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

**Chapter 2: Thinking Like an Economist**

(Introduction) In mathematics, we use calculators to solve questions. In calculators, there are lots of different codes or symbols that are used in math. All of these are parts of the language of mathematics. Moreover in Biology scientists use terms to identify the hormones such as estrogen, parathyroid, or other incomprehensible substances. Depending on the field of study that a person takes, the language of study can be different. Because Biology and Math have different characteristics, they have different codes or languages to use. Economics is no different to other fields of study. If scientists use a word called, "cerebellum", then the economists use a word called, "supply". As a part of the economist's language, there are supply, demand, deadweight loss, elasticity, comparative advantage or consumer surplus. These different terms clarify the movement in economy. 

 (The Economist as Scientist) Economics is similar to science. Economists approach the study of the economy in the same way as a physicist approaches the study of physics and as a biologist approaches the study of life. In science especially in Physics, scientists collect data from numerous experiments. Then they analyze the data collection and concludes the experiment by stating their hypothesis or theories. Economists also follow the similar steps to study economy. First, they make theories as scientists do. Then they collect data, and analyze these data to clarify their theories. The difference in economists and scientists is instead of using tongs, microscopes, or motion detectors, economists use graphs and models to solve problems. 

 (The Scientific Method: Observation, Theory, and More Observation)

Economists use data collection to test their theories. However it is fairly difficult to have experiments in economics. Physicists can study gravity by dropping the ball to generate data to test their theories. Unfortunately, economists are not allowed to manipulate a nation's economy to get data to support their theories. Even though economy is similar to science, economists usually have to satisfy with whatever data the nation provides them. Also unlike scientists who more pay attentions to experiments, economists focus on the current events or history to find the changes in economy. Depending on what happened around the world, there can be a big fluctuation in economy.

(examples) 1) an Iraq war between US and Iraq raised the price of oil because the war stopped the oil production in Iraq. 2) a hurricane in Idaho caused the increase in price of potatoes because the amount of potato supplied decreased.

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 (The Roles of Assump<span style="color: rgb(9, 11, 10);"> tions)

<span style="color: rgb(9, 11, 10);"> Economists make assumptions to simplify and make the complex world easier to understand. Moreover depending on what types of problems they face, economists use different assumptions. The most important part of assumptions is how prices respond. Most of the time, price causes other significant changes in economy. For example, if the price of Gucci hat increases, the number of consumers will decrease. However price is not something that changes frequently. Moreover it is related with time horizon. By using these two characteristics of economy, economists use different assumptions to study the short and long-run effects of a change in money.

<span style="font-family: Impact,Charcoal,sans-serif;"><span style="color: rgb(231, 145, 13);"> (Economic Models)

Economists use models such as diagrams and equations to understand the concepts of economics more easily. For example, by setting up a model of supply-demand graph, economists can see the problems more clearly without any confusion. Moreover by using the models, not only economists, but also people who are interested in economics can easily learn how each concept applies in certain types of questions.

<span style="font-family: Impact,Charcoal,sans-serif; color: rgb(23, 115, 56);"> (Our First Model: The Circular- Flow Diagram)

The movement in economy is similar to the movement of blood in humans. It keeps rotating through the heart to keep the body functions. However when the flow of blood stops by clotted blood vessels or some other reasons, a person gets a heart attack and it leaves severe damages to body. Similar to this if even a small part of economy stops functioning, there might be some adversities occurring. The given picture of heart is another way of showing "the circular-flow diagram" in a biological way. If we redefine the circular-flow diagram economically then it means "//a visual model of the economy that shows how dollars flow through markets among households and firms//". In this model, there are two types of decision makers- firms and households. Firms produce goods and services using inputs. Labor, land, and capital are examples of inputs and they are also called as the factors of production. Without these inputs, firms cannot produce goods to sell. On the other hand, households purchase the factors of production and consume all the products or services that firms provide. These are the basic concepts of firms and households in the circular-flow diagram. Since there are two types of decision makers, there are also two types of markets called, "markets for goods and services" and "markets for the factors of production". If the markets are for goods and services, households are consumers and firms are sellers. On the other hand if the markets are for the factors of production, then households are now sellers and firms are consumers. Since the diagram is called "circular-flow diagram", dollars flow in every direction.

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<span style="font-family: Impact,Charcoal,sans-serif; color: rgb(194, 25, 146);"> (Our second model: The production possibilities frontier)



The second model is a production possibilities frontier. This graph shows the combination of output that the economy can possibly produce with the limited resources and with the current technology they have. As you can see, all the dots are on the actual curve. It is because the resource is limited that it is impossible to have a dot outside of the curve. Moreover if the dots are exactly on the curve, then an outcome of each dot is efficient. However if a dot is inside of the curve, then it means an outcome is inefficient. However the inefficient dot can be useful in the increase of production, IF the inefficient dot reaches one of the efficient dots. If the inefficient dot overlaps with the efficient dot, then there will be increase in production of both goods because companies or producers will make more efficient products by using its resource rather than wasting the resource for making inefficient goods.

To make this graph work in economy, one of the Ten Principles of Economics has to occur: the opportunity cost. An opportunity cost is the cost of something what consumers or producers lose to get another goods. For examples, there are 10 workers in a factory and they all bake cheese cakes. However 4 men are talented in making computers and 6 men are talented in baking. To get more benefits (or incomes), the factory owner decides to send the best computer maker to help producing computers. If one man can bake two pieces of cheese cake, the factory owner now is giving up two pieces of cheese cake to produce more computers. In this case, two pieces of cheese cake will be the owner's opportunity cost because he just lost a man who could bake a cake. But even though he lost one of the bakers, he now gained one of the best computer makers. By connecting the points of changes in both goods, the curve forms in the graph. Moreover the slope of the curve is same as the opportunity cost of each good. The production possibilities frontier applies the concept of trade-off between the outputs and also many other things such as economic growth by the opportunity cost, scarcity, and efficiency. <span style="color: rgb(9, 11, 10);">media type="youtube" key="a5rxIY46J7s&hl=ko&fs=1" height="344" width="425"

<span style="color: rgb(9, 11, 10);"> (Microeconomics and Macroeconomics)

The field of Economics is divded into Microeconomics and Macroeconomics. **<span style="color: rgb(26, 162, 33);">Microeconomics ** is the study of how households and firms make decisions and how they work together in specific markets. Micro-economists may study how rent control may affect housing in a city or how mandatory school attendance affects worker’s earnings. Microeconomics and macroeconomics are closely <span style="color: rgb(209, 26, 26);">__linked__ because it would be impossible to comprehend macroeconomic developments without thinking of the microeconomic decisions that are associated. <span style="color: rgb(46, 151, 234);">For example, a macroeconomist would analyze the effect of cut in federal income tax on production of goods and services on the whole, by looking closely at the effects of tax cut on how much they decide to spend on goods and services. Although these two fields are closely associated with one another, they both are different and distinct because they <span style="color: rgb(39, 165, 44);">tackle with different questions and have differing set of models.
 * <span style="color: rgb(255, 118, 0);">Macroeconomics ** is the ‘study of economy-wide phenomena.’ Macroeconomics studies economics not just on particular companies, but economy as a whole. Macroeconomists would study how the borrowing by the federal government or the different policies to increase growth in national living standards, may have effects.

(The Economist As Policy Adviser) When economists try to explain about our world, they are ‘scientists’. But when they try to develop it, they are ‘<span style="color: rgb(23, 151, 42);">policy advisors ’. <span style="color: rgb(253, 158, 33);"> There are two types of general statements in our world: <span style="color: rgb(122, 83, 238);">Positive and Normative. First, suppose two people are talking on the topic of minimum-wage laws.
 * <span style="color: rgb(255, 178, 46);">Positive vs. Normative Analysis ** :

Sally: ‘Minimum-wage laws are the cause of unemployment.’ Janet: ‘The minimum wage should be increased by the government.’

Here Sally simply explains how the world works and is<span style="color: rgb(112, 22, 202);"> __descriptive__. These statements are **<span style="background-color: rgb(252, 252, 253); color: rgb(28, 97, 233);">positive **. Where as Janet gives out a solution and talks about how the world ‘ought to be’, being <span style="color: rgb(202, 68, 228);">__prescriptive__. These statements are<span style="color: rgb(41, 173, 26);"> **normative**. Difference between Positive and Normative statements ** A key difference is ‘how we judge their validity.’ We could prove some positive statements true or false by looking at **<span style="color: rgb(57, 150, 208);">__evidence__ **. However, normative statements involve <span style="color: rgb(146, 87, 229);">__values and facts__. Normative statements involve more than decision of what is good and bad, but our viewpoint on different philosophies of religion and politics.
 * <span style="color: rgb(179, 30, 54);">

The two statements are closely linked in ‘a person’s set of beliefs’. Specifically, positive statements about how the world works have an effect on normative statements about which policies are sought-after. However, positive analysis cannot lead to normative conclusions. <span style="color: rgb(74, 74, 242);">**__Value judgments__** are involved.
 * <span style="color: rgb(32, 151, 87);">Similarity between Positive and Normative statements **

<span style="color: rgb(227, 84, 215);"> Former president Truman realized that economists did not give advice in a simple and straight forward manner. This can be seen in the Ten Principles of Economics: ‘People face trade-offs.’ Economists know that policy decisions are extremely difficult and that every good thing comes with its costs.
 * (Economists in Washington)**

Truman and many other presidents relied and still rely on advice given by economists. For example, Economists at the Department of Treasury help propose tax policies. Economists at the Department of Justice help strengthen nation’s ‘antitrust laws.’ Economists also help and affect many other areas outside the government of administration.
 * <span style="color: rgb(58, 233, 242);">Influence of Economists: **

Economists also affect policy indirectly through their writings, such as Economist John Maynard Keynes.

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<span style="color: rgb(235, 25, 202);"> <span style="color: rgb(176, 78, 218);">**(** <span style="color: rgb(3, 3, 3);"><span style="color: rgb(176, 78, 218);">**Why Economists Disagree)** Why do economists have confliction with policymakers?

1) Economists might disagree with the <span style="color: rgb(243, 161, 48);">__<span style="color: rgb(244, 159, 26);">“validity” __ of some positive statements (of how our world works) 2) Economists might have differences in <span style="color: rgb(246, 183, 49);">__“value”__ and normative statements (of what policy should do to improve our world).

<span style="color: rgb(0, 0, 0);">Economists may have conflictions because of differing feelings of how valid some theories are, or how the “size of important parameters that measure how economic variables are related”. For example, an issue that arouses a lot of confliction between economists is: whether taxes should be made on households’ incomes or its expenditure. Advocates who are not against consumption tax believe that it would lead to more savings of money in households and a fast growth in living standards.Whereas advocates, who root for status quo and the current income tax system, would believe that household saving would not act in much response to ‘change in tax laws.’ This conflict shows two groups of economists having disagreement in normative views due to disagreement in positive views.
 * Differences in Scientific Judgments**

<span style="color: rgb(0, 0, 0);">Economists disagree often about policies of the public. Economists have disagreements in both normative and positive views.
 * Differences in Values**

Although there is much conflict, economists also agree on many things. Below are ten propositions in which economists agree on:
 * <span style="color: rgb(88, 176, 39);">Perception vs. Reality **

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. 4) Fiscal policy (e.g.) tax cut and/or government expenditure increase.) has a significant stimulative impact on a less than fully employed economy. 5) If the federal budget is to be balanced, it should be done over the business cycle rather than yearly. 6) Cash payments increase the welfare of recipients to a greater degree than do transfers in-kind of equal cash value. 7) A large federal budget deficit has an adverse effect on the economy. 8) A minimum wage increases unemployment among young and unskilled workers. 9) The government should restructure the welfare system along the lines of a “negative income tax.” 10) Effluent taxes and marketable pollution permits represent a better approach to pollution control than imposition of pollution ceilings.

Source: Richard M. Alston, J. R. Kearl, and Michael B. Vaughn, “Is There Consensus among Economists in the 1990s?” American Economic Review (May 1992): 203-209.

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Questions for Review

1. What's the difference between Normative analysis and Positive analysis? 2. Define Microeconomics and Macroeconomics. 3. What is the circular-flow diagram?

Answers for the questions

1. Normative analysis means an opinion about how the economy ought to be. However Positive analysis is a scientific statement about the economy. 2. Microeconomics is a study of economy between firms and households. Macroeconomics is a study of economy which focuses on the national economy. 3. The circular-flow diagram is a graph that represents the relationships between the firms and households.

(Citations)

1) http://www.flickr.com/search/?q=economist+&m=text 2) http://kr.youtube.com/watch?v=DC_LSwTHFdk 3) http://kr.youtube.com/watch?v=uVp45ewh0Ug 4) http://kr.youtube.com/watch?v=a5rxIY46J7s&feature=related 5) http://www.flickr.com/photos/7974683@N08/2316625861/ 6) http://www.flickr.com/photos/mscolly/145052885/ 7) http://www.flickr.com/photos/blutkind/139053383/ 8) http://images.search.yahoo.com/images/view?back=http%3A%2F%2Fimages.search.yahoo.com%2Fsearch%2Fimages%3Fei%3DUTF-8%26p%3Dheart%26fp_ip%3DKR%26fr2%3Dtab-web%26fr%3Dyfp-t-501&w=400&h=320&imgurl=www.umm.edu%2Fgraphics%2Fimages%2Fen%2F19612.jpg&rurl=http%3A%2F%2Fwww.umm.edu%2Fimagepages%2F19612.htm&size=26.9kB&name=19612.jpg&p=heart&type=JPG&oid=efd5ad70f3099f22&no=9&tt=7,604,553&sigr=117kh26ld&sigi=1185qfun7&sigb=12v29jqac 9) http://images.search.yahoo.com/images/view?back=http%3A%2F%2Fimages.search.yahoo.com%2Fsearch%2Fimages%3Fp%3Dproduction%2Bpossibilities%2Bfrontier%26y%3DSearch%26fr%3Dyfp-t-501%26ei%3Dutf-8%26js%3D1%26x%3Dwrt&w=464&h=316&imgurl=www.all-science-fair-projects.com%2Fscience_fair_projects_encyclopedia%2Fupload%2F3%2F37%2FPpf2_small.png&rurl=http%3A%2F%2Fwww.all-science-fair-projects.com%2Fscience_fair_projects_encyclopedia%2FProduction_possibilities_frontier&size=9.6kB&name=Ppf2_small.png&p=production+possibilities+frontier&type=png&oid=181b94851017dd36&no=5&tt=46&sigr=13dc70r5e&sigi=12vh2fhi1&sigb=13q0rt8oh

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