Thinking Like an Economist

1. Thinking Like an Economist Lecturer: Jack Wu

2. IS THE ECONOMIST A SCIENTIST? • Economics = queen of social science (Only Nobel Prize in Economics) • Economics in Business is like Physics in Engineering • Economists = scientists • Devise theories • Collect data • Analyze these data • Verify or refute their theories

3. 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.

4. Basic Economic Models Two of the most basic economic models include: • The Circular Flow Diagram • The Production Possibilities Frontier

5. 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. • Decision makers • Firms & Households • Markets • For goods and services • For factors of production

6. MARKETS FOR GOODS AND SERVICES • Firms sell Goods and Goods • Households buy services and services bought sold HOUSEHOLDS FIRMS • Buy and consume • Produce and sell goods and services goods and services • Own and sell factors • Hire and use factors of production of production MARKETS Labor, land, Factors of FOR and capital production FACTORS OF PRODUCTION • Households sell Wages, rent, • Firms buy and profit The Circular Flow Diagram Spending Revenue Income = Flow of inputs and outputs = Flow of dollars

7. QUESTION • What are missing in this circular flow diagram?

8. 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.

9. 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.

10. D C 2,200 A 2,000 Production possibilities frontier B 1,000 300 600 700 Quantity of Computers Produced 3,000 Quantity of 0 1,000 Cars Produced

11. NOTES • The production possibilities frontier shows the combinations of output - in this case, cars and computers - that the economy can possibly produce. • The economy can produce any combination on or inside the frontier. • Points outside the frontier are not feasible given the economy’s resources.

12. EFFICIENT OR INEFFICIENT? • Efficient levels of production • Economy’s getting all it can from the scarce resources available • Points on the production possibilities frontier • Trade-off: • The only way to get more of one good is to get less of the other good • Positive opportunity cost • Inefficient levels of production • Points inside production possibilities frontier. • Zero opportunity cost.

13. 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.

14. A Shift in Production Possibilities Frontier • Resource Availability Changes (natural resources, human resources, physical resources) • Technology Changes

15. A shift in the production possibilities frontier Due to a technological advance in computer industry Quantity of Computers Produced 3,000 4,000 2,200 2,300 G A 600 650 0 1,000 Quantity of Cars Produced

16. TECHNOLOGICAL ADVANCE • A technological advance in the computer industry enables the economy to produce more computers for any given number of cars. As a result, the production possibilities frontier shifts outward. If the economy moves from point A to point G, then the production of both cars and computers increases.

17. Important Concepts • Concepts illustrated by the Production Possibilities Frontier • Efficiency • Tradeoffs • Opportunity Cost • Economic Growth

18. 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

19. 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

20. 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.

21. Positive and Normative Analysis • Positive statements are statements that attempt to describe the world as it is. • Called descriptive analysis • Normative statements are statements about how the world should be. • Called prescriptive analysis

22. Quick Quiz 4 • Positive or Normative Statements? • An increase in the minimum wage will cause a decrease in employment among the least-skilled. • State governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor.

23. WHY ECONOMISTS DISAGREE? • Economists may disagree • Validity of alternative positive theories about how the world works • Economists may have different values • Different normative views about what policy should try to accomplish