1. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Chapter 2 Thinking Like an Economist © 2002 by Nelson, a division of Thomson Canada Limited

2. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Overview  The Economist as a Scientist  The Economist as a Policy-Maker  Where Economists Disagree and where Economists Agree

3. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Economics trains us to think... … in terms of alternatives. … and understand the cost of individual and social choices. … and provide us with insights into how certain events and issues are related.

4. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Thinking Like an Economist  The economic way of thinking requires one to think analytically and objectively.  The economic way of thinking is like the Scientific Method.

5. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition The Economic Way of Thinking  The Scientific Method uses abstract models to help understand how a complex real-world operates.  The Scientific Method develops theory, collects and analyzes data to prove the theory.

6. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition The Economic Way of Thinking includes... … the development of abstract models from theories and the analysis of the models using two approaches: –descriptive: reporting facts, etc. –analytical: abstract reasoning

7. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition The Circular-Flow Model  Provides a simple way of describing all the economic transactions that occur in a Market Economy.  Emphasizes decentralization in that economic decisions are made by Households and Businesses in Product and Resource Markets.

8. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Diagram: The Circular-Flow Model Households Businesses Resource Markets Product Markets

9. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Diagram: The Circular-Flow Model Households Businesses Product Markets Flow of Resources Supply Resources Demand Resources Resource Markets

10. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Diagram: The Circular-Flow Model Households Businesses Product Markets Flow of Supply Resources Demand Resources Land Labour Capital Resource Markets

11. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Diagram: The Circular-Flow Model Households Businesses Product Markets Flow of Goods and Services Supply Goods & Services Demand Goods & Services Resource Markets

12. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Diagram: The Circular-Flow Model Households Businesses Product Markets The Flow of Dollars $ Spending $ Revenue Resource Markets

13. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Diagram: The Circular-Flow Model Households Businesses Product Markets The Flow of Dollars $ Revenue $ Expenses $ Income $ Spending Resource Markets

14. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Diagram: The Circular-Flow Model Households Businesses Product Markets The Flow of Dollars $ Revenue $ Expenses $ Income Rent Wages Profit $ Spending Resource Markets

15. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Diagram: The Circular-Flow Model Households Businesses Product Markets $ $ $ $ Dollar Flow Real Flow Resource Markets

16. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Microeconomics and Macroeconomics  Microeconomics focuses on “the individual parts of the economy.” –e.g. individual markets –e.g. price increase in the house market  Macroeconomics looks at the “economy as a whole.” –e.g. aggregate of markets –e.g. average price increase for all goods

17. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition A Second Economic Model: Production Possibilities Frontier…. … is a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and technology.

18. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Production Possibilities Frontier Computers Cars 0

19. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Production Possibilities Frontier Computers 700 A Cars 0 2000

20. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Production Possibilities Frontier Computers 3000 700 A Cars E 0 2000

21. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Production Possibilities Frontier Computers 3000 1000 700 A Cars E F 0 2000

22. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Production Possibilities Frontier Computers 3000 1000 700 A Cars E F 0 2000

23. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Principles of Economics Illustrated by the Production Possibilities Frontier...  Efficiency  Tradeoffs  Opportunity Cost  Economic Growth

24. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Efficient Resource Use Production Possibilities Frontier Computers 3000 1000 2000 700 A Cars E F 0 B? 1000 300

25. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Production Possibilities Frontier Computers 3000 1000 2000 700 A Cars E F 0 1000 900 C Tradeoffs

26. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Production Possibilities Frontier Computers 3000 1000 2000 700 A Cars E F 0 1000 900 C Opportunity Cost of next 200 cars is 1000 computers. Opportunity cost of 1 car is 5 computers Opportunity Cost

27. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Economic Growth Production Possibilities Frontier Computers 3000 1000 2000 700 Cars 0 1000 300

28. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Quick Quiz! Check It Out!  In what sense is economics like science?  Define: Microeconomics Macroeconomics

29. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Overview The Economist as a Scientist  The Economist as a Policy-Maker  Where Economists Disagree and where Economists Agree

30. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Two Roles of Economists... When they are trying to explain the world, they are Scientists. When they are trying to change the world they are Policy-makers.

31. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Positive versus Normative Analysis  Positive: Statements or assertions dealing with matters of fact or questions about how things are (descriptive analysis).  Normative: Statements that reflect individual opinions (prescriptive analysis).

32. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Positive or Normative Statements?  An increase in the minimum wage will cause a decrease in employment among the least skilled.  Higher federal budget deficits will cause interest rates to increase.  The income gains from a higher minimum wage are worth more than any slight reduction in employment.  Provincial governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor.

33. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Economists in Government...  Department of Finance — formulate tax policy.  Industry Canada — design competition policy.  Foreign Affairs — assist with trade agreements.  Human Resources Development Canada — formulate labour market policies.  Bank of Canada — implement monetary policy.  Environment Canada — design environment laws.

34. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Economists in the Private Sector...  C.D. Howe Institute — suggest policy options.  Fraser Institute — suggest policy options.  Provide forecasts for companies.  Assist firms manage resources efficiently.  Assist with investment decisions.

35. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Quick Quiz! Check It Out!  Give an example of a positive statement.  Name three areas of government policy which economists provide advice for.  Identify two ways in which economists assist the private sector.

36. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Overview The Economist as a Scientist The Economist as a Policy-Maker  Where Economists Disagree and where Economists Agree

37. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Do Economists Always Agree With Each Other? Three reasons why they don’t:  Disagree about the validity of alternative positive theories  Each have different values, thus different normative views  Advice of charlatans or cranks complicates ability to agree

38. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Examples of When Economists (Majority) Do Agree...  A ceiling on rents reduces the quantity and quality of housing available.  Tariffs and import quotas usually reduce general economic welfare.

39. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Thinking Like an Economist...  Economics uses the scientific approach.  Economics is divided into Microeconomics and Macroeconomics.  Economics is analyzed through both Positive and Normative statements.

40. Principles of Microeconomics & Principles of Macroeconomics: Ch. 2 Second Canadian Edition Overview The Economist as a Scientist The Economist as a Policy-Maker Where Economists Disagree and where Economists Agree