Chapter 2: Thinking Like an Economist

Course Introduction

• This chapter is part of both micro and macroeconomics courses.
• Covers fundamentals of markets essential for both micro and macro classes.
• In macro (Econ 102), these concepts are crucial and frequently revisited.

Key Objectives

• Understand two main economic models:
  • Circular Flow Diagram
  • Production Possibilities Frontier (PPF)
• Know the difference between microeconomics and macroeconomics.
• Distinguish between positive and normative statements.

Roles of an Economist

1. Scientist: Describes the world as it is.
2. Policy Adviser: Suggests improvements for society.
   • Focus on describing causal relationships without bias.

Positive vs. Normative Statements

• Positive Statements: Describe the world as it is, without opinions or value judgments (e.g., "taxes are 4%").
• Normative Statements: Include opinions and value judgments (e.g., "taxes should be higher").

The Circular Flow Diagram

• Represents the economy's basic structure.
• Two flows in the economy:
  • Flow of money (dollars)
  • Flow of goods and services and factors of production
• Two economic agents:
  • Households: Own factors of production, buy goods and services.
  • Firms: Buy/rent factors of production, sell goods and services.
• Two markets:
  • Goods and Services Market
  • Factors of Production Market

Factors of Production

• Labor (L): Physical work, measured in hours.
• Capital (K): Buildings, tools, equipment (produced to produce).
• Human Capital (H): Education, skills, expertise.
• Natural Resources (N): Land, air, water (natural state resources).

Assumptions in Economic Models

• Simplify reality to understand causal relationships.
• Assumptions help in learning despite being unrealistic (e.g., only two countries and two goods in a model).

Models: Circular Flow and PPF

• Circular Flow:

  • Visual representation of economic transactions.
  • Money flow and real variables (goods/services and inputs) are tracked.
  • Shows interactions between households and firms.

• Production Possibilities Frontier (PPF):

  • Graph showing maximum production combinations of two goods.
  • Dependent on available resources and technology.
  • Highlights concepts like opportunity cost and trade-offs.

Production Possibilities Frontier

• Efficiency and Feasibility:
  • Points on PPF are efficient; points inside are inefficient.
  • Points outside are not feasible.
• Opportunity Cost:
  • True cost of something is what we give up to get it.
  • Slope of PPF represents opportunity cost.

Economic Growth

• Represented by an outward shift of the PPF.
• Occurs with more resources or improved technology.

Types of PPF

• Linear PPF: Constant opportunity cost (unrealistic).
• Bowed Out PPF: Increasing opportunity cost, more realistic due to variability in resource productivity.

Conclusion

• Covered the distinction between positive and normative statements.
• Discussed micro vs. macroeconomics relevance for this chapter.
• Concepts like circular flow and PPF are foundational and will recur in macroeconomic discussions.