Principles of Economics Chapter 2 PDF

N. GREGORY MANKIW PRINCIPLES OF ECONOMICS Eight Edition 2 CHAPTER Thinking Like an Economist...

N. GREGORY MANKIW PRINCIPLES OF ECONOMICS Eight Edition 2 CHAPTER 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 1 management system for classroom use.  The Economist as a Scientist Economics is a science Economists are scientists – Devise theories – Collect data – Analyze these data “I’m a social scientist, Michael. Verify or refute their theories That means I can’t – Use the scientific method explain electricity or anything like that, but if you ever want to know about people, I’m your man.” © 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 2 management system for classroom use.  The Economist as a Scientist Scientific method – Dispassionate development and testing of theories about how the world works – Observation, theory, more observation Conducting experiments in economics – Is often impractical Substitute for laboratory experiments – Economists pay close attention to the natural experiments offered by history © 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 3 management system for classroom use.  The Economist as a Scientist The role of assumptions 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 4 management system for classroom use.  The Economist as a Scientist 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 5 management system for classroom use.  The Economist as a Scientist Circular-flow diagram – Visual model of the economy – Shows how dollars flow through markets among households and firms Two decision makers – Firms and Households Two markets – For goods and services – For factors of production (inputs) © 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 6 management system for classroom use.  The Economist as a Scientist Firms – Produce goods and services – Use factors of production (inputs) Households – Own factors of production – Consume goods and services © 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 7 management system for classroom use.  The Economist as a Scientist Firms and Households interact in markets Markets for goods and services – Firms are sellers – Households are buyers Markets for factors of production – Firms are buyers – Households are sellers © 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 8 management system for classroom use.  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 9 management system for classroom use.  The Economist as a Scientist Production possibilities frontier – A graph – Combinations of output that the economy can possibly produce – Given the available Factors of production Production technology © 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 10 management system for classroom use.  Figure 2 The production possibilities frontier The production possibilities Quantity of frontier shows the Computers combinations of output—in Produced this case, cars and computers —that the economy can possibly produce. C The economy can produce 3,000 F Production any combination on or inside the frontier. A Possibilities 2,200 Points outside the frontier are B Frontier not feasible given the 2,000 economy’s resources. The slope of the production possibilities frontier measures D 1,000 the opportunity cost of a car in E terms of computers. This opportunity cost varies, depending on how much of 0 300 600 700 1,000 the two goods the economy is Quantity of producing. 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 11 management system for classroom use.  The Economist as a Scientist Efficient levels of production – The economy is getting all it can from the scarce resources available – Points on the production possibilities frontier – Trade-off: The only way to produce more of one good is to produce less of the other good Moving from point A to point B: give up 200 computers to produce 100 more cars © 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 12 management system for classroom use.  The Economist as a Scientist Inefficient levels of production – Points inside production possibilities frontier Opportunity cost of producing one good – Give up producing units of the other good – Slope of the production possibilities frontier © 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 13 management system for classroom use.  The Economist as a Scientist Bowed outward production possibilities frontier – Opportunity cost of a car is highest When the economy is producing many cars and fewer computers – Opportunity cost of a car is lower When the economy is producing fewer cars and many computers – Resource specialization © 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 14 management system for classroom use.  The Economist as a Scientist Technological advance – Outward shift of the production possibilities frontier – Economic growth – Produce 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 15 management system for classroom use.  Figure 3 A shift in the production possibilities frontier Quantity of Computers A technological advance in Produced the computer industry 4,000 enables the economy to produce more computers for any given number of cars. 3,000 As a result, the production 2,300 G possibilities frontier shifts 2,200 outward. A If the economy moves from point A to point G, then the production of both cars and computers increases. 0 600 650 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 16 management system for classroom use.  The Economist as a Scientist 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 17 management system for classroom use.  The Economist as Policy Adviser Positive statements: descriptive – Attempt to describe the world as it is – Confirm or refute by examining evidence: “Minimum-wage laws cause unemployment” Normative statements: prescriptive – Attempt to prescribe how the world should be: “The government should raise the minimum wage” © 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 18 management system for classroom use.  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 19 management system for classroom use.  Figure A-1 Types of Graphs The pie chart in panel (a) shows how U.S. national income is derived from various sources. The bar graph in panel (b) compares the average income in four countries. The time-series graph in panel (c) shows the productivity of labor in U.S. businesses over time. © 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 20 management system for classroom use.  Graphing: A Brief Review Graphs of two variables: the coordinate system – Display two variables on a single graph – Scatterplot – 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 21 management system for classroom use.  Figure A-2 Using the Coordinate System Grade point average is measured on the vertical axis and study time on the horizontal axis. Albert E., Alfred E., and their classmates are represented by various points. We can see from the graph that students who study more tend to get higher grades. © 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 22 management system for classroom use.  Graphing: A Brief Review Curves in the coordinate system Data – Number of novels purchased – Price of novels and Income Demand curve – Effect of a good’s price – On the quantity of the good consumers want to buy – For a given income © 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 23 management system for classroom use.  Table A-1 Novels Purchased by Emma This table shows the number of novels Emma buys at various incomes and prices. For any given level of income, the data on price and quantity demanded can be graphed to produce Emma’s demand curve for novels, as shown in Figures A-3 and A-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 24 management system for classroom use.  Graphing: A Brief Review 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 Movement along a curve Shifts in a 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 25 management system for classroom use.  Figure A-3 Demand Curve Price of Novels $11 10 (5, $10) 9 (9, $9) 8 (13, $8) 7 (17, $7) 6 (21, $6) 5 (25, $5) 4 Demand, D1 3 2 1 0 5 10 15 20 25 30 Quantity of novels purchased The line D1 shows how Emma’s purchases of novels depend on the price of novels when her income is held constant. Because the price and the quantity demanded are negatively related, the demand curve slopes downward. © 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 26 management system for classroom use.  Figure A-4 Shifting Demand Curves Price of $11 When income Novels increases, the demand 10 (13, $8) curve shifts to the right. 9 (16, $8) 8 7 (10, $8) D2 (income= 6 $50,000) 5 When income decreases, the D3 4 (income= D1 demand curve (income= 3 shifts to the left. $30,000) $40,000) 2 1 0 5 10 13 15 16 20 25 30 Quantity of novels purchased The location of Emma’s demand curve for novels depends on how much income she earns. The more she earns, the more novels she will purchase at any given price, and the farther to the right her demand curve will lie. Curve D1 represents Emma’s original demand curve when her income is $40,000 per year. If her income rises to $50,000 per year, her demand curve shifts to D 2. If her income falls to $30,000 per year, her demand curve shifts to D 3. © 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 27 management system for classroom use.  Graphing: A Brief Review Slope – Ratio of the vertical distance covered – To the horizontal distance covered – As we move along the line Δ (delta) = change in a variable The “rise” (change in y) divided by the “run” (change in x). y Slope  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 28 management system for classroom use.  Graphing: A Brief Review 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 29 management system for classroom use.  Figure A-5 Calculating the Slope of a Line Price of Novels $11 10 9 8 (13, $8) 7 6–8=–2 6 (21, $6) 5 21 – 13 = 8 4 Demand, D1 3 2 1 0 5 10 13 15 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 y- coordinates 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 30 management system for classroom use.