not correct way when used fixed basket of goods
• All factors create create GDP measurements off

The GDP Deflator versus the Consumer Price Index

• GDP Deflator is Ratio of Nominal GDP and to Real
• Reflects the prices with the production by the nation
• Comapares all service to base
• CPI measures of goods with consumers purchases
• Compares prices over time

Indexing

• Amount that determine economic influence with size
• Indexation has automatic change based on the affects to inflating
• The (COLA), cost-of-living- allow and adjust
• Soc security and taxes affects

Factors Impacting Price Change

• The Elsticity and impact to what will be affect the price in market.
• Can be farming price and more.
• News affect the market.
• OPEC's oil failure hurt a lot of thing

Final Points on all Material

• What happened when drug crime increase.
• Increase use of federal agents.
• Drug price decrease with quantity sold
• The supply, demand with the price affects everything
• The price change on total revenue is constant.
• Elasticity and total Revenue run along with market
• The measure that goods affect with customers will always put in to account depending

Economics uses the scientific method to study resource allocation. Economists develop theories, collect data, and analyze natural experiments. They use assumptions and economic models to simplify complex situations and understand the world.