2,Thinking Like An Economist,3,Interdependence and the Gains from Trade,CHAPTER 2 THINKING LIKE AN ECONOMIST,In chapter 2, look for the answers to these questions:,What are economists two roles? How do they differ? What are models? How do economists use them? What are the elements of the Circular-Flow Diagram? What concepts does the diagram illustrate? How is the Production Possibilities Frontier related to opportunity cost? What other concepts does it illustrate? What is the difference between microeconomics and macroeconomics? Between positive and normative?,CHAPTER 3 INTERDEPENDENCE AND THE GAINS FROM TRADE,In chapter 3, look for the answers to these questions:,Why do people and nations choose to be economically interdependent? How can trade make everyone better off? What is absolute advantage? What is comparative advantage? How are these concepts similar? How are they different?,0,CHAPTER 2 THINKING LIKE AN ECONOMIST,Assumptions & Models,Assumptions simplify the complex world, make it easier to understand. Example: To study international trade, assume two countries and two goods. Unrealistic, but simple to learn and gives useful insights about the real world. Model: a highly simplified representation of a more complicated reality. Economists use models to study economic issues.,CHAPTER 2 THINKING LIKE AN ECONOMIST,Some Familiar Models,A road map,CHAPTER 2 THINKING LIKE AN ECONOMIST,Some Familiar Models,A model of human anatomy from high school biology class,CHAPTER 2 THINKING LIKE AN ECONOMIST,Some Familiar Models,A model airplane,CHAPTER 2 THINKING LIKE AN ECONOMIST,Our First Model: The Circular-Flow Diagram,The Circular-Flow Diagram: A visual model of the economy, shows how dollars flow through markets among households and firms. Two types of “actors”: households firms Two markets: the market for goods and services the market for “factors of production”,CHAPTER 2 THINKING LIKE AN ECONOMIST,Factors of Production,Factors of production: the resources the economy uses to produce goods & services, including labor land capital (buildings & machines used in production),CHAPTER 2 THINKING LIKE AN ECONOMIST,FIGURE 1: The Circular-Flow Diagram,Households: own the factors of production, sell/rent them to firms for income buy and consume goods & services,CHAPTER 2 THINKING LIKE AN ECONOMIST,FIGURE 1: The Circular-Flow Diagram,Households,Firms: buy/hire factors of production, use them to produce goods and services sell goods & services,CHAPTER 2 THINKING LIKE AN ECONOMIST,FIGURE 1: The Circular-Flow Diagram,CHAPTER 2 THINKING LIKE AN ECONOMIST,Our Second Model: The Production Possibilities Frontier,The Production Possibilities Frontier (PPF): A graph that shows the combinations of two goods the economy can possibly produce given the available resources and the available technology. Example: Two goods: computers and wheat One resource: labor (measured in hours) Economy has 50,000 labor hours per month available for production.,0,PPF Example,Producing one computer requires 100 hours labor. Producing one ton of wheat requires 10 hours labor.,0,CHAPTER 2 THINKING LIKE AN ECONOMIST,A,B,C,D,E,PPF Example,A C T I V E L E A R N I N G 1: Points off the PPF,A.On the graph, find the point that represents (100 computers, 3000 tons of wheat), label it F. Would it be possible for the economy to produce this combination of the two goods?Why or why not? B.Next, find the point that represents (300 computers, 3500 tons of wheat), label it G. Would it be possible for the economy to produce this combination of the two goods?,16,A C T I V E L E A R N I N G 1: Answers,17,Point F:100 computers, 3000 tons wheat,Point F requires 40,000 hours of labor. Possible but not efficient: could get more of either good w/o sacrificing any of the other.,A C T I V E L E A R N I N G 1: Answers,18,Point G:300 computers, 3500 tons wheat,Point G requires 65,000 hours of labor. Not possible because economy only has 50,000 hours.,CHAPTER 2 THINKING LIKE AN ECONOMIST,The PPF: What We Know So Far,Points on the PPF (like A E) possible efficient: all resources are fully utilized Points under the PPF (like F) possible not efficient: some resources underutilized (e.g., workers unemployed, factories idle) Points above the PPF (like G) not possible,CHAPTER 2 THINKING LIKE AN ECONOMIST,The PPF and Opportunity Cost,Recall: The opportunity cost of an item is what must be given up to obtain that item.,Moving along a PPF involves shifting resources (e.g., labor) from the production of one good to the other. Society faces a tradeoff: Getting more of one good requires sacrificing some of the other. The slope of the PPF tells you the opportunity cost of one good in terms of the other.,CHAPTER 2 THINKING LIKE AN ECONOMIST,The PPF and Opportunity Cost,The slope of a line equals the “rise over the run” the amount the line rises when you move to the right by one unit.,1000,100,= 10,Here, the opportunity cost of a computer is 10 tons