1. 1.2 Economic Theory
The Role of Theory
An economic theory is a simplification of economic reality that is used to make predictions about the real world.

2. Economic Theory Simplify the problem Simplifying assumptions
Rational self-interest
Everybody uses theories
Economists tell stories
Normative versus positive statements

3. Marginal Analysis Compare marginal cost with marginal benefit
1.2 Economic Theory
Marginal Analysis
Compare marginal cost with marginal benefit
Choice requires time and information
Market economics and national economics

4. Market Participants Four types of participants Households Firms
1.2 Economic Theory
Market Participants
Four types of participants
Households
Firms
Governments
The rest of the world

5. 1.2 Economic Theory
Markets
Markets are the means by which buyers and sellers carry out exchange.
Product markets
Resource markets
Labor market

6. 1.2 Economic Theory
A Circular-Flow Model
A circular-flow model describes the flow of resources, products, income, and revenue among economic decision makers.

7. Circular-Flow Model Govt Figure 1.1 WRIP CELL 1.2 Economic Theory
In a Market and a Mixed Economic System
services
services
taxes
taxes
WRIP
CELL
Figure 1.1