Chapter%202 - ECON1200: Principles of Microeconomics Fall...

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ECON1200: Principles of Microeconomics Instructor: Ramsey Abu-Absi Fall 2009 Notes: Mankiw 5e Chapter 2 Chapter 2 – Page 1 CHAPTER 2: Thinking Like an Economist (p. 21) The Economist as Scientist Economists employ the scientific method in developing and testing theories about how the economy works. The Scientific Method: Observation, Theory, and More Observation One difficulty in using the scientific method in economics is that experimentation can prove to be extremely difficult. Economists can’t manipulate the economy in order to test theories. Therefore, economists have to rely on the collection of data in order to test their theories. The Role of Assumptions Assumptions can distort reality, but they are important to make because they can make the world easier to understand. In order to obtain a basic understanding of economic principles, we will make many simplifying assumptions in this class. If one continues on to an advanced level of economic study, she will find that assumptions are gradually relaxed with the intention of investigating more realistic views of the economy. Any scientific discipline has an artistic side: the art of deciding which simplifying assumptions to make. The assumptions that are made should still provide a reasonably realistic view of the model being studied. Economic Models Economic models are most often composed of diagrams and equations. They omit many details in order to allow us to see what is important. These details are omitted in a systematic way by formulating assumptions that simplify reality in order to improve our understanding of it. Our First Model: The Circular -Flow Diagram The Circular Flow Diagram is a visual model of the economy that explains in general terms how the economy is organized and how economic agents interact with one another. Figure 1 on p. 25 depicts the circular flow. There are two types of decision-makers: households and firms. Firms produce goods and services using inputs such as labor, land and capital. Capital refers to buildings and machinery used in the production process. These inputs are called the factors of production . Households own the factors of production and consume the goods and services produced by firms. Households and firms interact in two types of markets.
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This note was uploaded on 06/23/2010 for the course ECON 1200 taught by Professor Cook during the Spring '08 term at Toledo.

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Chapter%202 - ECON1200: Principles of Microeconomics Fall...

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