Chapter 2 - Thinking Like Economists PDF

Chapter 2: Thinking Like an Economist © 2015 Cengage Learning. All Rights Reserved....

Chapter 2: Thinking Like an Economist © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 1 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  In this chapter, we will discuss:  What are economists’ two roles?  How economists approach the world? (the field’s methodology)  What are models?  Circular-Flow Diagram  Production Possibilities Frontier  What is the difference between microeconomics and macroeconomics? Between positive and normative statements? © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, 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 for classroom use.  The Economist as a Scientist  Economists play two roles: 1. Scientists: try to explain the world 2. Policy advisors: try to improve it © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 3 3 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  The Economist as a Scientist  Use a scientific method to study the economy  Development theories  Test theories  Collect & analyze data to verify or refute theories  Conducting experiments is often impractical  Use natural experiments offered by history © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 4 4 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  The Economist as a Scientist  Assumptions  Simplify the complex world and make it easier to understand  Example: to study international trade, assume two countries and two goods  Help focus on the essence of the problem  Economists use models to study economic issues  Highly simplified representation of a more complicated reality © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 5 5 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Source: Klein, G. & Bauman, Y. (2010). The Cartoon Introduction to Economics  The Economist as a Scientist  Examples of models:  The model teeth at the dentist’s office  A model of human anatomy from high school biology class  A road map Don’t forget to floss! ©ittipon/Shutterstock.com ©wavebreakmedia/Shutterstock.com ©Accord/Shutterstock.com © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 7 7 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  The Economist as a Scientist  Economic models  Diagrams and equations  Omit many details  Built with assumptions  Simplify reality to improve our understanding of it  Allow us to see what’s truly important © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 8 8 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  The Economist as a Scientist  Our First Model: The Circular-Flow Diagram  Visual model of the economy  Shows how dollars and goods&services flow through markets among households and firms  Two decision makers  Firms and Households  Interacting in two markets  Market for gods and services  Market for factors of production (inputs) © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 9 9 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Factors of Production  Factors of production: the resources the economy uses to produce goods & services, including  labor  land  capital (buildings and machines used in production) © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 10 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  FIGURE 1: The Circular-Flow Diagram Households:  Own the factors of production, sell/rent them to firms for income  Buy and consume goods & services Firms Households Firms:  Buy/hire factors of production  Produce goods and services  Sell goods & services © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 11 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  FIGURE 1: The Circular-Flow Diagram Revenue Spending Markets for G&S Goods & G&S sold Services bought Firms Households Factors of Labor, land, production Markets for capital Factors of Wages, rent, Production Income profit © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 12 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Second Model: The Production Possibilities Frontier  a graph that shows the combinations of two goods that  the economy can possibly produce given:  the available factors of production and  available technology © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 13 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Second Model: The Production Possibilities Frontier  Example:  Two goods: cars and boats  One resource: labor  Economy has 100,000 labor hours per month.  Producing one car requires 10,000 hours labor.  Producing one boat requires 2,500 hours labor. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 14 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Second Model: The Production Possibilities Frontier  Producing one car requires 10,000 hours labor.  Producing one boat requires 2,500 hours labor. Employment of Production labor hours Cars Boats Cars Boats A 100,000 hrs 0 hr 10 0 B 80,000 20,000 ____ _____ C 60,000 40,000 ____ _____ D 40,000 60,000 ____ _____ E 20,000 80,000 _____ _____ F 0 100,000 _____ _____ © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 15 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Production Cars Boats A 10 0 40 B 8 8 35 C 6 16 30 D 4 24 25 Boats E 2 32 20 F 0 40 15 10 5 0 0 2 4 6 8 10 Cars © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 16 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  ACTIVE LEARNING 1 Points off the PPF A. On the graph, find the point that represents (6 cars, 24 boats), label it G.  Would it be possible for the economy to produce this combination of the two goods? Why or why not? B. Next, find the point that represents (4 cars, 16 boats), label it H.  Would it be possible for the economy to produce this combination of the two goods? © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 17 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  ACTIVE LEARNING 1 Answers 40  Point G: 35 6 cars, 24 boats 30  Point G requires 25 Boats 120,000 hours 20 of labor. 15 Not possible 10 because 5 economy 0 0 2 4 6 8 10 only has Cars 100,000 hours. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, 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 for classroom use.  ACTIVE LEARNING 1 Answers  Point H: 40 35 4 cars, 16 boats 30  Point H requires 25 Boats 80,000 hours 20 of labor. 15 10  Possible but 5  not efficient 0 0 2 4 6 8 10  resources Cars underutilized © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 19 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  The PPF: What We Know So Far Points on the PPF: possible  Efficient: all resources are fully utilized Points under the PPF: possible  Not efficient: some resources underutilized (e.g., workers unemployed, factories idle) Points above the PPF  Not possible © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 20 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  The PPF and Opportunity Cost  Recall: The opportunity cost of an item is what must be given up to obtain that item.  Moving along a PPF  Involves shifting resources (e.g., labor) from the production of one good to the other.  Society faces a tradeoff:  Getting more of one good requires sacrificing some of the other.  The slope of the PPF is the  Opportunity cost of one good in terms of the other. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 21 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  The PPF and Opportunity Cost The slope of a line equals the slope = –8 Boats “rise over the run” 2 cars = –4 Boats/Car  the amount the 40 line rises when 35 30 you move to the 25 right by one unit. Boats 20 15 10 Opportunity cost of 5 1 car = 0 4 boats. 0 2 4 6 8 10 Cars © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 22 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACTIVE LEARNING 2 PPF and Opportunity Cost In which country is the opportunity cost of cloth lower? FRANCE ENGLAND Wine Wine 600 600 500 500 400 400 300 300 200 200 100 100 0 0 0 100 200 300 400 0 100 200 300 400 Cloth Cloth ACTIVE LEARNING 2 Answers England, because its PPF is not as steep as France’s. FRANCE ENGLAND Wine Wine 600 600 500 500 400 400 300 300 200 200 100 100 0 0 0 100 200 300 400 0 100 200 300 400 Cloth Cloth  The Shape of the PPF  Suppose the following  Draw the production production possibilities possibilities curve 45 Cars Boats 40 35 A 10 0 30 B 8 14 25 C 6 26 Boats 20 15 D 4 34 10 E 2 38 5 0 F 0 40 0 2 4 6 8 10 Cars © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 25 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  The Shape of the PPF  The PPF could be a straight line or bow-shaped.  Shape of the PPF  Straight line: constant opportunity cost  Previous example: the opportunity cost of 1 car is 4 boats  Bowed outward: increasing opportunity cost  As more units of a good are produced, we need to give up increasing amounts of the other good produced © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 26 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Why the PPF Might Be Bowed Outward As the economy 45 shifts resources 40 35 from boats to cars: 30 25 PPF becomes Boats 20 15 steeper 10 5 0 and the opportunity 0 2 4 6 8 10 cost of cars Cars increases. 27 Why the PPF Might Be Bowed Outward At point F, most At F, opportunity cost workers are of cars is low. 45 F producing boats, 40 even those who 35 30 are better suited to 25 building cars. Boats 20 15 10 So, do not have to 5 give up much 0 0 2 4 6 8 10 boats to get more Cars cars. 28  Why the PPF Might Be Bowed Outward At B, most workers are producing cars. 45F The few left in boat 40 production are the 35 30 best boat makers. 25 Boats 20 B Producing more cars 15 10 At B, opportunity would require shifting cost of cars is 5 high. some of the best boat 0 0 2 4 6 8 10 makers away from Cars boat production causing a big drop in boat output. 29  Why the PPF Might Be Bow-Shaped  The PPF is bowed outward when:  Different workers have different skills  Different opportunity costs of producing one good in terms of the other  There is some other resource, or mix of resources with varying opportunity costs  E.g., different types of land suited for different uses © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 30 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Economic Growth and the PPF With additional Wheat (tons) Economic resources or an growth shifts 6,000 improvement in the PPF technology, 5,000 outward. the economy can 4,000 produce more 3,000 computers, 2,000 more wheat, 1,000 or any combination in between. 0 0 100 200 300 400 500 600 Computers © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 31 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  The PPF: A Summary  The PPF shows all combinations of two goods that an economy can possibly produce, given its resources and technology.  The PPF illustrates the concepts of tradeoff and opportunity cost, efficiency and inefficiency, unemployment, and economic growth.  A bow-shaped PPF illustrates the concept of increasing opportunity cost. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 32 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Microeconomics and Macroeconomics  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  These two branches of economics are closely intertwined, yet distinct—they address different questions. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 33 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Source: Klein, G. & Bauman, Y. (2010). The Cartoon Introduction to Economics © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 34 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  The Economist as Policy Advisor  As scientists, economists make positive statements  Positive statements: descriptive  Attempt to describe the world as it is  Confirm or refute by examining evidence: “Minimum-wage laws cause unemployment”  As policy advisors, economists make Normative statements  Normative statements: prescriptive  Attempt to prescribe how the world should be: “The government should raise the minimum wage” © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 35 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  ACTIVE LEARNING 3 Identifying positive vs. normative Which of these statements are “positive” and which are “normative”? How can you tell the difference? 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 music downloads. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, 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 for classroom use.  ACTIVE LEARNING 3 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. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, 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 for classroom use.  ACTIVE LEARNING 3 Answers 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 music downloads. Positive – describes a relationship. Note that a statement need not be true to be positive. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, 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 for classroom use.  Why Economists Disagree  Economists often give conflicting policy advice  Can disagree about the validity of alternative positive theories about the world  May have different values and, therefore, different normative views about what policy should try to accomplish  Yet, there are many propositions about which most economists agree © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 39 permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  ASK THE EXPERTS Ticket Resale “Laws that limit the resale of tickets for entertainment and sports events make potential audience members for those events worse off on average.” © 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 40 management system for classroom use.  Summary As scientists, economists try to explain the world using models with appropriate assumptions. Two simple models are the Circular-Flow Diagram and the Production Possibilities Frontier. Microeconomics studies the behavior of consumers and firms, and their interactions in markets. Macroeconomics studies the economy as a whole. As policy advisers, economists offer advice on how to improve the world. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, 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 for classroom use.