THINKING LIKE AN ECONOMIST Chapter 2 Copyright © 2014 by Nelson Education Ltd.2-1

THINKING LIKE AN ECONOMIST  Before delving into the substance and details of economics, it is helpful to have an overview of how economists approach the world.  This chapter, therefore, discusses the field’s methodology.  What is distinctive about how economists confront a question?  What does it mean to think like an economist? Copyright © 2014 by Nelson Education Ltd.2-2

THE ECONOMIST AS SCIENTIST  Economists try to address their subject with a scientist’s objectivity. Copyright © 2014 by Nelson Education Ltd.2-3

The Scientific Method  The scientific method involves observation, theory, and more observation.  Economists use theory and observation like other scientists, but they do face an obstacle that makes their task especially challenging:  Experiments are often difficult in economics. Copyright © 2014 by Nelson Education Ltd. Thinkstoc k 2-4

The Role of Assumptions  Assumptions can simplify the complex world and make it easier to understand.  The art in scientific thinking is deciding which assumptions to make. Copyright © 2014 by Nelson Education Ltd.2-5

Economic Models  Economists also use models to learn about the world that are most often composed of diagrams and equations.  Economic models omit many details to allow us to see what is truly important.  All the models are built with assumptions. Copyright © 2014 by Nelson Education Ltd.2-6

Our First Model: The Circular-Flow Diagram  Circular-Flow Diagram : a visual model of the economy that shows how dollars flow through markets among households and firms Copyright © 2014 by Nelson Education Ltd.2-7

FIGURE 2.1: The Circular Flow Copyright © 2014 by Nelson Education Ltd.2-8

Our Second Model: The Production Possibilities Frontier  Production Possibility Frontier : 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 Copyright © 2014 by Nelson Education Ltd.2-9

FIGURE 2.2: The Production Possibilities Frontier Copyright © 2014 by Nelson Education Ltd.2-10

FIGURE 2.3: A Shift in the Production Possibilities Frontier Copyright © 2014 by Nelson Education Ltd.2-11

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 Copyright © 2014 by Nelson Education Ltd.2-12

QuickQuiz In what sense is economics like a science? Draw a production possibilities frontier for a society that produces food and clothing. Show an efficient point, an inefficient point, and an infeasible point. Show the effects of a drought. Define microeconomics and macroeconomics. 2-13Copyright © 2014 by Nelson Education Ltd.

THE ECONOMIST AS POLICY ADVISER  When economists are trying to explain the world, they are scientists.  When they are trying to help improve it, they are policy advisers. Copyright © 2014 by Nelson Education Ltd.2-14

Positive versus Normative Analysis  Positive statements : claims that attempt to describe the world as it is  Normative statements : claims that attempt to prescribe how the world should be Copyright © 2014 by Nelson Education Ltd.2-15

Copyright © 2014 by Nelson Education Ltd. Which of these statements are“positive”and which are “normative”? How can you tell the difference? a. Prices rise when the government increases the quantity of money. b. The government should print less money. c. A tax cut is needed to stimulate the economy. d. An increase in the price of burritos will cause an increase in consumer demand for video rentals Active Learning Discussion Questions

Copyright © 2014 by Nelson Education Ltd. a. Prices rise when the government increases the quantity of money. Positive: describes a relationship, could use data to confirm or refute b. The government should print less money. Normative: this is a value judgment, cannot be confirmed or refuted 2-17 Active Learning Answers

Copyright © 2014 by Nelson Education Ltd. c. A tax cut is needed to stimulate the economy. Normative: another value judgment d. An increase in the price of burritos will cause an increase in consumer demand for video rentals. Positive: describes a relationship Note: A statement need not be true to be positive Active Learning Answers

TABLE 2.1: Websites of Some Major Economic Organizations Copyright © 2014 by Nelson Education Ltd.2-19

Why Economists’ Advice Is Not Always Followed  Any economist who advises government knows that his or her recommendations are not always heeded.  In the real world, figuring out the right policy is only part of the job for the government. Copyright © 2014 by Nelson Education Ltd.2-20

QuickQuiz Give an example of a positive statement and an example of a normative statement. Name three parts of government that regularly rely on advice from economists. 2-21Copyright © 2014 by Nelson Education Ltd.

WHY ECONOMISTS DISAGREE  There are two basic reasons:  They can disagree about the validity of alternative positive theories about how the world works.  They can have different values and, therefore, different normative views about what a policy should try to accomplish. Copyright © 2014 by Nelson Education Ltd. Thinkstock 2-22

Differences in Scientific Judgments  Economists often disagree about the direction in which truth lies.  For example, economists disagree about whether the government should levy taxes based on a household’s income or its consumption. Copyright © 2014 by Nelson Education Ltd.2-23

Differences in Values  Suppose that Peter and Paula both take the same amount of water from the town well. To pay for maintaining the well, the town taxes its residents. Peter has income of $ and is taxed $5000, or 10 percent of his income. Paula has income of $ and is taxed $2000, or 20 percent of her income.  Is this policy fair?  If not, who pays too much and who pays too little? Copyright © 2014 by Nelson Education Ltd.2-24

Perception versus Reality  Because of differences in scientific judgments and differences in values, some disagreement among economists is inevitable.  But they do often share a common view. Copyright © 2014 by Nelson Education Ltd.2-25

Perception versus Reality 1.A ceiling on rents reduces the quantity and quality of housing available. (93 percent) 2.Tariffs and import quotas usually reduce general economic welfare. (93 percent) 3.Flexible and floating exchange rates offer an effective international monetary arrangement. (90 percent) Copyright © 2014 by Nelson Education Ltd.2-26

Perception versus Reality 4.Fiscal policy (e.g., tax cut and/or government expenditure increase) has a significant stimulative impact on a less than fully employed economy. (90 percent) 5.The government should not restrict employers from outsourcing work to foreign countries. (90 percent) 6.Economic growth in developed countries like Canada leads to greater levels of well-being. (88 percent) 7.Agricultural subsidies should be eliminated. (85 percent) Copyright © 2014 by Nelson Education Ltd.2-27

THE END Chapter 2 Copyright © 2014 by Nelson Education Ltd.2-28