Understand Decision Making 2-1 The Economist’s Toolkit 2-2 Opportunity Costcompetition 2-3 Production Possibilities Curve

The Economist’s Toolkit 2-1 The Economist’s Toolkit LO1-1 Understand how economists use economic models. LO1-2 Evaluate economic activity using graphs. LO1-3 Explain why economists can disagree.

The Economist’s Toolkit 2-1 The Economist’s Toolkit The Methodology of Economics model assumption Applying Graphs to Economics direct relationship inverse relationship Why Do Economists Disagree? positive economics normative economics

The Methodology of Economics A model is a simplification of reality used to understand the relationship between variables. A model is also called a theory. A model emphasizes those variables that are most important by assuming that all other variables remain unchanged. Using a model makes the relationship between the chosen variables easier to understand. 2-1 The Economist’s Toolkit

An assumption is something that is accepted as being true. The Methodology of Economics An assumption is something that is accepted as being true. A model must include an assumption and is useful only if it yields accurate predictions. When the evidence confirms a model, the assumption is accepted as true. When the evidence does not support an assumption, the model is rejected. 2-1 The Economist’s Toolkit

Why is an assumption important to a model? The Methodology of Economics model assumption Why is an assumption important to a model? A model must focus only on the most important variables. Therefore, it must be assumed that other variables remind unchanged or constant. It is too complex to include all variables in a model. 2-1 The Economist’s Toolkit

Applying Graphs to Economics A direct relationship is a positive relationship between two variables. When one variable increases, the other variable increases. When one variable decreases, the other variable decreases. Both variables change in the same direction. 2-1 The Economist’s Toolkit

Applying Graphs to Economics An inverse relationship is a negative relationship between two variables. When one variable increases, the other variable decreases. Variables change in opposite directions. 2-1 The Economist’s Toolkit

Applying Graphs to Economics direct relationship inverse relationship Economists can use a graph or table to present date. Do you have a preference? Why? Most prefer a graph because the line clearly shows the relationship between variables. 2-1 The Economist’s Toolkit

Positive economics is an analysis based on facts. Why Do Economists Disagree? Positive economics is an analysis based on facts. Positive analysis uses statements that can be proven either true or false. Often uses the words “if” and “then.” A positive statement does not have to be correct. The key is whether the statement is testable. 2-1 The Economist’s Toolkit

Normative economics is an analysis based on value judgments. Why Do Economists Disagree? Normative economics is an analysis based on value judgments. Normative statements express an opinion on a subject. The opinion cannot be proven by facts to be true or false. Statement will use normative words or phrases, such as good, bad, should, and ought to be. 2-1 The Economist’s Toolkit

Why Do Economists Disagree? positive economics normative economics Assume an argument is based on incorrect facts. Is this a positive or norm-ative analysis? Why? This is a positive argument because facts are testable. Even if the facts are wrong, the argument is not normative and based on opinion. 2-1 The Economist’s Toolkit

2-2 Opportunity Cost LO 2-1 Explain why all decisions have trade-offs and opportunity costs. LO 2-2 Understand how to perform marginal analysis.

Opportunity Cost 2-2 Trade-offs and Opportunity Cost trade-off Marginal Analysis marginal analysis marginal benefit marginal cost cost benefit analysis net benefit

A trade-off is all the options given up when a decision is made. Trade-offs and Opportunity Cost A trade-off is all the options given up when a decision is made. Opportunity cost is the value of the next best option sacrificed for a chosen option. It is the cost of not choosing the best alternative. 2-2 Opportunity Cost

Explain the difference between trade-offs and opportunity cost? A trade-off includes all options given up when a decision is made. An opportunity cost is only the best option sacrificed. 2-2 Opportunity Cost

Marginal analysis is the decision about how much more or less to do. Marginal benefit is the extra gain from an additional unit of change. Marginal cost is the extra cost from an additional unit of change. 2-2 Opportunity Cost

Marginal Analysis Cost benefit analysis compares the additional rewards and costs of an action to determine if the benefits outweigh the costs. Net benefit is the difference between the marginal benefit and the marginal cost of an option. 2-2 Opportunity Cost

What does it mean to “think at the margin”? Marginal Analysis marginal analysis marginal benefit marginal cost cost benefit analysis net benefit What does it mean to “think at the margin”? “Think at the margin” means make a decision about how much more or less to do. This involves comparing marginal benefits to marginal cost. 2-2 Opportunity Cost

Production Possibilities Curve 2-3 Production Possibilities Curve LO 3-1 Interpret a production possibilities curve. LO 3-2 Understand how scarcity relates to the production possibilities curve. LO 3-2 Demonstrate how economic growth occurs using the production possibilities curve.

Production Possibilities Curve 2-3 Production Possibilities Curve Production Possibilities Curve production possibilities curve technology efficiency underutilization Opportunity Costs and the Production Possibilities Curve law of increasing opportunity Source of Economic Growth economic growth

Production Possibilities Curve The production possibilities curve shows the maximum possible output for an economy. The model has two assumptions. Fixed Resources – All resources remain unchanged. Technology unchanged – Technology also is assumed to be fixed. ► Technology is the body of knowledge applied to how goods and services are produced. 2-3 Production Possibilities Curve

Production Possibilities Curve Efficiency is producing the maximum output with the given resources and technology. Underutilization occurs when an economy fails to fully use its resources. As a result, the economy produces less than maximum output. 2-3 Production Possibilities Curve

Production Possibilities Curve Technology Efficiency underutilization Explain why all points along the production possibilities curve are efficient points. All points along the production possibilities curve are efficient at full capacity. They are maximum points because the economy is using all its resources and the latest technology. 2-3 Production Possibilities Curve

Opportunity Costs and the Production Possibilities Curve The law of increasing opportunity cost states that the opportunity cost increases as production of an output expands. As more of an economy’s resources are devoted to producing one product, even greater quantities of production of the other product must be given up. This law exists because not all resources are equally suited to all types of production. 2-3 Production Possibilities Curve

Opportunity Costs and the Production Possibilities Curve law of increasing opportunity cost Explain the condition of scarcity and opportunity costs in terms of the production possibilities curve. To move between points along the PPC, an economy must shift resources. For example, labor is shifted out of tank production into producing sailboats. 2-3 Production Possibilities Curve

Sources of Economic Growth Economic growth is the ability of an economy to produce greater levels of output. For this growth to occur the assumption the resources and technology are fixed is removed. One way to achieve growth is to gain resources. Any increase in resources shifts the production possibilities curve outward. Another way to achieve growth is new knowledge that makes an economy more productive. The economy can produce more from the same resources, so the curve shifts outward. 2-3 Production Possibilities Curve

Sources of Economic Growth Explain how changing an assumption shifts the production possibilities curve. To shift the production possibilities curve requires changing either of two assumptions of the model. An outward shift occurs when resources are increased. Another way is an advance in technology. 2-3 Production Possibilities Curve