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3 (24) - CHAPTER 2 ECONOMIC MODELS TRADE-OFFS AND TRADE 41...

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Unformatted text preview: CHAPTER 2 ECONOMIC MODELS: TRADE-OFFS AND TRADE 41 — CHECK YOUR UNDERSTANDING 2-2 1. I.ifhich of the following statements is a positive statement? Which is a normative statement? a. Society should take measures to prevent people from engaging in dangerous personal behavior. b. People who engage in dangerous personal behavior impose higher costs on society through higher medical costs. 2. True or false? Explain your answer. a. Policy choice A and policy choice B attempt to achieve the same social goal. Policy choice A, however, results in a much less efficient use of resources than policy choice B. Therefore, economists are more likely to agree on choosing policy choice B. b. when two economists disagree on the desirability of a policy, it’s typically because one of them has made a mistake. c. Policy makers can always use economies to figure out which goals a society should try to achieve. [so A Lookm This chapter has given you a first view of what it means to do economics, starting with the general idea of models as a way to make sense of a complicated world and then moving on to two simple introductory models. Solutions appear at back of book. To get a real sense of how economic analysis works, however, and to show just how useful such analysis can be. we need to move on to a more powerful model. In the next two chapters we will study the quintessential economic model, one that has an amaz- ing ability to make sense of many policy issues, predict the effects of many forces. and change the way you look at the world. That model is known as I‘supply and demand."] 1. 2. Almost all economics is based on models. “thought experiments" or simplified versions of reality. many of which use mathematical tools such as graphs. An impor- tant assumption in economic models is the other things equal assumption, which allows analysis of the effect of a change in one factor by holding all other relevant fac- tors unchanged. One important economic model is the production possi- bility frontier. It illustrates: opportunity cost (showing how much less of one good can be produced if more of the other good is produced); efl‘iciency (an economy is efficient in production if it produces on the production possibility frontier and efficient in allocation if it produces the mix of goods and services that people want to consume): and economic growth (an outward shift of the production possi- bility frontier). There are two basic sources of growth: an increase in factors of production, resources such as land, labor, capital. and human capital, inputs that are not used up in production, and improved technology. Another important model is comparative advantage. which explains the source of gains from trade between individuals and countries. Everyone has a comparative advantage in something—some good or service in which that person has a lower opportunity cost than everyone 4. 5. else. But it is often confused with absolute advantage, an ability to produce a particular good or service better than anyone else. This confusion leads some to erro- neously conclude that there are no gains from trade between people or countries. In the simplest economies people barber—trade goods and services for one another—rather than trade them for money, as in a modern economy. The circular-flow diagram represents transactions within the economy as flows of goods. services. and money between households and firms. These transactions occur in markets for goods and services and factor markets, markets for factors of production—land. labor, capital. and human capital. It is useful in understanding how spending. production. employment, income. and growth are related in the econo- my. Ultimately, factor markets determine the economy’s income distribution, how an economy’s total income is allocated to the owners of the factors of production. Economists use economic models for both positive economics. which describes how the economy works, and for normative economies, which prescribes how the economy should work. Positive economics often involves making forecasts. Economists can determine correct answers for positive questions, but typically not ...
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