Principles of Economics

1. Principles of Economics Lecture 2 Thinking like an economist

2. Role of economic models Economists use diagrams and equations in models to learn more about the economy. When making models, economists often use assumptions.

3. Circular Flow Diagram Just remember: • Inputs: labor, land, capital, technology, etc. • Outputs: goods and services

4. The Production Possibilities Frontier (PPF) Assume firms in Khon Kaen province only have resources to produce 2 things: noodles and ice tea. Further assume that if firms only produce noodles the maximum output is 1000 packages of noodles per day, if firms only produce ice tea the maximum output is 2000 bottles of ice tea per day

5. The PPF bottles of ice tea Point g is beyond the frontier: impossible g 2000 Point h is possible, but not efficient 1000 h 0 500 1000 p. of noodles

6. The PPF The PPF represents every point whereby the allocation of resources to produce noodles and ice tea are fully maximized.

7. The shape of the PPF The shape of the PPF is often bowed outward as a result of differences in marginal costs of resource allocation.

8. The shape of the PPF When Khon Kaen’s firms use their resources to produce for example 1800 bottles of ice tea and 300 packages of noodles, some resources are probably badly allocated such as persons that are very good in producing noodles or equipment better suited for noodles…..

9. The PPF bottles of ice tea i 2000 1800 1000 0 300 500 1000 p. of noodles

10. ….Therefore, it is easy to give up a few bottles of ice tea (for example -10) tea for many packages of noodles (+ 50) and the PPF is flat. Below an example: i 1800 1790 300 350

11. The PPF bottles of ice tea Relatively flat i In other words, in point i the opportunity cost of producing one more package of noodles is very low. 2000 1800 1000 0 300 500 1000 p. of noodles

12. The shape of the PPF When Khon Kaen’s firms use their resources to produce for example 500 bottles of ice tea and 800 packages of noodles, some resources are probably badly allocated such as persons that are very good in producing ice tea or equipment better suited for ice tea…..

13. The PPF bottles of ice tea i 2000 Relatively flat 1800 1000 Relatively steep j 0 300 500 1000 p. of noodles

14. In point j the opportunity cost of producing one more package of noodles is very high, because firms in Khon Kaen use many resources that are better suitable for the production of bottles of ice tea: the PPF is relatively steep.

15. j 500 450 800 810

16. Shifts in the PPF • If resources expand, the PPF shifts outward (for example better technology). • If resources decline, the PPF shifts inward. (for example ageing of the population and out-migration)

17. positive versus normative • Positive statements: claims that attempt to describe the world as it is • Normative statements: claims that attempt to prescribe how the world should be

18. Why economists disagree? • Differences in scientific judgments For example certainties in questionnaires • Differences in values For example poverty • Perception versus reality For example: Is the world economy really facing a recovery after the 2009 economic recession?

19. Chapters 1 and 2 introduced some basic ideas and methods of economics. • Chapters 3 and 4 start to analyze the principles of economic behavior in detail.

20. Homework Page 16: answer problems and applications 5 and 7 Read chapter 2 and answer problems and applications 3, 4 and 6 on page 37