Thinking Like an EconomistChapter 2Copyright 2001 by Harcourt, Inc.All rights reserved. Requests for permission to make copies of any part of the work should be mailed to:Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida 32887-6777.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Every field of study has its own terminologyMathematicsaxiomsintegralsvector spacesPsychologyego id cognitive dissonanceLaw tortsvenuesPromissory estoppelHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Every field of study has its own terminologyEconomicsSupplyDemandElasticityConsumer SurplusComparative advantageOpportunity costDeadweight lossHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Economics trains you to. . . . uThink in terms of alternatives.uEvaluate the cost of individual and social choices.uExamine and understand how certain events and issues are related.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The Economist as a ScientistThe economic way of thinking . . .uInvolves thinking analytically and objectively.uMakes use of the scientific method.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The Scientific MethoduUses abstract models to help explain how a complex, real world operates.uDevelops theories, collects, and analyzes data to prove the theories.Observation, Theory and More Observation!Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The Role of Assumptionsu Economists make assumptions in order to make the world easier to understand.u The art in scientific thinking is deciding which assumptions to make.u Economists use different assumptions to answer different questions.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The Economic Way of ThinkinguIncludes developing abstract models from theories and the analysis of the models.uUses two approaches:uDescriptive (reporting facts, etc.)uAnalytical (abstract reasoning)Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Economic Modelsu Economists use models to simplify reality in order to improve our understanding of the worldu Two of the most basic economic models include:uThe Circular Flow ModeluThe Production Possibilities FrontierHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The Circular-Flow ModelThe circular-flow model is a simple way to visually show the economic transactions that occur between households and firms in the economy.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The Circular-Flow DiagramFirmsHouseholdsMarket for Factors of ProductionMarket for Goods and ServicesSpendingRevenueWages, rent, and profitIncomeGoods & Services soldGoods & Services boughtLabor, land, and capitalInputs for productionHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The Circular-Flow DiagramHouseholdsu Buy and consume goods and servicesu Own and sell factors of productionFirmsu Produce and sell goods and servicesu Hire and use factors of productionHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The Circular-Flow DiagramMarkets for Factors of Productionu Households sellu Firms buyMarkets for Goods & Servicesu Firms sellu Households buyHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The Circular-Flow DiagramFactors of Productionu Inputs used to produce goods and servicesu Land, labor, and capitalHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The Production Possibilities FrontierThe production possibilities frontier is a graph showing the various combinations of output that the economy can possibly produce given the available factors of production and technology.Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The Production Possibilities FrontierQuantity of Computers ProducedQuantity of Cars Produced3,00001,0002,0007001,000300AB2,200600CDHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The Production Possibilities FrontierQuantity of Computers ProducedQuantity of Cars Produced3,0001,0002,0002,200 A70060030001,000BCDProduction possibilities frontierHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Concepts Illustrated by the Production Possibilities FrontieruEfficiencyuTradeoffsuOpportunity CostuEconomic GrowthHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.4,000The Production Possibilities FrontierQuantity of Computers ProducedQuantity of Cars Produced3,0002,000A70001,000E2,100750An outward shift in the production possibilities frontierHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Microeconomics and MacroeconomicsuMicroeconomics focuses on the individual parts of the economy.uHow households and firms make decisio