Chapter+2+-+Micro

__**Chapter 2 - Principles of Microeconomics by N. Gregory Mankiw**__

__Key Terms__ circular flow diagram production possibilities frontier microeconomics macroeconomics positive statements normative statements


 * Thinking Like An Economist**

//__Intro__//

In many fields of studies, there are different languages and sets of words that are used for that field. For example, in math, we say "plus" or "square root." In music, we use "quarter notes" and "rests." In biology, we sometimes say "synthesize" or "cells." Likewise, in the field of economy, there are certain words we use and certain ways to think and see things, which is what we will focus on in this chapter. What and how do economists think?

The field of economics is unique in a way that we have to combine many distinct fields and combine them into one. For example, the scientific method is used as a way to test how the world of economy works. Let's say that you want to figure out a good way to earn money. Like the scientific method, you devise a strategy, and experiment with it by trying it. After, you analyze the data similar to how a biologist would. However, they may also use history to make decisions based on prior experience. And in my opinion, this is what makes economy more interesting.


 * Economy As a Science**

As stated above, Economy can be a science. Economists use the scientific method to prove theories in the vast, theoretical world of economics. For example, if they want to know what happens if you introduce a Game Boy into a third-world country, economists might look up records of other similar third-world countries, and see the effect. These experiments play a big role in decision making.

But there's a huge problem that most economists face. Though many economists theorize and make observations upon experiments, the problem is that it's really hard to experiment something if they want to find out. For example, if a biologist wanted to find out how fast a certain type of cell grows, the biologist could just get a petri dish, put the cell in, and record results. However, an economist just can't make an economy change by will, or experiment. As a result, they need to look at former data, and just do the best that they can with what they have.




 * Assumptions**



The truth is, people think. And one of the best abilities of humans is for their ability to think critically and make assumptions. In economics, the main point of assumption is to make life easier on us, which is good for everyone. For example, when opening a vanilla ice cream sundae business, the first thing you think about is how to procure vanilla ice cream, and chocolate syrup. Then, you could add complications, such as where to sell the ice cream, at what price, and what other toppings to offer. Similarly, economists assume things to make it easier. For example, when talking about trade between two countries, it would be easier to just assume that there are only two goods being traded and the countries had free trade, and that there were no other government taxes, or any complications.

Also, economists assume things differently for different goods. If you dropped a beach ball and a basketball of the top of a building, it would be obvious that the basketball would reach the floor before the beach ball in normal circumstances. Likewise, economists use different assumptions for different situations.


 * __Economic Models__**

Models also are used to make life easier.



For example, this heart diagram makes it easier for us to learn about the heart if we wish. It gives us a visual aid and helps us learn how the heart works more easily than simply reading about it.

Economics also uses various models that are essential when studying it. Instead of pictures, diagrams of economy are usually portrayed through graphlike diagrams and equations that you will soon learn. Remember, it makes life easier, not harder.


 * Circular-Flow Diagram**

The first model is called the **circular-flow diagram**. It's a visual diagram that shows how the money in our economy is being circulated. The money keeps on revolving around as if in a circle, hence the name //circular//-flow diagram.



To make this easier, let's redefine these terms. The household is basically the people that live in a household. They buy products in the market known as the Markets for Goods and Services. For example, if I'm hungry and buy a Big Mac, I'm going to the Markets for Goods and Services, which in this case is McDonalds, and buying a product as a household using the wage I earned from working. Households also sell their labor and work in the market known as the Markets For Factors of Production. So again, if I'm a regular guy, and if I get hired by Burger King, then I am selling my service of work and labor to Burger King in the Markets For Factors of Production in return for money, which is my wage..

The firm is a company or group of individuals working together that earn money. McDonalds is a firm. Nike is a firm. Adidas is a firm. The store across the street is a firm. Anything that sells anything is a firm.

In the Markets For Goods and Services, firms bring the good(s) and services that they are selling. So if the firm that I own is Taco Bell, I go to the Markets For Goods and Services, in this case, the Taco Bell store, and I sell my tacos there, and earn money, which is Revenue. The firms go to the Markets For Factors of Production to give up all their profit and wages to pay for their workers and other bills, such as electrical bills, and workers' wages. So, if I earn 1000 dollars in a day, I pay about 100 bills for my store rent, 500 dollars for the workers' wages, 200 for all other bills, and I keep 200 dollars for myself. So I'm paying money with the money I earned, and paying to keep my firm alive.

Finally, the money keeps on going in a circular motion, hence the name Circular-Flow Diagram. Money isn't lost, created, just circulated.

Remember, everyone is both a firm and household at the same time. For example, after my long day at Taco Bell, in which I am a part of the firm, I become a household when I go home. When I'm at home, and when if I spend 10 bucks for dinner, I'm going to the Markets For Goods and Services as a household. In conclusion, we are not only one. Everyone has to be both a household and a firm.


 * Production-Possibilities Frontier**

The second diagram to know is the **Production Possibilities Frontier**. The Production Possibilities Frontier is a graph that shows how much the economy can produce with a certain amount of factors of production combined with technology. Here's a picture of a Production-Possibilities Frontier Curve:



So the blue line and inside, is the amount of goods that an economy can produce. The blue line on the edge is the maximum that an economy can produce. It is called an //efficient// outcome because it's maximizing all the goods that they can produce using the limited amount of resources. So they're getting everything they can while using everything they have.

So the blue line and inside, is the amount of goods that an economy can produce.

And the blue line on the edge is the maximum that an economy can produce. It is called an efficient outcome because it's maximizing all the goods that they can produce using the limited amount of resources. So they're getting everything they can while using everything they have. In this graph, the efficient points are the points B,C, and D.

On the other hand, any point inside the line is called an inefficient outcome because something is wrong with the economy and output is minimal, such as depression and/or unemployment. In this point, point A is inefficient because they're producing less with the same amount of resources.

Finally, point C is a point unconceivable for an economy to output without external trade or other factors, which you'll learn in later chapters. For now, it's impossible to reach that output with the limited amount of resources. For example, point X in this graph above is impossible due to limited resources.

Now you're probably asking why (probably not) the curve is a curve and not a straight line. Well, think of it this way. People are unique. Some people are good at some things, other people are good at other things. For this reason, we can't really create a straight line. The classic example is Guns vs. Butter. Some people are better at producing guns, while other people are better at producing butter.

Let's say that we have 100 gun factory workers making 1 gun per day, and 100 butter factory workers making one gallon of butter per day. So if they each do their respective jobs, then the economy will produce 100 guns and 100 gallons of butter per day. However, if the economy is in need of butter, or a gun, then because the workers are not doing the jobs they specialize in, output decreases. So let's say that 100 gun factory workers produce only 0.5 gallons of butter per day, and the 100 butter workers produce only 0.5 guns. Then, just draw a graph. It'll be a curve. If the workers are equally good at both jobs, then it WOULD be a straight line. However, due to specialization, the line is curved.

The production possibilities frontier is one of the most important models of economy. it basic model is used for more complex economic concepts such as scarcity, efficiency, trade-offs, opportunity, elasticity, and economic growth. As you read on, you will be seeing this graph probably more than most others.


 * Microeconomics vs. Macroeconomics**

Many subjects are studied extensively on many different levels. For example, in biology, certain scientists study the organelles and infinitesimal things in the human body. On the other hand, ecology biologists study whole ecosystems and how the whole environment interacts and works.

Likewise, there are usually two levels of economy. **Microeconomics** is the study of how separate households and firms make decisions regarding money. Think of the word base. Micro- means small. Think about the words microscope, microchips, microphone. All of them has some sort of affiliation with small. Likewise, it's easier to think of microeconomics, as "small economics," or economics that is referring to small, specific markets. For example, a microeconomist might study how money circulates in Los Angeles, or rent problem in New York.

On the other hand, **Macroeconomics** is the study of economics in the scope of the whole world. They study economies of whole countries and their affects on other countries. Macroeconomists study economics such as the trade of America with China, and how it affects the rest of the world.

Despite that they are both economies, they have many differences, and are so different that they are taken in different AP tests, and have different textbooks. Though there are some similarities, they each have different ways of study and different diagrams.

Here's a video that explains things:

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=The Economists As Policy Adviser = = = ===  === Economists play two roles in the society. When they are trying to explain the world, they are working as scientists. When they are trying to help improve it, then they are acting as policy advisers. 

Positive versus Normative Analysis
To distinguish two roles of economists, we can examine the use of language. It generally consists of two types: positive statements and normative statements. Positive statements are descriptive claims about how the world is, while normative statements are prescriptive claims about how the world ought to be.

Positive: Minimum-wage laws cause unemployment. Normative: The government should raise the minimum wage.

Much of economics is positive, trying to explain how the economy works. However, those who use economics often have goals that are normative, wanting to learn how to improve the economy. When economist make normative statements, they are speaking not as scientists but as policy advisers.

Key Terms
positive statements- descriptive statements that explain how the world is normative statements- prescriptive statements that explain how the would ought to be

Economists in Washington

Economist’ advice in policy decisions is not always straightforward because of trade-offs. An economist who says that policy decisions are easy is not to be trusted. Here are some examples of organization in Washington where economists work.

Council of Economic Advisers -advises the president and writes the annual Economic Report of the President, which discusses recent developments in the economy and presents the council’s analysis of current policy issues

Department of the Treasury -helps design tax policy

Department of Labor -analyzes data on workers and those looking for work to help formulate labor-market policies

Department of Justice -helps enforce the nation’s antitrust laws

Congressional Budget Office -advises Congress on policy proposals

Federal Reserve -analyzes economic developments in the United States and throughout the world

Economists’ influence on policy is huge that their research and writings often affect policy indirectly.

=Why Economists Disagree =

Economists often give conflicting advice to policymakers, and there are two basic reasons for that. 1.Economists may disagree about the validity of alternative positive theories about how the world works. 2.Economists may have different values and therefore different normative views about what policy should try to accomplish. 

Differences in Scientific Judgments and Values
As we have discussed already, economics is science. Science is a search for understanding about the world, and scientists sometimes disagrees about the direction in which truth lies. This is the same for the economics. For example, economists can disagree about whether the government should tax a household’s income or its consumption because each has different judgment on what would happen as results. Economists give conflicting advice sometimes because they have different values. 

Perception versus Reality
Although there are many inevitable disagreements among economists, economists agree in many cases as well. Some of the propositions which economists agree are: 1.A ceiling on rents reduces the quantity and quality of housing available. 2.Tariffs and import quotas usually reduce general economic welfare. 3.Flexible and floating exchange rates offer an effective international monetary arrangement.

=<span style="font-family: 'Times New Roman',Times,serif; color: rgb(255, 79, 0)">Summary of Ch.2 =

-Economists think and study like scientist. Just like scientists, they make assumptions and build simplified models, such as the circulation flow diagram and the production possibilities frontier, in order to understand the world around them more easily. -Circular flow diagram is a visual model of the economy that shows how money circulate markets among households and firms. Production possibilities frontier is a graph that shows the combination of output that the economy can possibly produce given the available factors of production and production technology. -Economics consists of two fields, microeconomics and macroeconomics. Microeconomists study how households and firms make decisions and how they interact in markets, while macroeconomists study economy-wide phenomena, such as inflation, unemployment, and economic growth. -There are two types of use of language, positive statements and normative statements. Positive statements are descriptive claims about how the world is. Normative statements are prescriptive claims about how the world ought to be. When economists use normative statements, they are speaking as policy advisers, not scientists. -Economists often don’t agree upon policymaking decisions. This is due to their differences in scientific judgments or in values.

<span style="font-family: Verdana,Geneva,sans-serif; color: rgb(150, 74, 74)">Review Questions
1.Determine whether the phrases belong to macroeconomics or microeconomics

a. direct cause of growing rate of unemployment b. your decision on what to buy at the supermarket c. effects of depression on the country d. process in which market moves to equilibrium

2.Determine whether the statements are positive or normative.

a. Unemployment is caused by the minimum wage policy. b. Minimum wage should be lowered to decrease the rate of unemployment. c. Market always moves toward the equilibrium. d. Suppliers have to decrease the quantity supplied to get rid of surplus of products.

Answers 1. a.macroeconomics b.microeconomics c.macroeconomics d.microeconomics

2. a. positive statements b. normative statements c. positive statements d. normative statements

Citations: Mankiw, //Principles of Microeconomics// http://www.flightglobal.com/blogs/airline-business/20071017-Mad_scientist_caricature.png http://www.people.eku.edu/ruppelf/Eco230/circularflow.gif http://www.brownbearbrothers.com/sitebuilder/images/The_Thiking_Gorilla-315x277.jpg http://www.smm.org/heart/lessons/gifs/heartDiagram.gif [|http://www.lclark.edu/~bekar/Mankiw/ch22/image/mod22nf1.gif] http://upload.wikimedia.org/wikipedia/commons/thumb/6/67/Production_Possibilities_Frontier_Curve.svg/470px-Production_Possibilities_Frontier_Curve.svg.png