Chapter+2+(JEM)+-+Thinking+Like+an+Economist

Economists are just like scientists: they make theories, collect datas, and come up with evidences to refute their arguements. Their studies revolve around the basic scientific method of research: observations and theories. When a person observes a high rate of unemployment, he might come up with a theory that the rate of unemployment increase as the level of inflation decreases, just as Isaac Newton came up with the theor of gravity when he observed an apple falling off a tree. There is, though, a difference in method between general science and economics. In science, it's very easy to do experiments whenever a person wants to do. However, it is very difficult for an economist to perform an experiment. Therefore, most economists study history books, or go to the scene where the situation is occuring to observe it themselves.

Like many other scientists, economists also use models to simplify the view of an economy. There are two basic models that are discussed in this chapter:

1. The first model to explain is the **circular-flow diagram**. The diagram shows the interaction between firms and households, leaving out a whole bunch of other details. A //household// who buys and consums has what is known as the //factors of production//: Land, labor, and capital. They give these factors to the //factor market// where they can gain income as a result. Then the factors of production go to the firms who sell and produce. In return, they give wages, rent, and profit to the factor market. The produced goods and services are sold to //goods market// in returns for revenues, to be available for sale to the households. The households buy the goods and services and give their spendings to the goods market. This process constantly repeats itself in circular activity, and thus the name, circular-flow.

2. The sceond model is the **production possibilities frontier** (PPF). In this graph, we assume that there are only two products produced in an economy: games and books. If the economy uses all of its resources to make games, it can produce 1000 games. If it uses its resources only on books, it can make 2000 books. And from these points, there comes a curved line showing how much the economy can produce given the limited amount of resources to produce different number of products. The reason why it's a curve and not a line is because everyone is different. When the economy is producing only games, it decides to send some laborers to make books. One laborer is specialized the most in making books, so he is sent to produce books. The second person sent to make books is less specialized than the first person. And then the next person is also worse than the person before. As this continues, the opportunity cost for producing another book increases as more people go to produce the other product. If all the resources are spent efficiently, the point where it shows the level of production is exactly on the curve of PPF. However, if the point is within the curve, it shows that the resources are not fully used. The point cannot go outside of the PPF because PPF is the curve that shows the maximum level of production the economy can produce. However, there is a way to reach this point: Technological development and trade. If the technology improves, the production becomes faster more efficient producing more goods with the same amount of resources. Also, if the society trades with another society, it can produce only the product that it is specialized in and import the other good from the other society. This allows the economy to produce more than before. The result of these two cases is the shift in PPF outward. Here is an Powerpoint