Chapter 2 Notes—Thinking Like an Economist

Chapter 2 Notes—Thinking Like an Economist Intro  Terms of economic language—Supply, demand, elasticity, comparative advantage, consumer supplies, deadweight loss  They devise theories, collect data, and analyze the data in attempt to verify/refute their theories The Economist as Scientist     The Scientific Method: Observation, Theory, and More Observation o Science is the refinement of everyday thinking o Ex. Economist observes increasing prices. Theory of inflation. Theory assets high inflation caused by government printing too much money. To test theory, collect and analyze data o In Economics, experiments is impractical, so can only use observed data  Use data from natural experiments offered by history  Historical episodes give insight into the economy of the past, and allow us to illustrate and evaluate economic theories of the present The Role of Assumptions o Assumptions can simplify the complex world and make it easier to understand  Ex. To study the effect of international trade, we assume only there are only two countries and they produce only two goods o There are different assumptions for short-run and long-run effects Economic Models o Studying models is useful for learning how economies work o Economists models consist of diagrams and equations  They don’t include every feature of the economy Our First Model—The Circular Flow Diagram o o o Model of how the economy is organized and how participants in the economy interact with one another Circular-flow diagram—a visual model of the economy that shows how dollars flow through markets among households and firms o   o Doesn’t include the roles of government or international trade Our Second Model—The Production Possibilities Frontier o 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 o Efficiency of PPF  Efficient is economy is getting all it can from the scarce resources it has available  Points along the PPF  Inefficient outcome is economy producing less that it can given resources available  Ex. Due to widespread unemployment o Opportunity cost—the cost of something is what you give up to get it  The opportunity cost of one good is measured in terms of the other good  Bowed outward curve—The opportunity cost of a car is greater when the economy is producing many cars and few computers  Bowed shape—when economy uses most of its resources for computers, those suited for cars are making computers. By increasing car production will reduce computers made. Opportunity cost of car is low. As move down slope, the best computer technicians move out so the opportunity cost of the car is higher now o The PPF shows trade-offs between outputs of different goods at a given time, but the trade-off can change over time  Ex. technology can make more computers with the same inputs, so the opportunity cost of cars is greater Microeconomics and Macroeconomics o Microeconomics—the study of how households and firms make decisions and how they interact in markets o Macro—the study of economy-wide phenomena, including inflation, unemployment, and economic growth The Economist as Policy Adviser  Positive versus Normative Analysis o Economists are scientists and policy advisors, with different goals and languages o Positive statements—claims that attempt to describe the world as it is  Can confirm or refute by examining evidence o Normative statements—claims that attempt to prescribe how the world should be  Involves values as well as facts. A mix of positive analysis and judgments    Involves our views on ethics, religion, and political philosophy Economists in Washington o Economists’ advise isn’t straight forward because we face trade-offs  What helps someone now might hurt them later o Economists are involved in formulating spending plans, design tax policy, formulate labor-market policies, Congressional Budget Office, Federal Reserve (sets nation’s monetary policy) Why Economist’ Advice Is Not Always Followed o President hears what policy is best from his economic advisers, then gets other advisers related input, then how he proposes policy to the public, anticipate misunderstandings, how media responds, how Congress will view it an amend it Why Economists Disagree    Differences in Scientific Judgments o Economists may disagree about the validity of alternative positive theories o Sometimes disagree because they have different hunches about the validity of alternative theories or about the size of important parameters that measure how economic variables are related  Ex. switching to consumption tax would encourage houses to save more because not taxed, which would lead to growth in productivity and living standards. Others disagree because different positive views about saving responsiveness to tax incentives Differences in Values o Economists may have different values and therefore different normative views about what government policy should aim to accomplish o Ex. Peter makes 100,000 and pays $10,000 of income on taxes. Paula has 20,000 and pays $4,000 on taxes. BUT is her low income due to medical reasons or career choice. Is Peters income due to inheritance or working long hard hours at his job Perception versus Reality o Many economists will agree on an issue, but the public disagrees o Ex. rent ceilings on apartments. Economists say no since it limits quantity and quality available, but the cities still do it Let’s Get Going  Maynard Keynes o A master-economist must possess a rare combination of gifts—math, history, statesman, philosophy, understand symbols and speak in words, etc. Graphing: A Brief Review  Why graphs      o A way to visually express ideas that are less clear with equations or words o When analyzing data, graphs provide a way of finding and interpreting patterns Graphs of a Single Variable o Pie chart, Bar-Graph, and Time-Series Graph (over a period of time) Graphs of Two Variables: The Coordinate System (x,y) o Displays the relationship between variables o Positive correlation (move in the same direction) and negative correlation (move in opposite directions) Curves in the Coordinate System o Demand curve—traces the effect of a good’s price on the quantity of the good sold  One variable needs to remain constant to trace the relationship of the others o There is a difference between movement along the curve and shifts in the curve  When a variable that is not named on either axis changes, the curve shifts Slope o Change in y / change in x o The flatter the slope, the more the change affects the peoples behavior o The steeper the slope, the price doesn’t matter Cause and Effect o Omitted Variables    o Need to hold all variables constant except the one in question Correlation does not imply causation Ex. more lighter in house leads to cancer. But the idea is that more lighters means more smoking, which is what causes the cancer Reverse Causality  Ex. Would look at graph where more police is more violent  But fails to take into account that larger cities are more violent, so they need a large police force  Does the police cause crime or does crime cause police  Ex. Couples buy minivans in preparation for the baby, but the sale of minivans doesn’t cause population growth