Download Chapter 2 Definitions Economic Models The Circular Flow Model

Definitions
Microeconomics – the study of how
households and firms make decisions
and how they interact in markets.
Chapter 2
Thinking Like an Economist
Positive versus Normative
Analysis
Positive statements are descriptive.
n They make a claim about how the world is.
n They are capable of being verified (proven
true or false).
Normative statements are claims that attempt
to proscribe how the world should be.
n They deal with values, ethics, and other
principles that cannot be verified.
Macroeconomics – the study of
economy-wide phenomena, including
inflation, unemployment, and economic
growth.
Positive or Normative Statements?
u
u
u
u
An increase in the minimum wage will cause a
decrease in employment among the least skilled.
Higher federal budget deficits will cause interest
rates to increase.
The income gains from a higher minimum wage are
worth more than any slight reduction in
employment.
Provincial governments should be allowed to collect
from tobacco companies the costs of treating
smoking-related illnesses among the poor.
Economic Models
The Circular Flow Model
A model abstracts from the details of
reality.
A model is a simplified description of
some aspect of the economy.
Economy consists of two sectors:
n
Households/individuals – own
productive resources.
n
n
Firms – use inputs or factors to
produce goods and services.
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The Circular Flow Model
The Circular Flow Model
Productive resources (also known as
means of production or factors) include:
n Natural resources
- Oil, lumber, fish, etc.
n Human resources
n Capital resources
-man-made inputs like buildings,
machinery, etc.
Households and firms meet/interact in
markets.
1.
Factor (resource) market – firms
purchase inputs from households
2.
Product market – households
purchase goods and services from
firms.
Diagram: The Circular-Flow Model
Diagram: The Circular-Flow Model
Product
Markets
Product
Markets
Businesses
Households
Households
Flow of
Resources
Supply
Resources
Resource Markets
Businesses
Demand
Resources
Resource Markets
Diagram: The Circular-Flow Model
Product
Markets
Diagram: The Circular-Flow Model
Demand
Goods &
Services
Product
Markets
Supply
Goods &
Services
Flow of Goods
and Services
Households
Supply
Resources
Flow of
Land
Labour
Capital
Resource Markets
Businesses
Demand
Resources
Businesses
Households
Supply
Resources
Demand
Resources
Resource Markets
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Diagram: The Circular-Flow Model
Diagram: The Circular-Flow Model
$
g
din
en
Sp
Product
Markets
$R
ev
en
ue
$
g
din
en
Sp
The Flow of Dollars
Households
Businesses
$ In
co
me
es
ns
pe
x
$E
Resource Markets
Resource Markets
Diagram: The Circular-Flow Model
g
din
en
p
$S
Product
Markets
Diagram: The Circular-Flow Model
Product
Markets
$R
ev
en
ue
$
$ In
co
me
Rent
Wages
Profit
Resource Markets
Businesses
es
ns
pe
x
$E
How do markets co-ordinate
supply and supply?
n
n
n
What ensures that firms produce (supply) the
amount of goods that households wish to
consume (purchase)?
In a market system, resource allocations are
based on the decisions of individual
producers and consumers, without any
central direction (“decentralized economy ”).
How are activities co-ordinated within the
market?
$
Dollar Flow
Real Flow
The Flow of Dollars
Households
$R
ev
en
ue
The Flow of Dollars
Businesses
Households
Product
Markets
Businesses
Households
$
$
Resource Markets
Supply and demand models explain how
activities are coordinated within each
market
Prices guide seller and buyer behaviour.
n
n
When there is too much (little) supply,
prices fall (rise).
In response to falling (rising) prices,
producers cut back (increase)
production.
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A Second Economic Model:
Production Possibilities Frontier….
Computers
… is a graph that shows the various
combinations of output that the
economy can possibly produce given
the available factors of production and
technology.
Also called the PPF.
Production Possibilities Frontier
Cars
0
Production Possibilities Frontier
Production Possibilities Frontier
E
A
2000
Computers
Computers
3000
A
2000
Cars
0
Cars
700
0
Production Possibilities Frontier
Production Possibilities Frontier
3000
3000
E
E
A
2000
Computers
Computers
700
F
0
700
1000
A
2000
F
Cars
0
700
1000
Cars
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Production Possibilities Frontier
Principles of Economics Illustrated by the Production
Possibilities Frontier . . .
E
Efficient
Resource Use
u
u
u
u
Efficiency
Tradeoffs
Opportunity Cost
Economic Growth
Computers
3000
A
2000
B?
1000
F
0
300
1000
700
Cars
Production Possibilities Frontier
E
Pt. B is not efficient, since we could
produce more of both goods with
available resources.
Computers
n
Tradeoffs
3000
A
2000
C
1000
F
0
700
1000
900
Cars
Production Possibilities Frontier
E
n
If the economy is using resources
efficiently, then tradeoffs are involved.
To produce more cars, must produce
fewer computers.
3000
Computers
n
2000
Opportunity Cost of next 200 cars
is 1000 computers. Opportunity
cost of 1 car is 5 computers
A
C
1000
Opportunity
Cost
F
0
700
900
1000
Cars
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Production Possibilities Frontier
Economic Growth
Computers
The economy as a whole can produce
more goods as:
n More resources become available
n Technology improves, allowing for more
efficient usage of existing resources.
Economic growth is representing by a
shifting out the PPF.
3000
2000
1000
0
300
700
1000
Cars
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