Chapter+2+Thinking+Like+an+Economist.JAKS

=Chapter 2. = =Thinking Like an Economist =



=**Definitions** =  Circular Flow Diagram: A visual model of the economy that shows how dollars flow through markets among households and firms Production possibilities frontier: a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology Microeconomics: The study of how households and firms make decisions and how they interact in markets Macroeconomics: The study of economy-wide phenomena, including inflation, unemployment, and economic growth Positive Statement: claims that attempt to describe the world as it is Normative Statement: claims that attempt to prescribe how the world should be

=**LEARNING OBJECTIVES:** =  By the end of this chapter, students should understand: o Economics is about the allocation of scarce resources. o Economist is a social scientist who tries to address social phenomena from a scientific perspective.

**I. Introduction**

 * 1) Scientific method consists of observation, making hypothesis, testing the hypothesis, and reaching the conclusion.
 * 2) Economists use the same idea to propose a theory, which describes certain phenomenon present in the economy.
 * 3) Economists, like physicists, have to make assumptions because the real world is complex and they need to design simple models. This helps us to focus on the essence of the problem.

II. Important Model #1: The Circular-Flow Diagram
 1. Circular flow diagram is a visual model of how dollars(or any currency) flows through markets among households and firms. 2. This model is divided into two types of decision makers-firms and households. Firms produce goods and services using inputs (labor, land, and capital). These factors are called the factors of production. Household own this factor, and consumer all the goods and services. 3. In markets for goods and services, households buy goods and firms sell goods. Cash flows towards the firm, which in turn, generates revenue for the company. 4. The second market, markets for factors of production, consists of households being sellers and firms being buyers. Firms obtain factors of production from households through wages and rent, and they spend their profits to achieve their goal. 5. The outer loop is the flow of dollars, and the inner loop is the flow of inputs and outputs. http://www.quakerearthcare.org/Images/imagesforinterestgroups/Economicsgraph3.gif

III. Important Model #2: Production Possibilities Frontier
 1. This is a graph that shows how two outputs varies over fixed factors & production technology. 2. With resources it has, company can only operate on the curve, or below the curve. 3. The only way to go off the curve is to have a better technology–which explains the trade-off mentioned in Ch.1. 4. The graph is curved because the opportunity cost of producing one good varies over outputs of other good. Curve occurs when there's a specialized resource, and when this resource is used to make other good, then the opportunity cost has to rise, which changes the shape of the curve.

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IV. How Economics Is Used in Real Life
<span style="font-family: 'Palatino Linotype','Book Antiqua',Palatino,serif;"> 1. Microeconomics is a study of individual households and how they make decisions (trade-offs). This is linked to the macroeconomics, which looks at the society as a whole. These two fields are closely related, but in order to study them, separate models are necessary, which is why they are often taught separately. 2. Economists try to explain the world with positive statement, an attempt to describe the world as it is. On the other hand, economic policy-makers try to improve the economy-a normative statement. 3. In economics, positive statements are prevalent, but those who want to apply economics need to have normative statements. 4. Economists always disagree with each other because each person puts different values over key ideas. For example, one might value minimum wage more than the firm's profit, whereas the other disagree with that. Furthermore, they might have different scientific judgements, and theories may not always be correct in the real-world, where many details are factors in phenomena of the economy.

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