1. Thinking Like an Economist
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1

2. Reminder: Quiz 1 Quiz 1 (September 27th,Next Saturday)
Quiz 1 covers Chapters 1 and 2
There will be multiple choice questions and short-answer questions.

3. Overview
The scientific method for Economist (how economics faculties do their research)
Example of Natural experiment
The circular-flow model
Production Possibility Frontier(PPF)
Examples of Microeconomics, Macroeconomics and econometrics
Positive analysis Vs Normative analysis

4. The Economist as a Scientist
Economics
(Social) Science
Economists
Scientists
Devise theories (Hypothesis, Micro or Macro)
Collect data (Empirical test)
Analyze these data (Econometrics)
Verify or refute their theories
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 4

5. The Economist as a Scientist
Scientific method
Dispassionate (不带偏见的) development and testing of theories about how the world works
Observation, theory, and more observation
Conducting experiments
Difficult / impossible
Observation (data)
Close attention to natural experiments
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 5

6. Example Observation, theory or model, back to observation (data)
An economist experiencing increasing price (Inflation)
He proposed a theory: inflation arises when government print too much money
collect data on price and money from different countries
If price and money are strongly correlated, he should be more confident in the theory.

7. Example 2 A higher education level, a higher wage level (observation)
Hypothesis: higher education will lead to higher wage. (education is the cause)
We are more interested in the return to education!!!
Data: census, a strong correlation between wage and education
We can conclude that the return to education is positive.
Is it the end of the story?

8. Example 2 continued
No! Selection bias could happen! (people with higher ability would select to stay in school longer, they can earn a higher wage because of their high ability and/or schooling)
We want to eliminate selection bias.
Solutions? Natural experiment
Angrist and Krueger (1991): compulsory schooling laws+ difference in date of birth

9. compulsory schooling laws
Compulsory schooling laws require students to enter school in the calendar year in which they turn 6
Children born in late months of the year will enter school at an earlier age
Compulsory schooling laws requires children to stay in school until 16
At the age of 16, those students would be in different grades.

10. Example 2 continued Date of birth is random, not correlated to ability
Date of birth + compulsory schooling laws: a natural experiment in which children are compelled to attend school for different length of time
devide observations into groups based on dates of birth(of course, with variation in education). Then compare the difference in wage level across groups.
There should be no significant difference of ability for each group.Then, difference in wage should only be attributed to difference in education.

11. The Economist as a Scientist
Economic models
Diagrams & equations
Omit many details
Allow us to see what’s truly important
Built with assumptions
Simplify reality to improve our understanding of it
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 11

12. The Economist as a Scientist
The role of assumptions
Assumptions
Can simplify the complex world
Make it easier to understand
Focus our thinking - essence of the problem
Example (international trade, only two countries and two goods)
Different assumptions
To answer different questions
Short-run or long-run effects
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 12

13. The Economist as a Scientist
Circular-flow diagram
Visual model of the economy
Shows how dollars flow through markets among households and firms
Decision makers
Firms & Households
Markets
For goods and services (Ipad, laptop,cars)
For factors of production (labor market)
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 13

14. More on Factor of production
Firm use labor, land, and capital to produce goods and service
labor (including knowledge and skill)
land (not only land, but other natural resource)
capital (only refers to buildings, machines, not financial capital)
labor market( for example, the job market for university graduates or phds)

15. The Economist as a Scientist
Firms
Produce goods and services
Use factors of production / inputs
Households
Own factors of production
Consume goods and services
No international trade, No government
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 15

16. The Economist as a Scientist
Markets for goods and services
Firms – sellers
Households – buyers
Markets for inputs
Firms – buyers
Households - sellers
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 16

17. Figure 1 The circular flow
This diagram is a schematic representation of the organization of the economy. Decisions are made by households and firms. Households and firms interact in the markets for goods and services (where households are buyers and firms are sellers) and in the markets for the factors of production (where firms are buyers and households are sellers). The outer set of arrows shows the flow of dollars, and the inner set of arrows shows the corresponding flow of inputs and outputs.
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 17

18. The Economist as a Scientist
Production possibilities frontier
A graph
Combinations of output that the economy can possibly produce
Given the available
Factors of production (fixed)
Production technology (fixed)
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 18

19. Figure 2 The production possibilities frontier Quantity of Computers
Produced
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. C
3,000
1,000 F
Production
Possibilities
Frontier A
2,200 B
2,000
600
700 D
1,000
300 E
Quantity of
Cars Produced
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 19

20. The Economist as a Scientist
Efficient levels of production
The economy is getting all it can
From the scarce resources available
Points on the production possibilities frontier
Trade-off:
The only way to produce more of one good
Is to produce less of the other good
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 20

21. The Economist as a Scientist
Inefficient levels of production
Points inside production possibilities frontier
Opportunity cost of producing one good
Give up producing the other good
Slope of the production possibilities frontier
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 21

22. The Economist as a Scientist
Bowed out production possibilities frontier
Opportunity cost of a car – highest
Economy - producing many cars and fewer computers (E, use most of its resource to produce cars)
Opportunity cost of a car – lower
Economy - producing fewer cars and many computers (point F, use most of its resource to produce computers)
Resource specialization
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 22

23. The Economist as a Scientist
Technological advance
Outward shift of the production possibilities frontier
Economic growth
Produce more of both goods
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 23

24. Figure 3 A shift in the production possibilities frontier Quantity of
Computers
Produced
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.
4,000
1,000
3,000 G
2,300
2,200
650 A
600
Quantity of
Cars Produced
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 24

25. The Economist as a Scientist
Microeconomics
The study of how households and firms make decisions (choices)
And how they interact in markets
Macroeconomics
- The study of economy-wide phenomena, including inflation, unemployment, and economic growth
Econometrics
Statistical method in economics
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 25

26. Examples
Micro: the impact of foreign competition o auto industry; The relationship between wage and education
Macro: the effect of a federal income tax cut on the overall production of good and services; or whether Obama's stimulus package could increase employment
Econometrics: peer effect: (the influence of your friend's behavior on your behavior)

27. The Economist as a Policy Adviser
Positive vs. Normative analysis
Positive statements (a fact)
Attempt to describe the world as it is
Descriptive
Confirm or refute by examining evidence
Normative statements(with judgement)
Attempt to prescribe (指定) how the world should be
Prescriptive
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 27

28. Examples: Positive analysis Minimum wage laws cause unemployment
Right to work laws will increase manufacturing employment.
Normative analysis
The government should raise the minimum wage.
The government should enforce right to work laws.