Thinking Like an Economist

1
Chapter 2

• Thinking Like an Economist
• Ratna K. Shrestha

2
Overview

• The Economist as a Scientist
• The Economist as a Policy-Maker
• Where Economists Disagree and where Economists
  Agree

3
Economics Trains us to Think

• in terms of alternatives.
• and understand the cost of individual and social
  choices.
• and provide us with insights into how certain
  events and issues are related.

4
Thinking Like an Economist

• The economic way of thinking requires one to
  think analytically and objectively.
• The economic way of thinking is like the
  Scientific Method.

5
Scientific Method

• Scientific Method uses abstract models to help
  understand how a complex real-world operates.
• e.g., biologist use plastic replica of human body
  to study anatomy.
• The Scientific Method develops theory, collects
  and analyzes data to prove the theory.

6
Economic Way of Thinking Includes

• the development of abstract models from theories
  and the analysis of the models using two
  approaches
• descriptive reporting facts, etc.
• analytical abstract reasoning
• As do other scientists, economists make
  assumptions in developing models. To study
  international trade for example, we may assume
  two countries and two goods.

7
The Circular-Flow Model

• The economy consists of millions of people
  involved in many activities.
• The circular-flow model provides a simple way of
  describing all the economic transactions that
  occur in a Market Economy.
• It emphasizes decentralization in that economic
  decisions are made by Households and Businesses
  in Product and Resource Markets.

8
The Circular-Flow Model
Product Markets
Businesses
Households
Resource Markets
9
Diagram The Circular-Flow Model
Product Markets
Flow of Resources
Businesses
Households
Supply Resources
Demand Resources
Resource Markets
10
Diagram The Circular-Flow Model
Product Markets
Flow of
Businesses
Households
Land Labor Capital
Supply Resources
Demand Resources
Resource Markets
11
Diagram The Circular-Flow Model
Product Markets
Supply Goods Services
Demand Goods Services
Flow of Goods and Services
Businesses
Households
Resource Markets
12
The Circular-Flow Model
Product Markets
Spending
Revenue
The Flow of Dollars
Businesses
Households
Resource Markets
13
Diagram The Circular-Flow Model
Product Markets
Spending
Revenue
The Flow of Dollars
Businesses
Households
Expenses
Income
Resource Markets
14
Diagram The Circular-Flow Model
Product Markets
Spending
Revenue
The Flow of Dollars
Businesses
Households
Rent Wages Profit
Expenses
Income
Resource Markets
15
Diagram The Circular-Flow Model
Product Markets


Dollar Flow Real Flow
Businesses
Households


Resource Markets
16
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

17
A Second Economic Model

• Production Possibilities Frontier (PPF)is a
  graph that shows the various combinations of
  output that the economy can possibly produce
  given the available factors of production and
  technology.

18
Production Possibilities Frontier
Computers
Cars
0
19
Production Possibilities Frontier
A
2000
Computers
Cars
700
0
20
Production Possibilities Frontier
E
3000
A
2000
Computers
Cars
700
0
21
Production Possibilities Frontier
E
3000
A
2000
Computers
F
Cars
1000
700
0
22
Production Possibilities Frontier
E
3000
A
2000
Computers
F
Cars
1000
700
0
23
Concepts Illustrated by the PPF

• Efficiency
• Tradeoffs
• Opportunity Cost
• Economic Growth

24
Production Possibilities Frontier
E
Efficient Resource Use
3000
A
2000
B?
1000
Computers
F
Cars
1000
700
0
300
25
Production Possibilities Frontier
E
Tradeoffs
3000
A
2000
C
1000
Computers
F
Cars
1000
700
0
900
26
Production Possibilities Frontier
Opportunity Cost of next 200 cars is 1000
computers. Opportunity cost of 1 car is 5
computers
E
3000
2000
A
Opportunity Cost
C
1000
Computers
F
Cars
1000
700
0
900
27
The PPF
Quantity of Computers Produced
Improvement in technology in the production of
Computers
3,000
2,000
A
Quantity of Cars Produced
700
0
1,000
28
Production Possibilities Frontier
Economic Growth
3000
Improvement in technology in the production of
both
2000
1000
Computers
Cars
1000
700
0
300
29
Microeconomics and Macroeconomics

• Microeconomics focuses on the individual parts
  of the economy.
• e.g. individual markets
• e.g. price increase in the housing market
• Macroeconomics looks at the economy as a whole.
• e.g. aggregate of markets
• e.g. average price increase for all goods
• e.g. unemployment

30
Two Roles of Economists

• When they are trying to explain the world, they
  are Scientists.
• When they are trying to change the world they are
  
• Policy-makers.

31
Positive versus Normative Analysis

• Positive Statements or assertions dealing with
  matters of fact or questions about how things are
  (descriptive analysis).
• Normative Statements that reflect individual
  opinions about how the world should be
  (prescriptive analysis).

32
Positive or Normative Statements?

• An increase in the minimum wage will cause a
  decrease in employment among the least skilled.
• Higher federal budget deficits will cause
  interest rates to increase.
• The income gains from a higher minimum wage are
  worth more than any slight reduction in
  employment.
• Provincial governments should be allowed to
  collect from tobacco companies the costs of
  treating smoking-related illnesses among the poor.

33
WHY ECONOMICS IS WORTH STUDYING?

• Two main benefits from studying economics
• Understanding
• Expanded career opportunities
• Understanding
• Economic ideas is all around you. You cannot
  ignore them.
• As you progress with you study of economics,
  youll gain a deeper understanding of what is
  going on around you.

34
WHY ECONOMICS IS WORTH STUDYING?

• 2. Expanded Career Opportunities
• Most students of economics dont become
  economists.
• But knowledge of economics is vital is many
  fields such as banking, finance, business,
  management, insurance, real estate, law,
  government, journalism, health care and the arts.
• Economics graduates are not the highest-paid
  professional, but they are close to the top.

35
WHY ECONOMICS IS WORTH STUDYING?

• The Costs of Studying Economics
• The main cost of studying economics is forgone
  leisure time.
• Most students find that economics is difficult
  and that it takes time to master.
• The trick is practice, or learning by doing.
• Benefits Versus Costs
• Weigh up your benefits and costs!

36
Economists in Government

• Department of Finance formulate tax policy.
• Industry Canada design competition policy.
• Foreign Affairs assist with trade agreements.
• Human Resources Development Canada formulate
  labor market policies.
• Bank of Canada implement monetary policy.
• Environment Canada design environment laws.

37
Economists in the Private Sector

• C.D. Howe Institute suggest policy options.
• Fraser Institute suggest policy options.
• Provide forecasts for companies.
• Assist firms manage resources efficiently.
• Assist with investment decisions.

38
Do Economists Always Agree With Each Other?
Three reasons why they dont

• Disagree about the validity of alternative
  positive theories
• Each have different values, thus different
  normative views

39
Examples of When Economists (Majority) Do Agree

• A ceiling on rents reduces the quantity and
  quality of housing available.
• Tariffs and import quotas usually reduce general
  economic welfare.
• Tax cuts has a significant stimulative impact on
  a less than fully employed economy.