Download Thinking Like an Economist

Thinking Like an
Economist
Lecturer: Jack Wu
Economic Models
 Economists use models to simplify reality in
order to improve our understanding of the
world
 Economists make assumptions in order to
make the world easier to understand.
 Economists use different assumptions to
answer different questions.
Basic Economic Models
Two of the most basic economic models
include:


The Circular Flow Diagram
The Production Possibilities Frontier
Circular-Flow Diagram
 The circular-flow diagram is a visual model of the
economy that shows how dollars flow through
markets among households and firms.
The Circular Flow Diagram
MARKETS
FOR
GOODS AND SERVICES
•Firms sell
Goods
•Households buy
and services
sold
Revenue
Wages, rent,
and profit
Goods and
services
bought
HOUSEHOLDS
•Buy and consume
goods and services
•Own and sell factors
of production
FIRMS
•Produce and sell
goods and services
•Hire and use factors
of production
Factors of
production
Spending
MARKETS
FOR
FACTORS OF PRODUCTION
•Households sell
•Firms buy
Labor, land,
and capital
Income
= Flow of inputs
and outputs
= Flow of dollars
Quick Quiz 1
 Identify the parts of the circular-flow diagram




immediately involved in the following transactions.
John buys a car from Ford for $25,000.
Ford pays George $4,000/month for work on the
assembly line.
Julie gets a $20 hair cut.
Joe receives $5,000 of dividends on his Ford stock.
Production Possibilities Frontier
 The production possibilities frontier is 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.
Quantity of
Computers
Produced
0
Quantity of
Cars Produced
Shape of Production Possibilities
Frontier
 Concave curve (bowed outward):
The opportunity cost of producing one good
increases as the production of this good rises.
REASON:
Some resources are better suited to the production of
this good than another good (and vice versa).
 Straight line:
The opportunity cost of producing one good is constant
as the production of this good rises.
Important Concepts
 Concepts illustrated by the Production
Possibilities Frontier




Efficiency
Tradeoffs
Opportunity Cost
Economic Growth
Quick Quiz 2
 A small country produces two goods: corn
(measured in bushels) and trucks. Points on
a production possibilities frontier are shown
as follows:
A
B
C
D
E
Trucks
0
10 20 30 40
Corns
70
60 45 25
0
Quick Quiz 2 (continued)
 To draw the production possibilities frontier.
 To calculate the opportunity cost of increasing the
number of trucks produced by ten:
between 0 and 10
between 10 and 20
between 20 and 30
between 30 and 40
A Shift in Production Possibilities
Frontier
 Resource Availability Changes
 Technology Changes
A Technology Advance in Computer Industry
Quantity of
Computers
Produced
0
Quantity of
Cars Produced
Quick Quiz 3
 Draw a production possibilities frontier for a
society that produces food and clothing.
1.The drought reduces the amount of food that
can be produced.
2.An advanced technology of producing clothing
is developed.
3.Society’s labor forces rise.
Positive and Normative Analysis
are statements that attempt
to describe the world as it is.
 Positive statements

Called descriptive analysis
are statements about how
the world should be.
 Normative statements

Called prescriptive analysis
Quick Quiz 4
 Positive or Normative Statements?


An increase in the minimum wage will cause a
decrease in employment among the leastskilled.
State governments should be allowed to
collect from tobacco companies the costs of
treating smoking-related illnesses among the
poor.