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WHAT’S NEW IN THE EIGHTH EDITION:
There is a new
Ask the Experts
feature on “Ticket Resale.”
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.
➢ two simple models—the circular flow and the production possibilities frontier.
➢ the difference between microeconomics and macroeconomics.
➢ the difference between positive and normative statements.
➢ the role of economists in making policy.
➢ why economists sometimes disagree with one another.
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.
The purpose of Chapter 2 is to familiarize students with how economists approach economic
problems. With practice, they will learn how to approach similar problems in this dispassionate systematic
2
THINKING LIKE AN ECONOMIST
14 ❖ 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 to understand the world around them. Two
simple economic models are the circular-flow diagram and the production possibilities frontier.
• The field of economics is divided into two subfields: microeconomics and macroeconomics.
Microeconomists study decision making by households and firms and the interactions among
households and firms in the marketplace. Macroeconomists study the forces and trends that affect
the economy as a whole.
• A positive statement is an assertion about how the 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 advisers than as scientists.
CHAPTER OUTLINE:
I. The Economist as Scientist
A. Economists Follow the Scientific Method.
2. Data can be collected and analyzed to evaluate theories.
3. Using data to evaluate theories is more difficult in economics than in physical science
4. Thus, economists pay close attention to the natural experiments offered by history.
B. Assumptions Make the World Easier to Understand.
1. Example: to understand international trade, it may be helpful to start out assuming that
2. One important role of a scientist is to understand which assumptions one should make.
3. Economists often use assumptions that are somewhat unrealistic but will have small effects
on the actual outcome of the answer.
C. Economists Use Economic Models to Explain the World around Us.
Chapter 2/Thinking Like an Economist ❖ 15
1. Most economic models are composed of diagrams and equations.
2. The goal of a model is to simplify reality to increase our understanding. Assumptions help to
simplify reality.
D. Our First Model: The Circular Flow Diagram
1. Definition of circular-flow diagram: a visual model of the economy that shows how
dollars flow through markets among households and firms.
2. This diagram is a very simple model of the economy. Note that it ignores the roles of
government and international trade.
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
where all of the stop signs, gas stations, or restaurants are located. It assumes that
the earth is flat and two-dimensional. But, despite these simplifications, a map
usually helps travelers get from one place to another. Thus, it is a good model.
Figure 1
16 ❖ Chapter 2/Thinking Like an Economist
a. There are two decision makers in the model: households and firms.
b. There are two markets: the market for goods and services and the market for factors of
production.
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 students
need to feel confident with this first graphical and mathematical model. Be deliberate
with every point. If you lose them with this model, they may be gone for the rest of
the course.
Chapter 2/Thinking Like an Economist ❖ 17
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.
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. The axes
show the levels of output per period.
A
B
C
D
E
mp3 Players
0
100
200
300
400
Music Downloads
70,000
60,000
45,000
25,000
0
Figure 2
18 ❖ Chapter 2/Thinking Like an Economist
4. Production is efficient at points on the curve (such as A and B). This implies that the
economy is getting all it can from the scarce resources it has available. There is no way to
produce more of one good without producing less of another.
5. Production at a point inside the curve (such as D) is inefficient.
a. This means that the economy is producing less than it can from the resources it has
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.
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.
a. The opportunity cost of a car is high when the economy is producing many cars and few
computers.
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
as the production of a good increases. You may want to use several specific
examples of resources that are more suited to producing cars than computers
(e.g., an experienced mechanic) as well as examples of resources that are more
suited to producing computers than cars (e.g., an experienced computer
programmer).
Chapter 2/Thinking Like an Economist ❖ 19
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.
II. The Economist as Policy Adviser
A. Positive versus Normative Analysis
Figure 3
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,
and allows them to see how opportunity cost can be measured by the slope. Also, it
will introduce students to the use of straight-line production possibilities frontiers
(which appear in Chapter 3). However, be careful if you choose to do this as students
often find the difference between straight-line and concave production possibilities
frontiers challenging.
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).
Students should be asked to calculate the opportunity cost of one movie and the opportunity
cost of one ice cream cone.
1. Example of a discussion of minimum-wage laws: Portia says, “Minimum-wage laws cause
unemployment.” Noah 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
1. Economists are aware that trade-offs are involved in most policy decisions.
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
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.
Have students bring in newspaper articles and in groups, identify each statement in
an editorial paragraph as being a positive or normative statement. Discuss the
differences among news stories, editorials, and blogs and the analogy to economists
as scientists and as policy advisers.
Chapter 2/Thinking Like an Economist ❖ 21
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.
2. Almost all economists believe that rent control adversely affects the availability and quality of
housing.
3. Most economists also oppose barriers to trade.
D.
Ask the Experts: Ticket Resale
IV. In the News: Why You Should Study Economics
1. Training in economics helps us to understand fallacies and to anticipate unintended
consequences.
V. Appendix—Graphing: A Brief Review
A. Graphs of a Single Variable
Table 1
Use the “Ask the Expert” questions and responses from economists throughout the
text to spark discussions. In this case, ask students their opinion on ticket scalping
laws. Discuss the opportunity for potential audience members to pay a price higher
than the stated ticket price to be able to attend the event rather than be excluded
from the event because there are no more tickets available at the stated ticket price.
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.
22 ❖ Chapter 2/Thinking Like an Economist
1. Pie Chart
B. Graphs of Two Variables: The Coordinate System
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.
b. The second number in the ordered pair is the
y
-coordinate and tells us the vertical
location of the point.
3. The point with both an
x
-coordinate and
y
-coordinate of zero is called the origin.
C. Curves in the Coordinate System
1. Often, economists want to show how one variable affects another, holding all other variables
constant.
a. An example of this is a demand curve.
b. The demand curve shows how the quantity of a good a consumer wants to purchase
varies as its price varies, holding everything else (such as income) constant.
Figure A-1
Figure A-2
Table A-1
Figure A-3
Chapter 2/Thinking Like an Economist ❖ 23
D. Slope
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.
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.
4. Another problem is reverse causality.
Figure A-4
Figure A-5
Figure A-6
Figure A-7
24 ❖ Chapter 2/Thinking Like an Economist
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.
b. However, it is entirely possible that the change in Variable B led to the change in Variable
A.
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 1 shows the production possibilities frontier for a society that produces food and clothing.
Point A is an efficient point (on the frontier), point B is an inefficient point (inside the frontier), and
point C is an infeasible point (outside the frontier).
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
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
cigarette lighters is positively related to the number of individuals diagnosed with
lung cancer. To discuss reverse causality, show that an increase in minivan sales is
followed by an increase in birth rates.
Chapter 2/Thinking Like an Economist ❖ 25
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
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.
Chapter Quick Quiz
1. c
Questions for Review
1. Economics is a science because economists use the scientific method. They devise theories, collect
data, and then analyze these data in an attempt to verify or refute their theories about how the world
26 ❖ Chapter 2/Thinking Like an Economist
6. Figure 3 shows a production possibilities frontier between milk and cookies (
PPF
1). If a disease kills
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
Chapter 2/Thinking Like an Economist ❖ 27
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
Markets for
28 ❖ 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 of the law of increasing opportunity costs. As the economy moves from producing many
guns and a little butter (point H) to producing fewer guns and more butter (point D), the
opportunity cost of each additional unit of butter increases because the resources best suited to
producing guns are shifting toward the production of butter. Thus, the number of guns given up
to produce one more unit of butter is increasing.
Markets for
a. $1
c. $40
a. $1
c. $40
Chapter 2/Thinking Like an Economist ❖ 29
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.
Figure 7 Figure 8
4. a. A: 40 lawns mowed; 0 washed cars
B: 0 lawns mowed, 40 washed cars
30 ❖ Chapter 2/Thinking Like an Economist
6. a. The statement that society faces a short-run trade-off between inflation and unemployment is a
b. The statement that a reduction in the rate of money growth will reduce the rate of inflation is a