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2Thinking Like an Economist
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Thinking Like an Economist
• Every field of study has its own terminology• Mathematics
• integrals axioms vector spaces• Psychology
• ego id cognitive dissonance
• Law• promissory estoppel torts venues
• Economics• supply opportunity cost elasticity consumer
surplus demand comparative advantage
deadweight loss
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Thinking Like an Economist
• Economics trains you to. . . .• Think in terms of alternatives.• Evaluate the cost of individual and social choices.•
Examine and understand how certain events andissues are related.
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THE ECONOMIST AS ASCIENTIST
• The economic way of thinking . . .• Involves thinking analytically and objectively.• Makes use of the scientific method.
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The Scientific Method: Observation, Theory,and More Observation
• Uses abstract models to help explain how acomplex, real world operates.
•
Develops theories, collects, and analyzes datato evaluate the theories.
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The Role of Assumptions
• Economists make assumptions in order tomake the world easier to understand.
• The art in scientific thinking is deciding which
assumptions to make.• Economists use different assumptions to
answer different questions.
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Economic Models
• Economists use models to simplify reality inorder to improve our understanding of theworld
•
Two of the most basic economic modelsinclude:• The Circular Flow Diagram• The Production Possibilities Frontier
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Our First Model: The Circular-Flow Diagram
• The circular-flow diagram is a visual model of theeconomy that shows how dollars flow throughmarkets among households and firms.
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Figure 1 The Circular Flow
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Spending
Goodsandservices bought
Revenue
Goodsandservicessold
Labor,land,andcapital
Income
= Flow of inputsand
outputs= Flow of dollars
Factorsof production
Wages,rent,and
profit
FIR MS•Produce and
sellgoods andservices•Hire and use
factorsof production
•Buy andconsumegoods andservices•Own and sell
factorsof production
HOUSEHOLDS
•Householdssell•Firms
buy
MARK ETSF
OR
FACTORS OFPRODUCTION
•Firmssell•Households
buy
MARK ETSF
OR
GOODS ANDSERVICES
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Our First Model: The Circular-Flow Diagram
• Firms• Produce and sell goods and services• Hire and use factors of production
•
Households• Buy and consume goods and services• Own and sell factors of production
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Our First Model: The Circular-Flow Diagram
• Markets for Goods and Services• Firms sell• Households buy
•
Markets for Factors of Production• Households sell• Firms buy
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Our First Model: The Circular-Flow Diagram
• Factors of Production• Inputs used to produce goods and services• Land, labor, and capital
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Our Second Model: The ProductionPossibilities Frontier
• The production possibilities frontier is a graph thatshows the combinations of output that theeconomy can possibly produce given the
available factors of production and the available production technology.
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Figure 2 The Production Possibilities Frontier
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Production
possibilities
frontier
A
B
C
Quantity of Cars Produced
2,200
600
1,000
3000 700
2,000
3,000
1,000
Quantity of
Computers
Produced
D
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Our Second Model: The ProductionPossibilities Frontier
• Concepts Illustrated by the ProductionPossibilities Frontier • Efficiency•
Tradeoffs• Opportunity Cost• Economic Growth
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Figure 3 A Shift in the Production Possibilities Frontier
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E
Quantityof Cars Produced
2,000
700
2,100
750
0
4,000
3,000
1,000
Quantityof Computers
Produced
A
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Microeconomics and Macroeconomics
• Microeconomics focuses on the individual partsof the economy.• How households and firms make decisions and how
they interact in specific markets• Macroeconomics looks at the economy as a
whole.• Economy-wide phenomena, including inflation,
unemployment, and economic growth
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Overview of the course
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THE ECONOMIST AS POLICY ADVISOR
• When economists are trying to explain theworld, they are scientists.
• When economists are trying to change the
world, they are policy advisor.
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POSITIVE VERSUS NORMATIVE ANALYSIS
• Positive statements are statements that attempt todescribe the world as it is.• Called descriptive analysis
•
Normative statements are statements about howthe world should be.• Called prescriptive analysis
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• Positive or Normative Statements?• An increase in the minimum wage will cause a
decrease in employment among the least-skilled.POSITIVE
• Higher federal budget deficits will cause interestrates to increase.
POSITIVE
?
?
POSITIVE VERSUS NORMATIVE ANALYSIS
?
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• Positive or Normative Statements?• The income gains from a higher minimum wage are
worth more than any slight reductions inemployment.
NORMATIVE
• State governments should be allowed to collect from
tobacco companies the costs of treating smoking-related illnesses among the poor.
NORMATIVE
?
?
POSITIVE VERSUS NORMATIVE ANALYSIS
?
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WHY ECONOMISTS DISAGREE
• They may disagree about the validity of alternative positive theories about how theworld works.
• They may have different values and, therefore,different normative views about what policyshould try to accomplish.
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Summary
• Economists try to address their subjects with ascientist’s objectivity.• They make appropriate assumptions and build
simplified models in order to understand the worldaround them.
• Two simple economic models are the circular-flowdiagram and the production possibilities frontier.
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Summary
• Economics is divided into two subfields:• Microeconomists study decisionmaking by
households and firms in the marketplace.•
Macroeconomists study the forces and trends thataffect the economy as a whole
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Summary
• A positive statement is an assertion about howthe world is.
• A normative statement is an assertion about
how the world ought to be.• When economists make normative statements,
they are acting more as policy advisors thanscientists.
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Summary
• Economists who advise policymakers offer conflicting advice either because of differencesin scientific judgments or because of
differences in values.• At other times, economists are united in the
advice they offer, but policymakers may chooseto ignore it.
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Course: Economic Analysis
•
Module I-Introduction to Economic Analysis• Module II- Microeconomics
• Module III: Macroeconomics
References:
• Pindyck, R and Rubinfeld, D L “Microeconomics”
• Chiang, A “Fundamental Methods of Mathematical Economics”
• Mankiw, N.”Principles of Macroeconomics”
• Perloff, Jeffrey M “Microeconomics: Theory and Application with
Calculus”.• Samuelson and Nordhaus “Economics”.
• Silberberg E and Suen, W “The Structure of Economics: A Mathematical
Analysis”.
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Evaluation Procedure
Assignments 10Quizzes 10
Class Participation 05
Project 10
Mid Term Exam 25
Final Exam 40
Total: 100 Marks
•