Chapter 2: Thinking Like an Economist - Production Possibilities Frontier

Chapter 2 Thinking Like an Economist 2-1 2-1 The Economists as Scientists Economics studies economic units’ behaviors, interactions, and the effects and forces of public policies (fiscal policy and monetary policy) What do economists do: They devise theories, col...

Chapter 2 Thinking Like an Economist 2-1 2-1 The Economists as Scientists Economics studies economic units’ behaviors, interactions, and the effects and forces of public policies (fiscal policy and monetary policy) What do economists do: They devise theories, collect data, and then analyze the data attempting to verify or refute their theories (the empirical); there are also the theoreticians 2-2 Define Economic Model An economic model is a simplified description of a real economic problem. It is an analytical framework and mathematical 3 THE IMPORTANT ROLE OF ASSUMPTIONS Assumptions are crucial for establishing an environment for economic analysis Assumptions can simplify the complexity of the real world and make analysis possible or easier Assumptions should be taken as given Different assumptions lead to different specific answers to economic problems, but a simpler version is useful for generalizing the answers Examples: Assume in a closed economy with one firm producing two goods; all the workers have the same educational attainment and skill level; the prices and wage rate are constant, … 2-4  CIRCULAR-FLOW DIAGRAM: OUR 1ST a visual model of the economy MODEL: that shows how goods and services, and money flow through THE markets among households and CIRCULAR- firms The following presented is a FLOW simpler version of the circular-flow DIAGRAM diagram involving two decision- makers and two markets, only 2-5 FIGURE 2.1 The Circular Flow 2-6 OUR 2ND MODEL: THE PRODUCTION POSSIBILITIES FRONTIER PRODUCTION POSSIBILITIES FRONTIER (PPF) a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology Recognize the specific shape of PPF: decreasing and bound outwards 2-7 FIGURE 2.2 The Production Possibilitie s Frontier 2-8 Active Learning Production Possibilities Frontier Example Production Point on graph Computers Wheat E D A 500 0 C B 400 1000 B C 250 2500 A D 100 4000 E 0 5000 2-9 Discussion Questions On the graph, find the point that represents 100 computers, 3000 tons of wheat; label it as F. Would it be possible for the economy to produce this combination of the two goods? Why or why not? Next, find the point that represents 300 computers, 3500 tons of wheat; label it as G. Would it be possible for the economy to produce this combination of the two goods? 2-10 Answers Wheat  Point F: 100 computers, (tons) 3000 tons of wheat 6,000 5,000  Point F requires 40 000 4,000 hours of labour. Possible but not efficient; could get 3,000 more of either good F 2,000 without sacrificing any of the other. 1,000 0 0 100 200 300 400 500 600 Computers 2-11 Answers (cont’d) Wheat  Point G: 300 computers, (tons) 3500 tons of wheat 6,000 5,000  Point G requires 65 000 hours of labour. Not possible 4,000 G because economy has only 3,000 50 000 hours. 2,000 1,000 0 0 100 200 300 400 500 600 Computers 2-12 FIGURE 2.3 A Shift in the Production Possibilities Frontier 2-13 Try it yourself (TIY): Draw a production possibilities frontier for a society that produces food and clothing. Show an efficient point, an inefficient point, and an infeasible point. Show the effects of a drought. 2-14 2-2 THE ECONOMIST AS POLICY ADVISER When economists are trying to explain the world, they are scientists. When they are trying to help improve it, they are policy advisers. POSITIVE STATEMENTS: claims that attempt to describe the world as it is. NORMATIVE STATEMENTS: claims that attempt to prescribe how the world should be. 2-15 Thinking time: Are the following positive or normative statements? A. Prices rise when the government increases the quantity of money. B. The government should print less money. C. A tax cut is needed to stimulate the economy. D. An increase in the price of burritos will cause an increase in consumer demand for video rentals. 2-16 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 2-17 Active Learning Answers (cont’d) 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: A statement need not be true to be positive. 2-18 Please read the rest for knowledge. They won’t be tested. ECONOMISTS IN OTTAWA Economists at Finance Canada help design tax policies. Economists at the Competition Bureau help design and enforce Canada’s competition laws. Economists at Global Affairs Canada help negotiate trade agreements with other countries. 2-20 ECONOMISTS IN OTTAWA (cont’d) Economists at Employment and Social Development Canada analyze data on workers and on those looking for work to help formulate labour market policies. Economists at Environment and Climate Change Canada help design environmental regulations. Statistics Canada employs economists to collect the data analyzed by other economists and then give policy advice. 2-21 WHY ECONOMISTS’ ADVICE IS NOT ALWAYS FOLLOWED Any economist In the real who advises world, figuring government out the right knows that his policy is only or her part of the job recommendatio for the ns are not government. always heeded. 2-22