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Chapter 2 - Thinking like an economist

Chapter 2 - Thinking like an economist - Chapter 2 Thinking...

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Chapter Thinking Like an Economist 2
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The Economist as a Scientist Economics = science Economists = scientists Devise theories Collect data Analyze these data Verify or refute their theories Scientific method Dispassionate development and testing of theories about how the world works 2
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The Economist as a Scientist The scientific method: observation, theory, and more observation Observation Theory Conducting experiments Difficult / impossible Observation Close attention to natural experiments - history 3
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The Economist as a Scientist The role of assumptions Assumptions Can simplify the complex world Make it easier to understand Focus our thinking - essence of the problem Different assumptions To answer different questions Short-run effects Long-run effects 4
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The Economist as a Scientist Economic models Diagrams & equations Omit many details Allow us to see what’s truly important Built with assumptions Simplify reality to improve our understanding of it 5
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The Economist as a Scientist Our first model: The circular-flow diagram Circular-flow diagram Visual model of the economy Shows how dollars flow through markets among households and firms Decision makers Firms & Households Markets For gods and services For factors of production 6
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The Economist as a Scientist Our first model: The circular-flow diagram Firms Produce goods and services Use factors of production / inputs Households Own factors of production Consume goods and services 7
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The Economist as a Scientist Our first model: The circular-flow diagram Markets for goods and services Firms – sellers Households – buyers Markets for inputs Firms – buyers Households - sellers 8
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Figure The circular flow 1 9 This diagram is a schematic representation of the organization of the economy. Decisions are made by households and firms. Households and firms interact in the markets for goods and services (where households are buyers and firms are sellers) and in the markets for the factors of production (where firms are buyers and households are sellers). The outer set of arrows shows the flow of dollars, and the inner set of arrows shows the corresponding flow of inputs and outputs.
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The Economist as a Scientist Our second model: The production possibilities frontier Production possibilities frontier A graph Combinations of output that the economy can possibly produce Given the available Factors of production Production technology 10
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Figure The production possibilities frontier 2 11 Quantity of Computers Produced Quantity of Cars Produced 0 300 600 700 1,000 3,000 A B C D E F 1,000 2,200 2,000 Production Possibilities Frontier The production possibilities frontier shows the combinations of output - in this case, cars and computers - that the economy can possibly produce.
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