Ch.2+Thinking+Like+an+Economist

Thinking Like an Economist

In order to study Economics, you have to think like an economist. But nobody's Michael Jordan as a beginner. It takes a while to become professional, as it takes a while to be able to think like an economist.

First, I'd like to address how the economists think.

Economists is just like science; they have hypothesis, collect data from observations, and analyzes it. Then they use the new knowledge to solve problems, improve the society, or sometimes simply, make more money.

How Is It Like Science?
Scientists have theories. They do experiments on it. They test it. Then, they confirm it.

Let's take for example, Law of Demand. Law of Demand states that the higher the price, the fewer quantities the people are willing to buy. But the economists did not come up with this Law at first. They realized that people tend to buy less of more expensive stuff. So they did a research on many markets, and studied the behavior of the people at different prices. After analyzing the data, they found the pattern. This is how the economists confirm their theories.

Also Like a Physicist?
The way physicists think is similar to the way economists think. Physicists, when finding the velocity of a falling object, ignores the air resistance. This is because the effect of the air resistance on the ball to the velocity is so small that they can ignore it and still get an accurate answer.

Like this, economists use the phrase //ceteris paribus// a lot. It is a Latin phrase meaning "With everything else staying the same."

For example, when economists deal with trades between two countries, they imagine that the world consists of only those two countries. This way is much better because it is easier to focus on the cause and effects easily. Of course the trade between these two countries will have some affects on other countries, but economists would say "trade between these two countries //ceteris paribus//." After understanding the cause and effects, then they start facing the real world.

Use of Models
The models are really useful in understanding Economics. It is useful because models can let you focus on things you want to compare. In Economics, graphs and diagrams are used as good models. But you should not forget that when making these models, it should be //ceteris paribus//.

The Circular-Flow Diagram
Our first model we are going to use is called Circular-Flow Diagram. It basically shows how the economy works.

In the diagram, blue-green arrows represents the flow of dollars, while yellow arrows represents the flow of goods and service.

Factor Markets are markets that cuts trees and digs oils. They sell these inputs for production to the firms. Firms pay the factor markets for these inputs. Then the firm turns these finished goods and services. The Product Markets receive them, and pay the Firms. Then the product markets advertise these goods and services and sell them to the households. And we pay for those goods and services. And we offer labor, land, and capital for the factor markets, where we receive our income.

As you can see in the diagram, the money you paid to the product markets comes back to you as income. This is called the Circular-Flow Diagram of Economy.

Production Possibilities Frontier
The second model is called the Production Possibilities Frontier, or the PPF. PPF is a graph that shows the combinations of output that a market can produce. It is easier to understand if you look at the actual graph. In this graph, we use Guns and Butters as example for a production. Remember, we consider we ONLY produce these two products, //ceteris paribus//.

the curve shows the maximum output a market can produce. For example, at point A, the factory can produce 100 units of butter and 30 guns. But at B, it can produce 50 units of butter and 120 guns. That means the factory cannot produce 101 units of butter and 30 guns, or 50 units of butter and 121 guns, because they are going to be points outside the curve. All the points inside a curve is possible. For example, at point D, let's say the factory can produce 70 units of butter and 50 guns. In this case, the factory is not using it's machines to their full potential. This is called inefficient. But at points on the curve like A and B, the factory is doing its best to produce as many goods of each as it can. Therefore, the factory is being efficient, not wasting any potential to produce.

The idea of opportunity costs and trade-offs help understand why the line exists.

Compare points A and B. At A, factory can produce 100 units of butter and 30 guns. But if the factory wants to make 90 more guns (point B), then the factory has to sacrifice 50 units of butter. This is the trade-offs. The opportunity cost of making 90 guns is losing 50 units of butter.

But why is the line curved?

You can notice that the slope of the line changes as the graph produce more units of butter or guns. It means that the opportunity cost of each good increases the more each good is made. The reason for this is that there are machines used specially for making guns and specially for making butter. In order to make more butter, some of the machines for making guns have to be used to make butter. Machines used to make guns is, of course, not as productive for butter as the machines used to make butter. Therefore, it becomes harfer to make more butter as the quantity of butter produced increases. Same goes for making more guns.

This is why the line is curved and the slope changed at almost every point.

Shifts in Graph
Factory can make outside its curve (point Y) when there’s a change in environment. When there’s a technological advance, a factory is able to make more goods with less cost. With new machines that are more efficient, the line of PPF can shift outside, meaning that the factory can produce more goods than it used to be able make.

Inversely, when a factory isn’t making as many goods as it used to be able to make (point X), it means that there are some problems in the factory. Maybe a machine broke down, or the people are getting lazy. These factors can make the factory production inefficient.

__**Key Concepts**__
 * circular-flow diagram**: the economic model of firms and households that show how money flows throughout the economy
 * production possibilities frontier**: graph that shows the available outcomes in a market between the combinations two products
 * microeconomics**: study of how households and firms make decisions and interact with each other
 * macroeconomics**: study of the occurrences of economy
 * positive statements**: illustrative comments (how the world //is//)
 * normative statements**: advising comments (how the world //ought to be//

1-2. 1. For the graph above, which point(s) is(are) the most efficient way to produce guns and butter?
 * __Questions__**

2. List at least one way that the graph above can shift.

Answers Ch 2 YD