Thinking Like an Economist Economics trains us to think in terms of alternatives, cost of choices, and provides insights on how certain issues are related Economists think both like scientists and policy makers. The Economist as a scientist uses the scientific method (observation, theory, and more observation) Similar to science interplay between theory and observation occurs in economics Any problems with this approach ???

Thinking Like an Economist Economic scientists observe and study the effects of an occurrence; economic policy makers design a policy response to an occurrence Economic policy makers/ policy advisors recommend policies to improve economic outcomes Policy decisions are tough because of the trade-off between equity and efficiency. Canadian Organizations that employ economists to give policy advice-???

Thinking Like an Economist Two important techniques used: Assumptions Short-run and long-run assumptions Economic models The circular-flow diagram The production possibilities frontier (PPF)

Model #1: The Circular-Flow Diagram The model offers a simple way of organizing all the economic transactions that occur between all households and firms in the economy. Economy has two types of decision-makers: Households – consumers of goods and services Firms – producers of goods and services Households and firms interact in two types of markets: Markets for goods & services Markets for factors of production

Revenue Markets for goods & services Spending Goods & services bought Goods & services sold Flow of goods & Services Firms Households Flow of $ L, Land, K Inputs for production Markets for Factors of Production W, R, and Profit Income

Model #2: PPF PPF shows the combinations of output that the economy can possibly produce given the available factors of production and given the available technology that can turn these factors into output. PPF demonstrates the following economic principles Scarcity Efficiency Trade-offs Opportunity cost

Production Possibility Frontier With given resources and technology Unattainable Quantity of TVs PPF Attainable Quantity of Stereos

Shifts in PPF Technological advances in a particular industry can shift the PPF thus increasing the quantity of goods produced with the existing resources. TVs produced Stereos produced

Microeconomics and Macroeconomics 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 Micro economics and macroeconomics are closely intertwined but the two fields are distinct

Positive and Normative Statements Positive statements are descriptive in nature and are capable of being verified. They attempt to describe the world as it is. Q: How does the economy work? Normative statements are statements of what ought to be done. They attempt to prescribe how the world should be. It involves one’s values and ethics. Q: How can we improve the working of the economy?

Why economists disagree? Most disagreements between economists result from inconclusive empirical evidence or differences in individual values. Disagree on the validity of positive theories about how the economy works (responsiveness of savings to taxes) Each has different normative values giving rise to conflicting policy prescriptions (progressive taxation) Political constraints (agricultural subsidies, rent control)