Thinking Like an Economist

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.

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The Circular Flow Diagram
Spending
Revenue










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.

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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.

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Quantity of
Computers
Produced
Quantity of
0
Cars Produced
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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.

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Important Concepts

• Concepts illustrated by the Production
  Possibilities Frontier
• Efficiency
• Tradeoffs
• Opportunity Cost
• Economic Growth

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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 0 10 20 30 40
• Corns 70 60 45 25 0

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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

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A Shift in Production Possibilities Frontier

• Resource Availability Changes
• Technology Changes

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A Technology Advance in Computer Industry
Quantity of
Computers
Produced
Quantity of
0
Cars Produced
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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.Societys labor forces rise.

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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

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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.