Thinking Like an Economist

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Premium PowerPoint Slides by:

V. Andreea CHIRITESCU

Eastern Illinois University

N. GREGORY MANKIW� �PRINCIPLES OF�ECONOMICS�Eighth Edition

Look for the answers to these questions:

• 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? Between positive and normative?

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© 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 management system for classroom use.

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The Economist as a Scientist

• Economists play two roles:
1. Scientists: try to explain the world
2. Policy advisors: try to improve it
• As scientists, economists employ the �scientific method
• Dispassionate development and testing of theories about how the world works

© 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 management system for classroom use.

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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
• Economists use models to study economic issues
• Highly simplified representation of �a more complicated reality

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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

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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
• Interacting in two markets
• Market for gods and services
• Market for factors of production (inputs)

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Figure 1 The circular flow

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Households:

• Own the factors of production, �sell/rent them to firms for income
• Buy and consume goods & services

Firms:

• Buy/hire factors of production, �use them to produce goods and services
• Sell goods & services

Figure 1 The circular flow

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The PPF

• Production possibilities frontier
• A graph: combinations of output that the economy can possibly produce
• Given the available
• Factors of production and technology
• Example:
• Two goods: computers and wheat
• One resource: labor (measured in hours)
• Economy has 50,000 labor hours per month available for production

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PPF Example

Producing one computer requires 100 hours labor.

Producing one ton of wheat requires 10 hours labor.

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PPF Example

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A

B

C

D

E

Active Learning 1 Points off the PPF

On the graph above, find the point that represents (100 computers, 3000 tons of wheat), label it F.

• Would it be possible for the economy to produce this combination of the two goods?�Why or why not?

Next, find the point that represents (300 computers, 3500 tons of wheat), label it G.

• Would it be possible for the economy to produce this combination of the two goods?

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Active Learning 1 Answers

• Point F: 100 computers, 3000 tons wheat
• Requires 40,000 hours of labor
• Possible but not efficient: could get more �of either good without sacrificing any of the other

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Active Learning 1 Answers

• Point G: 300 computers, 3500 tons wheat
• Requires 65,000 hours of labor.
• Not possible because the economy only has 50,000 hours

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The PPF: What We Know So Far

• Points on the PPF (like A – E): possible
• Efficient: all resources are fully utilized
• Points under the PPF (like F): possible
• Not efficient: some resources are underutilized (e.g., workers unemployed, factories idle)
• Points above the PPF (like G)
• Not possible

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The PPF

• Moving along a PPF
• Involves shifting resources 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
• The opportunity cost of one good in terms of the other

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The PPF and Opportunity Cost

The slope of a line equals the “rise over the run.”

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Opportunity cost of 1 computer =�10 tons of wheat.

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–1000

100

= –10

Active Learning 2 PPF and Opportunity Cost

In which country is the opportunity cost of cloth lower?

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Active Learning 2 Answers

England, because its PPF is not as steep as France’s

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Economic Growth and the PPF

With additional resources or an improvement in technology, �the economy can produce more computers,

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more wheat,

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or any combination in between.

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Economic growth shifts the PPF outward.

The Shape of the PPF

• Shape of the PPF
• Straight line: constant opportunity cost
• Previous example: the opportunity cost of 1 computer is 10 tons of wheat
• 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

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Why the PPF Might Be Bowed Outward

As the economy shifts resources from beer to mountain bikes:

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PPF becomes steeper

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and the opportunity cost of mountain bikes increases.

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Why the PPF Might Be Bowed Outward

At point A, most workers are producing beer, even those who are better suited to building bikes.

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So, do not have to give up much beer to get more bikes.

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A

At A, opportunity cost of mountain bikes is low.

Why the PPF Might Be Bowed Outward

At B, most workers are producing bikes. �The few left in beer production are the best brewers.

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Producing more bikes would require shifting some of the best brewers away from beer production �causing a big drop in beer output.

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A

B

At B, opportunity cost of mountain bikes is high.

Why the PPF Might Be Bowed Outward

• 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

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© 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 management system for classroom use.

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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

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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”

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Active Learning 3 Positive vs. Normative

Which of these statements are “positive” and which are “normative”? How can you tell the difference?

• Prices rise when the government increases the quantity of money.
• The government should print less money.
• A tax cut is needed to stimulate the economy.
• An increase in the price of burritos will cause an increase in consumer demand for music downloads.

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Active Learning 3 Answers

1. Prices rise when the government increases the quantity of money.

Positive – describes a relationship, could use data to confirm or refute.

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2. The government should print less money.

Normative – this is a value judgment, cannot be confirmed or refuted.

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Active Learning 3 Answers

3. A tax cut is needed to stimulate the economy.

Normative – another value judgment.

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4. 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.

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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

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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.”

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Propositions about Which Most Economists Agree (and percentage of economists who agree)

• A ceiling on rents reduces the quantity and quality of housing available. (93%)
• Tariffs and import quotas usually reduce general economic welfare. (93%)
• The United States should not restrict employers from outsourcing work to foreign countries. (90%)
• The United States should eliminate agricultural subsidies. (85%)
• Local and state governments should eliminate subsidies to professional sports franchises (85%)

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Propositions about Which Most Economists Agree (and percentage of economists who agree)

• Cash payments increase the welfare of recipients to a greater degree than do transfers-in kind of equal cash value. (84%)
• A large federal budget deficit has an adverse effect on the economy. (83%)
• The United States should not ban genetically modified crops. (82%)
• A minimum wage increases unemployment among young and unskilled workers. (79%)
• Government subsidies on ethanol in the United States should be reduced or eliminated. (78%)

© 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 management system for classroom use.

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Summary

• Economists are scientists
• Make appropriate assumptions and build simplified models
• The circular-flow diagram and the production possibilities frontier
• Microeconomists study decision making by households and firms and their interactions in the marketplace
• Macroeconomists study the forces and trends that affect the economy as a whole

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Summary

• A positive statement is an assertion about how the world is
• A normative statement is an assertion about how the world ought to be
• As policy advisers, economists make normative statements
• Economists sometimes offer conflicting advice
• Differences in scientific judgments
• Differences in values

© 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 management system for classroom use.

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