The Economic Way of Thinking

1
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.

2
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.

3
Diagram The Circular-Flow Model
Product Markets


Dollar Flow Real Flow
Businesses
Households


Resource Markets
4
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

5
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.

6
Production Possibilities Frontier
E
3000
A
2000
Computers
F
Cars
1000
700
0
7
Production Possibilities Frontier
E
3000
A
2000
Computers
F
Cars
1000
700
0
8
Principles of Economics Illustrated by the
Production Possibilities Frontier . . .

• Efficiency
• Tradeoffs
• Opportunity Cost
• Economic Growth

9
Production Possibilities Frontier
E
Efficient Resource Use
3000
A
2000
B?
1000
Computers
F
Cars
1000
700
0
300
10
Production Possibilities Frontier
E
Tradeoffs
3000
A
2000
C
1000
Computers
F
Cars
1000
700
0
900
11
Production Possibilities Frontier
Opportunity Cost of next 200 cars is 1000
computers. Opportunity cost of 1 car is 5
computers
E
3000
2000
A
Opportunity Cost
C
1000
Computers
F
Cars
1000
700
0
900
12
Production Possibilities Frontier
Economic Growth
3000
2000
1000
Computers
Cars
1000
700
0
300
13
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).

14
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.

15
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 environmental policy.

16
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.

17
Do Economists Always Agree With Each Other?
Three reasons why they dont

• 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

18
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.