1. Thinking Like an Economist
Lecturer: Jack Wu

2. Economic Models
Economists use models to simplify reality in order to improve our understanding of the world
Economists make assumptions in order to make the world easier to understand.
Economists use different assumptions to answer different questions.

3. Basic Economic Models Two of the most basic economic models include:
The Circular Flow Diagram
The Production Possibilities Frontier

4. Circular-Flow Diagram
The circular-flow diagram is a visual model of the economy that shows how dollars flow through markets among households and firms.

5. The Circular Flow Diagram
Firms sell
Households buy
MARKETS
FOR
GOODS AND SERVICES
Revenue
Spending
Goods
and services
sold
Goods and
services
bought
FIRMS
Produce and sell
goods and services
Hire and use factors
of production
Buy and consume
goods and services
Own and sell factors
of production
HOUSEHOLDS
Households sell
Firms buy
MARKETS
FOR
FACTORS OF PRODUCTION
Factors of
production
Labor, land,
and capital
Wages, rent,
and profit
Income
= Flow of inputs
and outputs
= Flow of dollars

6. Quick Quiz 1
Identify the parts of the circular-flow diagram immediately involved in the following transactions.
John buys a car from Ford for $25,000.
Ford pays George $4,000/month for work on the assembly line.
Julie gets a $20 hair cut.
Joe receives $5,000 of dividends on his Ford stock.

7. Production Possibilities Frontier
The production possibilities frontier is 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.

8. Quantity of
Computers
Produced
Quantity of
Cars Produced

9. Shape of Production Possibilities Frontier
Concave curve (bowed outward):
The opportunity cost of producing one good increases as the production of this good rises.
REASON:
Some resources are better suited to the production of this good than another good (and vice versa).
Straight line:
The opportunity cost of producing one good is constant as the production of this good rises.

10. Important Concepts
Concepts illustrated by the Production Possibilities Frontier
Efficiency
Tradeoffs
Opportunity Cost
Economic Growth

11. Quick Quiz 2
A small country produces two goods: corn (measured in bushels) and trucks. Points on a production possibilities frontier are shown as follows:
A B C D E
Trucks
Corns

12. Quick Quiz 2 (continued)
To draw the production possibilities frontier.
To calculate the opportunity cost of increasing the number of trucks produced by ten:
between 0 and 10
between 10 and 20
between 20 and 30
between 30 and 40

13. A Shift in Production Possibilities Frontier
Resource Availability Changes
Technology Changes

14. A Technology Advance in Computer Industry
Quantity of
Computers
Produced
Quantity of
Cars Produced

15. Quick Quiz 3
Draw a production possibilities frontier for a society that produces food and clothing.
1.The drought reduces the amount of food that can be produced.
2.An advanced technology of producing clothing is developed.
3.Society’s labor forces rise.

16. Positive and Normative Analysis
Positive statements are statements that attempt to describe the world as it is.
Called descriptive analysis
Normative statements are statements about how the world should be.
Called prescriptive analysis

17. Quick Quiz 4 Positive or Normative Statements?
An increase in the minimum wage will cause a decrease in employment among the least-skilled.
State governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor.