Thinking Like an Economist

1. Thinking Like an Economist • Economics trains us to think in terms of alternatives, cost of choices, and provides insights on how certain issues are related • Economists think both like scientists and policy makers. • The Economist as a scientist uses the scientific method (observation, theory, and more observation) • Similar to science interplay between theory and observation occurs in economics • Any problems with this approach ???

2. Thinking Like an Economist • Economic scientists observe and study the effects of an occurrence; economic policy makers design a policy response to an occurrence • Economic policy makers/ policy advisors recommend policies to improve economic outcomes • Policy decisions are tough because of the trade-off between equity and efficiency. • Canadian Organizations that employ economists to give policy advice-???

3. Thinking Like an Economist • Two important techniques used: • Assumptions • Short-run and long-run assumptions • Economic models • The circular-flow diagram • The production possibilities frontier (PPF)

4. Model #1: The Circular-Flow Diagram • The model offers a simple way of organizing all the economic transactions that occur between all households and firms in the economy. • Economy has two types of decision-makers: • Households – consumers of goods and services • Firms – producers of goods and services • Households and firms interact in two types of markets: • Markets for goods & services • Markets for factors of production

5. Revenue Markets for goods & services Spending Goods & services bought Goods & services sold Flow of goods & Services Firms Households Flow of $ L, Land, K Inputs for production Markets for Factors of Production W, R, and Profit Income

6. Model #2: PPF • PPF shows the combinations of output that the economy can possibly produce given the available factors of production and given the available technology that can turn these factors into output. • PPF demonstrates the following economic principles • Scarcity • Efficiency • Trade-offs • Opportunity cost

7. Production Possibility Frontier With given resources and technology Unattainable Quantity of TVs PPF Attainable Quantity of Stereos

8. Shifts in PPF • Technological advances in a particular industry can shift the PPF thus increasing the quantity of goods produced with the existing resources. TVs produced Stereos produced

9. Microeconomics and Macroeconomics • Microeconomics: the study of how households and firms make decisions and how they interact in markets • Macroeconomics: the study of economy-wide phenomena, including inflation, unemployment, and economic growth • Micro economics and macroeconomics are closely intertwined but the two fields are distinct

10. Positive and Normative Statements • Positive statements are descriptive in nature and are capable of being verified. They attempt to describe the world as it is. • Q: How does the economy work? • Normative statements are statements of what ought to be done.They attempt to prescribe how the world should be. It involves one’s values and ethics. • Q: How can we improve the working of the economy?

11. Why economists disagree? • Most disagreements between economists result from inconclusive empirical evidence or differences in individual values. • Disagree on the validity of positive theories about how the economy works (responsiveness of savings to taxes) • Each has different normative values giving rise to conflicting policy prescriptions (progressive taxation) • Political constraints (agricultural subsidies, rent control)