15
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WHAT’S NEW IN THE SIXTH EDITION:
There are some updates to the
FYI
on Who Studies Economics? There is a new
In the News
on “The
Economics of President Obama.” Table 1 has been updated and expanded.
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
➢ how economists apply the methods of science.
➢ how assumptions and models can shed light on the world.
CONTEXT AND PURPOSE:
Chapter 2 is the second chapter in a three chapter section that serves as the introduction of the text.
Chapter 1 introduced ten principles of economics that will be revisited throughout the text. Chapter 2
develops how economists approach problems while Chapter 3 will explain how individuals and countries
gain from trade.
2
THINKING LIKE AN ECONOMIST
16 ❖ Chapter 2/Thinking Like an Economist
KEY POINTS:
• Economists try to address their subject with a scientist’s objectivity. Like all scientists, they make
appropriate assumptions and build simplified models in order to understand the world around them.
Two simple economic models are the circular-flow diagram and the production possibilities frontier.
CHAPTER OUTLINE:
I. The Economist as Scientist
A. Economists Follow the Scientific Method.
1. Observations help us to develop theory.
2. Data can be collected and analyzed to evaluate theories.
B. Assumptions Make the World Easier to Understand.
1. Example: to understand international trade, it may be helpful to start out assuming that
there are only two countries in the world producing only two goods. Once we understand
how trade would work between these two countries, we can extend our analysis to a greater
number of countries and goods.
Chapter 2/Thinking Like an Economist ❖ 17
1. Most economic models are composed of diagrams and equations.
1. Definition of circular-flow diagram: a visual model of the economy that shows how
dollars flow through markets among households and firms.
Figure 1
To illustrate to the class how simple but unrealistic models can be useful, bring a
road map to class. Point out how unrealistic it is. For example, it does not show
18 ❖ Chapter 2/Thinking Like an Economist
2. This diagram is a very simple model of the economy. Note that it ignores the roles of
government and international trade.
a. There are two decision makers in the model: households and firms.
E. Our Second Model: The Production Possibilities Frontier
1. Definition of 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.
2. Example: an economy that produces two goods, cars and computers.
a. If all resources are devoted to producing cars, the economy would produce 1,000 cars
and zero computers.
Spend more time with this model than you think is necessary. Be aware that the
Figure 2
Chapter 2/Thinking Like an Economist ❖ 19
3. Because resources are scarce, not every combination of computers and cars is possible.
Production at a point outside of the curve (such as C) is not possible given the economy’s
current level of resources and technology.
ALTERNATIVE CLASSROOM EXAMPLE:
A small country produces two goods: mp3 players and music downloads. Points on a
production possibilities frontier can be shown in a table or a graph:
Points inside the curve, points on the curve, and points outside of the curve can also be
discussed.
You may want to include time dimensions for variables. This will help students to
realize that a new production possibilities frontier occurs for each period. Thus, the
axes show the levels of output per period.
20 ❖ Chapter 2/Thinking Like an Economist
6. The production possibilities frontier reveals Principle #1: People face trade-offs.
a. Suppose the economy is currently producing 600 cars and 2,200 computers.
b. To increase the production of cars to 700, the production of computers must fall to
2,000.
7. Principle #2 is also shown on the production possibilities frontier: The cost of something is
what you give up to get it (opportunity cost).
8. The opportunity cost of a car depends on the number of cars and computers currently
produced by the economy.
9. Economists generally believe that production possibilities frontiers often have this bowed-out
shape because some resources are better suited to the production of cars than computers
(and vice versa).
It is useful to point out that the production possibilities frontier depends on two
things: the availability of resources and the level of technology.
Be aware that students often have trouble understanding why opportunity costs rise
Chapter 2/Thinking Like an Economist ❖ 21
10. The production possibilities frontier can shift if resource availability or technology changes.
Economic growth can be illustrated by an outward shift of the production possibilities
frontier.
F. Microeconomics and Macroeconomics
1. Economics is studied on various levels.
a. Definition of microeconomics: the study of how households and firms make
decisions and how they interact in markets.
A Knight’s Tale, Chapter 2.
William (played by Heath Ledger) and two friends
have won some coins in a jousting tournament. He convinces his friends to forgo
You may also want to teach students about budget constraints at this time (call them
“consumption possibilities frontiers”). This reinforces the idea of opportunity cost,
Figure 3
ALTERNATIVE CLASSROOM EXAMPLE:
Ivan receives an allowance from his parents of $20 each week. He spends his entire
allowance on two goods: ice cream cones (which cost $2 each) and tickets to the movies
(which cost $10 each).
22 ❖ Chapter 2/Thinking Like an Economist
G.
FYI: Who Studies Economics?
1. Economics can seem abstract at first, but it is fundamentally very practical and the study of
economics is useful in many different career paths.
II. The Economist as Policy Adviser
A. Positive versus Normative Analysis
1. Example of a discussion of minimum–wage laws: Polly says, “Minimum-wage laws cause
unemployment.” Norma says, “The government should raise the minimum wage.”
2. Definition of positive statements: claims that attempt to describe the world as it is.
6. Much of economics is positive; it tries to explain how the economy works. But those who use
economics often have goals that are normative. They want to understand how to improve
the economy.
B. Economists in Washington
Use several examples to illustrate the differences between positive and normative
statements and stimulate classroom discussion. Possible examples include the
minimum wage, budget deficits, tobacco taxes, legalization of marijuana, and seat–
belt laws.
Chapter 2/Thinking Like an Economist ❖ 23
3. Economists are also employed by administrative departments within the various federal
agencies such as the Office of Management and Budget, the Department of Treasury, the
Department of Labor, the Congressional Budget Office, and the Federal Reserve.
C. Why Economists’ Advice Is Not Always Followed
1. The process by which economic policy is made differs from the idealized policy process
assumed in textbooks.
III. Why Economists Disagree
A. Differences in Scientific Judgments
1. Economists may disagree about the validity of alternative positive theories or about the size
of the effects of changes in the economy on the behavior of households and firms.
B. Differences in Values
C. Perception versus Reality
1. While it seems as if economists do not agree on much, this is in fact not true. Table 1
contains 20 propositions that are endorsed by a majority of economists.
Table 1
24 ❖ Chapter 2/Thinking Like an Economist
IV.
In the News: Environmental Economics
A. Some economists are working on ways to help save the planet.
V. Appendix—Graphing: A Brief Review
A. Graphs of a Single Variable
1. Pie Chart
2. Bar Graph
1. Economists are often concerned with relationships between two or more variables.
2. Ordered pairs of numbers can be graphed on a two-dimensional grid.
a. The first number in the ordered pair is the
x
-coordinate and tells us the horizontal
location of the point.
Many instructors may be unaware of how much trouble beginning students have
grasping the most basic graphs. It is important for instructors to make sure that
students are comfortable with these techniques.
Figure A-1
Figure A-2
Chapter 2/Thinking Like an Economist ❖ 25
5. Two variables that move in opposite directions (one increases when the other decreases)
have a negative correlation.
a. An example of this is a demand curve.
1. We may want to ask how strongly a consumer reacts if the price of a product changes.
a. If the demand curve is very steep, the quantity desired does not change much in
response to a change in price.
b. If the demand curve is very flat, the quantity desired changes a great deal when the
price changes.
Table A-1
Figure A-3
Figure A-4
Figure A-5
26 ❖ Chapter 2/Thinking Like an Economist
E. Cause and Effect
1. Economists often make statements suggesting that a change in Variable A causes a change
in Variable B.
a. If Variables A and B both change at the same time, we may conclude that the change in
Variable A caused the change in Variable B.
a. If Variable A and Variable B both change at the same time, we may believe that the
change in Variable A led to the change in Variable B.
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
1. Economics is like a science because economists devise theories, collect data, and analyze the data in
an attempt to verify or refute their theories. In other words, economics is based on the scientific
method.
Figure A-6
Figure A-7
There are two very good examples in the text that you should use in class. To
discuss the omitted variable problem, point out to students that a rise in the sales of
Chapter 2/Thinking Like an Economist ❖ 27
The effects of a drought are shown in Figure 2. The drought reduces the amount of food that can be
produced, shifting the production possibilities frontier inward. (If a drought also reduced the amount
of cotton available for the production of clothing, the intercept on the vertical axis would also
decrease.)
2. An example of a positive statement is “a higher price of coffee causes me to buy more tea.” It is a
positive statement because it is a claim that describes the world as it is. An example of a normative
28 ❖ Chapter 2/Thinking Like an Economist
statement is “the government should restrain coffee prices.” It is a normative statement because it is
a claim that prescribes how the world should be. Many other examples are possible.
3. Economic advisers to the president might disagree about a question of policy because of differences
in scientific judgments or differences in values.
Questions for Review
1. Economics is like a science because economists use the scientific method. They devise theories,
2. Economists make assumptions to simplify problems without substantially affecting the answer.
Assumptions can make the world easier to understand.
4. There are many possible answers.
5. There are many possible answers.
Chapter 2/Thinking Like an Economist ❖ 29
7. An outcome is efficient if the economy is getting all it can from the scarce resources it has available.
In terms of the production possibilities frontier, an efficient point is a point on the frontier, such as
Figure 4
8. The two subfields in economics are microeconomics and macroeconomics. Microeconomics is the
9. Positive statements are descriptive and make a claim about how the world is, while normative
10. Economists sometimes offer conflicting advice to policymakers for two reasons: (1) economists may
disagree about the validity of alternative positive theories about how the world works; and
(2) economists may have different values and, therefore, different normative views about what public
policy should try to accomplish.
30 ❖ Chapter 2/Thinking Like an Economist
Problems and Applications
1. See Figure 5; the four transactions are shown.
2. a. Figure 6 shows a production possibilities frontier between guns and butter. It is bowed out
because the opportunity cost of butter depends on how much butter and how many guns the
economy is producing. When the economy is producing a lot of butter, workers and machines
best suited to making guns are being used to make butter, so each unit of guns given up yields a
small increase in the production of butter. Thus, the frontier is steep and the opportunity cost of
producing butter is high. When the economy is producing a lot of guns, workers and machines
best suited to making butter are being used to make guns, so each unit of guns given up yields a
large increase in the production of butter. Thus, the frontier is very flat and the opportunity cost
of producing butter is low.
Chapter 2/Thinking Like an Economist ❖ 31
c. The Hawks might choose a point like H, with many guns and not much butter. The Doves might
choose a point like D, with a lot of butter and few guns.
3. See Figure 7. The shape and position of the frontier depend on how costly it is to maintain a clean
environment⎯the productivity of the environmental industry. Gains in environmental productivity,
such as the development of new way to produce electricity that emits fewer pollutants, lead to shifts
of the production-possibilities frontier, like the shift from PPF1 to PPF2 shown in the figure.
4. a. A: 40 lawns mowed; 0 washed cars
B: 0 lawns mowed, 40 washed cars
C: 20 lawns mowed; 20 washed cars
D: 25 lawns mowed; 25 washed cars
b. The production possibilities frontier is shown in Figure 8. Points A, B, and D are on the frontier,
while point C is inside the frontier.
5. a. A family’s decision about how much income to save is related to microeconomics.
b. The effect of government regulations on auto emissions is related to microeconomics.
32 ❖ Chapter 2/Thinking Like an Economist
6. a. The statement that society faces a short-run trade-off between inflation and unemployment is a
positive statement. It deals with how the economy
is
, not how it should be. Since economists
have examined data and found that there is a short-run negative relationship between inflation
and unemployment, the statement is a fact, thus it is a positive statement.
b. The statement that a reduction in the rate of money growth will reduce the rate of inflation is a
positive statement. Economists have found that money growth and inflation are very closely
related. The statement thus tells how the world is, and so it is a positive statement.
7. As the president, you would be interested in both the positive and normative views of economists,
but you would probably be
most
interested in their positive views. Economists are on your staff to