# Chap02-TradeOffs&amp;Trade - Chapter 2 Economic Models...

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Chapter 2 Economic Models: Trade-Offs and Trade Chapter Objectives In this chapter, students will learn: " Why models - simplified representations of reality - play a crucial role in economics. " Three simple but important models: the production possibility frontier, comparative advantage, circular-flow diagram. " The difference between positive economics (which tries to describe the economy and predict its behavior), and normative economics (which tries to prescribe economic policy). " When and why economists might disagree. Chapter Outline Opening Ex: The Wright Brothers created a wind tunnel to test models of airplanes because testing models is faster, cheaper and safer than building and testing full-scale versions. Economists use models in the same way. A. Models in Economics: Some Important Examples - a model is a simplified representation of a real situation that is used to study that real situation - models are intended to be as simple as possible while still providing reasonable predictive power - models allow economists to see the effects of only one change at a time. - the other things equal assumption ( ceteris paribus ) is a simplification tool - means that all other relevant factors remain unchanged - marginal analysis: most economic analysis looks at some change from current conditions (i.e., change from the status quo) - economic models make use of mathematical tools, especially graphs. - proxies - using one variable as a stand-in for another (e.g., use of patents as an of measure of innovation) Graphs and their meaning : Supply and Demand - the most basic graph in economics looks at price verses 2 quantities 1- the quantity of goods/services demanded by consumers and 2- the quantity of goods/services supplied by producers but, we know that this is wrong e.g., income affects demand e.g,, cost of inputs affects supply - each point on the graph provides two pieces of information - each point specifies one price and one quantity - the Demand Curve -is a inverse or a negative relationship (down-sloping to the right) i.e., the variables move in opposite directions Demand vs. the quantity demanded - demand - refers to the entire demand curve - this is a relationship between price and the quantity demanded over a range of prices - quantity demanded - refers to one single point on the demand curve - this is the amount that consumers would demand at one particular price - the Supply Curve -is a direct or a positive relationship (up-sloping to the right) i.e., both variables move in the same direction

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