Chapter 2

Thinking Like an Economist

Zander Gordan

Intro

• What are economists’ two roles? How do they differ?
  
• What are models? How do economists use them?
  
• What are the elements of the Circular-Flow Diagram? What concepts does the diagram illustrate?
  
• How is the Production Possibilities Frontier related to opportunity cost? What other concepts does it illustrate?
  
• What is the difference between microeconomics and macroeconomics?
  
• What is the difference between positive and normative statements?

The Economist as a Scientist – 1

• Economists play two roles:
  • Scientists: try to explain the world
    
  • Policy advisers: try to improve it
    
• As scientists, economists employ the scientific method:
  • Dispassionate development and testing of theories
    
  • Devise theories, collect data, and analyze data to verify or refute theories

The Economist as a Scientist – 2

• Scientific method in economics:
  • Observation → collect and analyze data
    
  • Develop a theory based on observed data
    
  • More observation → evaluate the theory
    
• Cannot use lab experiments → rely on natural experiments offered by history

The Economist as a Scientist – 3

• Economists make assumptions
  • Simplify the complex world
    
• Economists use models
  • Built with assumptions
    
  • Omit many details → focus on essentials
    
  • All models are subject to revision

The Circular-Flow Diagram

• Visual model of the economy
  
• Shows how dollars flow through markets among households and firms
  
• Two decision makers:
  • Households
    
  • Firms
    
• Interact in two markets:
  • Market for goods & services
    
  • Market for factors of production

The Circular-Flow Diagram

The Production Possibilities Frontier (PPF)

• Graph showing combinations of outputs an economy can produce
  
• Given:
  • Available factors of production
    
  • Available technology

The PPF - linear

The PPF - bowed outwards (increasing OC)

Areas of the PPF

• Efficient: points on the PPF
  
• Inefficient: points inside the PPF
  
• Not feasible: points outside the PPF

Microeconomics vs. Macroeconomics

• Microeconomics: decisions of households & firms; interaction in markets
  
• Macroeconomics: economy-wide phenomena (inflation, unemployment, growth)

The Economist as Policy Adviser

• Economists as scientists: explain events (positive statements)
  
• Economists as advisers: recommend policies (normative statements)

Positive vs. Normative

• Positive statements: descriptive, testable
  • “Minimum-wage laws cause unemployment.”
    
• Normative statements: prescriptive, value-based
  • “The government should raise the minimum wage.”

Why Economists Disagree

• Conflicting theories
  
• Different value judgments
  
• Yet, many propositions most economists agree on

Propositions Economists Agree On

• Rent ceilings reduce housing availability (93%)
  
• Tariffs & quotas reduce welfare (93%)
  
• US should not restrict outsourcing (90%)
  
• Eliminate farm subsidies (85%)
  
• Eliminate sports franchise subsidies (85%)
  
• Cash > in-kind transfers (84%)
  
• Large deficits harm economy (83%)
  
• Don’t ban GM crops (82%)
  
• Minimum wage increases unemployment (79%)
  
• Reduce ethanol subsidies (78%)

Summary

• Economists as scientists → assumptions & models (e.g., PPF, circular flow)
  
• Micro = individual decision-making; Macro = whole economy
  
• Positive = descriptive, Normative = prescriptive
  
• Economists may disagree (judgments, values)
  
• Policymakers may ignore advice due to politics