2Basic

Macro

econom

ics

Thin

kin

g L

ike a

n E

conom

ist

Thin

king L

ike a

n E

conom

ist

•E

conom

ics tra

ins y

ou to

. . . .

•T

hin

k in

term

s o

f alte

rna

tive

s.

•E

va

lua

te th

e c

ost o

f ind

ivid

ua

l an

d s

ocia

l ch

oic

es.

•E

xa

min

e a

nd

un

de

rsta

nd

ho

w c

erta

in e

ve

nts

an

d is

su

es a

re

rela

ted

.

TH

E E

CO

NO

MIS

T A

S A

SC

IEN

TIS

T

•T

he e

conom

ic w

ay o

f thin

kin

g . . .

•In

vo

lve

s th

inkin

g a

na

lytic

ally

an

d o

bje

ctiv

ely.

•M

ake

s u

se

of th

e s

cie

ntific

me

tho

d.

The S

cientific M

eth

od: O

bse

rvatio

n, T

heory, a

nd

More

Obse

rvatio

n

•U

ses a

bstra

ct m

odels

to h

elp

expla

in h

ow

a c

om

ple

x, re

al

world

opera

tes.

•D

evelo

ps th

eorie

s, c

olle

cts

, and a

naly

zes d

ata

to e

valu

ate

the th

eorie

s.

The R

ole

of A

ssum

ptio

ns

•E

conom

ists

make a

ssum

ptio

ns in

ord

er to

make th

e

world

easie

r to u

nders

tand.

•T

he a

rt in s

cie

ntific

thin

kin

g is

decid

ing w

hic

h

assum

ptio

ns to

make.

•E

conom

ists

use d

iffere

nt a

ssum

ptio

ns to

answ

er d

iffere

nt

questio

ns.

Eco

nom

ic Models

•E

conom

ists

use m

odels

to s

implify

reality

in o

rder to

impro

ve o

ur u

nders

tandin

g o

f the w

orld

•Tw

o o

f the m

ost b

asic

econom

ic m

odels

inclu

de:

•T

he

Circ

ula

r Flo

w D

iag

ram

•T

he

Pro

du

ctio

n P

ossib

ilities F

ron

tier

Our F

irst Model: T

he C

ircula

r-Flo

w D

iagra

m

•T

he c

ircu

lar-flo

w d

iag

ram

is a

vis

ual m

odel o

f the

econom

y th

at s

how

s h

ow

dolla

rs flo

w th

rough m

ark

ets

am

ong h

ousehold

s a

nd firm

s.

Fig

ure

1 T

he C

ircula

r Flo

w

Co

pyrig

ht ©

2004 S

ou

th-W

este

rn

Spendin

g

Goods a

nd

serv

ices

bought

Revenue

Goods

and s

erv

ices

sold

Labor, la

nd,

and c

apita

l

Incom

e

= F

low

of in

puts

and o

utp

uts

= F

low

of d

olla

rs

Facto

rs o

f

pro

ductio

n

Wages, re

nt,

and p

rofit

FIR

MS

•Pro

duce a

nd s

ell

goods a

nd s

erv

ices

•Hire

and u

se fa

cto

rs

of p

roductio

n

•Buy a

nd c

onsum

e

goods a

nd s

erv

ices

•Ow

n a

nd s

ell fa

cto

rs

of p

roductio

n

HO

US

EH

OLD

S

•Household

s s

ell

•Firm

s b

uy

MA

RK

ET

S

FO

R

FA

CT

OR

S O

F P

RO

DU

CT

ION

•Firm

s s

ell

•Household

s b

uy

MA

RK

ET

S

FO

R

GO

OD

S A

ND

SE

RV

ICE

S

Our F

irst Model: T

he C

ircula

r-Flo

w D

iagra

m

•F

irms

•P

rod

uce

an

d s

ell g

oo

ds a

nd

se

rvic

es

•H

ire a

nd

use

facto

rs o

f pro

du

ctio

n

•H

ousehold

s

•B

uy a

nd

co

nsu

me

go

od

s a

nd

se

rvic

es

•O

wn

an

d s

ell fa

cto

rs o

f pro

du

ctio

n

Our F

irst Model: T

he C

ircula

r-Flo

w D

iagra

m

•M

ark

ets

for G

oods a

nd S

erv

ices

•F

irms s

ell

•H

ou

se

ho

lds b

uy

•M

ark

ets

for F

acto

rs o

f Pro

ductio

n

•H

ou

se

ho

lds s

ell

•F

irms b

uy

Our F

irst Model: T

he C

ircula

r-Flo

w D

iagra

m

•F

acto

rs o

f Pro

ductio

n

•In

pu

ts u

se

d to

pro

du

ce

go

od

s a

nd

se

rvic

es

•L

an

d, la

bo

r, an

d c

ap

ital

Our S

eco

nd M

odel: T

he P

roductio

n P

ossib

ilities

Fro

ntie

r

•T

he p

rod

uctio

n p

ossib

ilities fro

ntie

ris

a g

raph th

at

show

s th

e c

om

bin

atio

ns o

f outp

ut th

at th

e e

conom

y c

an

possib

ly p

roduce g

iven th

e a

vaila

ble

facto

rs o

f pro

ductio

n

and th

e a

vaila

ble

pro

ductio

n te

chnolo

gy.

Fig

ure

2 T

he P

roductio

n P

ossib

ilities F

rontie

r

Co

pyrig

ht©

2003 S

ou

thw

este

rn/T

ho

mso

n L

earn

ing

Pro

du

ctio

n

po

ssib

ilities

fron

tier

A

B

C

Qu

an

tity o

f

Ca

rs P

rod

uc

ed

2,2

00

60

0

1,0

00

30

00

70

0

2,0

00

3,0

00

1,0

00

Qu

an

tity o

f

Co

mp

ute

rs

Pro

du

ce

d

D

Our S

eco

nd M

odel: T

he P

roductio

n P

ossib

ilities

Fro

ntie

r

•C

oncepts

Illustra

ted b

y th

e P

roductio

n P

ossib

ilities

Fro

ntie

r

•E

fficie

ncy

•T

rad

eo

ffs

•O

pp

ortu

nity

Co

st

•E

co

no

mic

Gro

wth

Fig

ure

3 A

Shift in

the P

roductio

n P

ossib

ilities F

rontie

r

Co

pyrig

ht ©

2004 S

ou

th-W

este

rn

E

Qu

an

tity o

f

Ca

rs P

rod

uc

ed

2,0

00

70

0

2,1

00

75

00

4,0

00

3,0

00

1,0

00

Qu

an

tity o

f

Co

mp

ute

rs

Pro

du

ce

d

A

Micro

eco

nom

ics and M

acro

eco

nom

ics

•M

icro

eco

no

mic

sfo

cuses o

n th

e in

div

idua

l parts

of th

e

econom

y.

•H

ow

ho

use

ho

lds a

nd

firms m

ake

de

cis

ion

s a

nd

ho

w th

ey in

tera

ct in

sp

ecific

ma

rke

ts

•M

acro

eco

no

mic

slo

oks a

t the e

conom

y a

s a

whole

.

•E

co

no

my-w

ide

ph

en

om

en

a, in

clu

din

g in

flatio

n, u

ne

mp

loym

en

t, an

d

eco

no

mic

gro

wth

TH

E E

CO

NO

MIS

T A

S P

OLIC

Y

AD

VIS

OR

•W

hen e

conom

ists

are

tryin

g to

expla

in th

e w

orld

, they a

re

scie

ntis

ts.

•W

hen e

conom

ists

are

tryin

g to

change th

e w

orld

, they a

re

polic

y a

dvis

or.

PO

SIT

IVE

VE

RS

US

NO

RM

AT

IVE

AN

ALY

SIS

•P

ositiv

e s

tate

me

nts

are

sta

tem

ents

that a

ttem

pt to

describ

e th

e w

orld

as it is

.

•C

alle

d d

escrip

tive

an

aly

sis

•N

orm

ativ

e s

tate

me

nts

are

sta

tem

ents

about h

ow

the

world

should

be.

•C

alle

d p

rescrip

tive

an

aly

sis

PO

SIT

IVE

VE

RS

US

NO

RM

AT

IVE

AN

ALY

SIS

•P

ositiv

e o

r Norm

ativ

e S

tate

ments

?

•A

n in

cre

ase

in th

e m

inim

um

wa

ge

will c

au

se

a d

ecre

ase

in

em

plo

ym

en

t am

on

g th

e le

ast-s

kille

d.

PO

SIT

IVE

•H

igh

er fe

de

ral b

ud

ge

t de

ficits

will c

au

se

inte

rest ra

tes to

incre

ase

.

PO

SIT

IVE

?

??

PO

SIT

IVE

VE

RS

US

NO

RM

AT

IVE

AN

ALY

SIS

•P

ositiv

e o

r Norm

ativ

e S

tate

ments

?

•T

he

inco

me

ga

ins fro

m a

hig

he

r min

imu

m w

ag

e a

re w

orth

mo

re

tha

n a

ny s

ligh

t red

uctio

ns in

em

plo

ym

en

t.

NO

RM

AT

IVE

•S

tate

go

ve

rnm

en

ts s

ho

uld

be

allo

we

d to

co

llect fro

m to

ba

cco

co

mp

an

ies th

e c

osts

of tre

atin

g s

mo

kin

g-re

late

d illn

esse

s a

mo

ng

th

e p

oo

r.

NO

RM

AT

IVE

?

??

WH

Y E

CO

NO

MIS

TS

DIS

AG

RE

E

•T

hey m

ay d

isagre

e a

bout th

e v

alid

ity o

f alte

rnativ

e

positiv

e th

eorie

s a

bout h

ow

the w

orld

work

s.

•T

hey m

ay h

ave d

iffere

nt v

alu

es a

nd, th

ere

fore

, diffe

rent

norm

ativ

e v

iew

s a

bout w

hat p

olic

y s

hould

try to

accom

plis

h.

Table

2 Te

n P

ropositio

ns a

bout W

hich

Most E

conom

ists Agre

e

Co

pyrig

ht ©

2004 S

ou

th-W

este

rn

Sum

mary

•E

conom

ists

try to

addre

ss th

eir s

ubje

cts

with

a s

cie

ntis

t’s

obje

ctiv

ity.

•T

he

y m

ake

ap

pro

pria

te a

ssu

mp

tion

s a

nd

bu

ild s

imp

lified

mo

de

ls in

o

rde

r to u

nd

ers

tand

the

wo

rld a

rou

nd

the

m.

•T

wo

sim

ple

eco

no

mic

mo

de

ls a

re th

e c

ircu

lar-flo

w d

iag

ram

an

d th

e

pro

du

ctio

n p

ossib

ilities fro

ntie

r.

Sum

mary

•E

conom

ics is

div

ided in

to tw

o s

ubfie

lds:

•M

icro

eco

nom

ists

stu

dy d

ecis

ion

ma

kin

g b

y h

ou

se

ho

lds a

nd

firms in

th

e m

ark

etp

lace.

•M

acro

econ

om

ists

stu

dy th

e fo

rce

s a

nd

tren

ds th

at a

ffect th

e

eco

no

my a

s a

wh

ole

Sum

mary

•A

positiv

e s

tate

ment is

an a

ssertio

n a

bout h

ow

the w

orld

is.

•A

norm

ativ

e s

tate

ment is

an a

ssertio

n a

bout h

ow

the

world

ought to

be.

•W

hen e

conom

ists

make n

orm

ativ

e s

tate

ments

, they a

re

actin

g m

ore

as p

olic

y a

dvis

ors

than s

cie

ntis

ts.

Sum

mary

•E

conom

ists

who a

dvis

e p

olic

ym

akers

offe

r conflic

ting

advic

e e

ither b

ecause o

f diffe

rences in

scie

ntific

judgm

ents

or b

ecause o

f diffe

rences in

valu

es.

•A

t oth

er tim

es, e

conom

ists

are

unite

d in

the a

dvic

e th

ey

offe

r, but p

olic

ym

akers

may c

hoose to

ignore

it.