Lecture 2 (Chapter-2 Thinking like an economists).pptx

N. GREGORY MANKIW PRINCIPLES OF ECONOMICS Eight Edition CHAPTER 2 Thinking Like an Economist PowerPoint Slides prepared by: V. Andreea CHIRITESCU Eastern Illinois University © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole...

N. GREGORY MANKIW PRINCIPLES OF ECONOMICS Eight Edition CHAPTER 2 Thinking Like an Economist PowerPoint Slides prepared by: V. Andreea CHIRITESCU Eastern Illinois University © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 1 Economics as a Science • Economists try to address their subject with a scientist’s objectivity. • The essence of science in economics is the scientific methodthe dispassionate development and testing of theories about how the world works. • Although economists use theory and observation like other scientists, they face an obstacle that makes their task especially challenging: In economics conducting experiments is often difficult and sometimes impossible. Economists pay close attention to the natural experiments offered by history. The Economist as a Scientist Assumptions – Can simplify the complex world and make it easier to understand. – The art in scientific thinking: deciding which assumptions to make. Different assumptions – To answer different questions – To study short-run or long-run effects © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 3 • Economic models – Diagrams and equations – Omit many details – Allow us to see what’s truly important – Built with assumptions – Simplify reality to improve our understanding of it. © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 4 • Microeconomics – The study of how households and firms make decisions and how they interact in markets. • Macroeconomics – The study of economy-wide phenomena, including inflation, unemployment, and economic growth © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 5 Positive vs. Normative Economics • Positive statements are objective statements dealing with matter of fact or they question about how things actually are. Positive statement are made without obvious value judgment or emotions and it can be measured by facts and figures. Example: A fall in interest rate will reduce the savings rate or "government-provided healthcare increases public expenditures“. • Normative statements are opinion or value judgment. They are not factual and can not be proved with facts and figures. Example: Government should increase tax on demerit goods like cigarettes or "government should provide basic healthcare to all citizens“. The words used for normative statements are should be may be might be. Why Economists Disagree • Economists may disagree – Validity of alternative positive theories about how the world works. • Economists may have different values – Different normative views about what policy should try to accomplish © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 7 Table 1 Propositions about Which Most Economists Agree Proposition (and percentage of economists who agree) 1. A ceiling on rents reduces the quantity and quality of housing available. (93%) 2. Tariffs and import quotas usually reduce general economic welfare. (93%) 3. Flexible and floating exchange rates offer an effective international monetary arrangement. (90%) 4. Fiscal policy (for example, tax cut and/or government expenditure increase) has a significant stimulative impact on a less than fully employed economy. (90%) 5. The United States should not restrict employers from outsourcing work to foreign countries. (90%) 6. Economic growth in developed countries like the United States leads to greater levels of well-being. (88%) 7. The United States should eliminate agricultural subsidies. (85%) 8. An appropriately designed fiscal policy can increase the long-run rate of capital formation. (85%) 9. Local and state governments should eliminate subsidies to professional sports franchises. (85%) 10. If the federal budget is to be balanced, it should be done over the business cycle rather than yearly. (85%) © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 8 Table 1 Propositions about Which Most Economists Agree 11. The gap between Social Security funds and expenditures will become unsustainably large within the next 50 years if current policies remain unchanged. (85%) 12. Cash payments increase the welfare of recipients to a greater degree than do transfers-in kind of equal cash value. (84%) 13. A large federal budget deficit has an adverse effect on the economy. (83%) 14. The redistribution of income in the United States is a legitimate role for the government.(83%) 15. Inflation is caused primarily by too much growth in the money supply. (83%) 16. The United States should not ban genetically modified crops. (82%) 17. A minimum wage increases unemployment among young and unskilled workers. (79%) 18. The government should restructure the welfare system along the lines of a “negative income tax.” (79%) 19. Effluent taxes and marketable pollution permits represent a better approach to pollution control than the imposition of pollution ceilings. (78%) 20. Government subsidies on ethanol in the United States should be reduced or eliminated. (78%) © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 9 Circular-Flow Diagram • In every economy income should be equal to the expenditure. • This phenomenon is best illustrated by the circular flow diagram, showing the flow of resources from households to firms and of products from firms to households. These flows are accompanied by reverse flow of money from firms to households and from households to firms. Figure 1 The circular flow This diagram is a schematic representation of the organization of the economy. Decisions are made by households and firms. Households and firms interact in the markets for goods and services (where households are buyers and firms are sellers) and In the markets for the factors of production (where firms are buyers and households are sellers). The outer set of arrows shows the flow of dollars, and the inner set of arrows shows the corresponding flow of inputs and outputs. © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 11 Production Possibility Frontier Quantity of Computers Produced C F 3,000 A 2,200 2,000 B Production Possibilities Frontier D 1,000 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. E 0 300 600 700 1,000 Quantity of Cars Produced © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 12 The economy can produce any combination on or inside the frontier. Inefficient levels of production: Points inside the production possibilities frontier. Ex: Point X (the resources may get wasted, left idle or misallocated) Efficient levels of production: The economy is getting all it can from the scarce resources available Points on the production possibilities frontier. Ex: Point A, B and C Unattainable levels of production: Points outside the frontier are not feasible given the economy’s resources. Ex: Point Y 13 Production Possibilities and Opportunity Cost An opportunity cost is the next best alternative forgone. Opportunity cost of producing one good is giving up producing units of the other good. The slope of the production possibilities frontier measures the opportunity cost of manufactured goods in terms of agricultural goods. This opportunity cost varies, depending on how much of the two goods the economy is producing. 14 Opportunity cost in terms of agricultural goods To produce 1 unit of agricultural goods: 25 units of agricultural goods = 20 units of manufactured goods 25 units of agricultural goods /25 = 20 units of manufactured goods /25 1 units of agricultural good = 4/5 units of manufactured goods Opportunity cost in terms of manufactured goods To produce 1 unit of manufactured goods: 20 units of manufactured goods = 25 units of agricultural goods 20 units of manufactured goods /20 = 25 units of agricultural goods /20 1 units of manufactured good = 5/4 units of agricultural goods 15 Technological advancement…… – Leads the production possibilities frontier to shift outward. – Promoting Economic growth – By producing more of both goods © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 16 Figure 3 A shift in the production possibilities frontier A technological advance in the computer industry enables the economy to produce more computers for any given number of cars. Quantity of Computers Produced 4,000 ↓ As a result, the production possibilities frontier shifts outward. 3,000 G 2,300 2,200 A 0 600 650 ↓ If the economy moves from point A to point G, then the production of both cars and computers increases. 1,000 Quantity of Cars Produced © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 17 Graphing: A Brief Review • Graphs serve two purposes: – Visually express ideas that might be less clear if described with equations or words – Powerful way of finding and interpreting patterns • Graphs of a single variable: – Pie chart – Bar graph – Time-series graph © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 18 Graphs of two variables The coordinate system – Display two variables on a single graph (ex: price and quantity) – Ordered pairs of points • x-coordinate – Horizontal location • y-coordinate – Vertical location © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 19 • Negatively related variables – The two variables move in opposite direction – Downward sloping curve • Positively related variables – The two variables move in the same direction – Upward sloping curve © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 20 Calculating Slope: – Ratio of the vertical distance covered – To the horizontal distance covered • Δ (delta) → change in a variable • Δ y → change in y • Δ x → change in x © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 21 Figure A-5 Calculating the Slope of a Line Price of Novels $11 10 9 8 7 6 5 4 3 2 1 0 (13, $8) 6–8=–2 (21, $6) 21 – 13 = 8 5 10 13 15 Demand, D1 20 21 25 30 Quantity of novels purchased To calculate the slope of the demand curve, we can look at the changes in the x- and ycoordinates as we move from the point (21 novels, $6) to the point (13 novels, $8). The slope of the line is the ratio of the change in the y-coordinate (–2) to the change in the x-coordinate (+8), which equals –1⁄4. © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 22 Types of Slope – Fairly flat upward-sloping line • Slope is a small positive number – Steep upward-sloping line • Slope is a large positive number – Downward sloping line • Slope is a negative number – Horizontal line: slope is zero – Vertical line: infinite slope © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 23