The role of assumptions assumptions make the world

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The Role of Assumptions Assumptions make the world easier to understand. The art in scientific thinking is deciding which assumptions to make. Economists use different assumptions to answer different questions 1.Example: to understand international trade, it may be helpful to start out assuming that there are only two countries in the world producing only two goods. Once we understand how trade would work between these two countries, we can extend our analysis to a greater number of countries and goods. 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.
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Economic Models Economists use economic models to explain the world around us. 1.Most economic models are composed of diagrams and equations. 2.The goal of a model is to simplify reality in order to increase our understanding. This is where the use of assumptions is helpful. Our First Model: The Circular Flow Diagram Circular-flow diagram -- a visual model of the economy that shows how dollars flow through markets among households and firms. For an example of circular flow diagram refer to the PowerPoint slide There are two decision makers in the model: households and firms. Households (consumers) try to maximize their satisfaction (utility) given limited resources. Firms (businesses) try to maximize profits by using resources efficiently in producing goods. There are two markets: the market for goods and services and the market of factors of production. Factor Markets any place where factors of production (i.e., land, labor, and capital) are bought and sold. Product Markets any place where finished goods and services (products) are bought and sold. Firms are sellers in the market for goods and services and buyers in the market for factors of production. Households are buyers in the market for goods and services and sellers in the market for factors of production. Dollars and Exchange - nearly every market transaction involves an exchange of dollars for goods or resources. Money thus plays a critical role in facilitating market exchanges and the specialization they permit. Locating Markets a market exists wherever and whenever an exchange takes place. This diagram is a very simple model of the economy. Note that it ignores the roles of government and international trade. Our Second Model: The Production Possibilities Frontier The production possibility frontier (PPF) illustrates the trade-offs facing an economy that produces only two goods. The PPF shows the maximum quantity of one good that can be produced for any given production of the other. It assumes that all resources are used full and efficiently.
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  • Spring '12
  • Green
  • Economics, production possibilities, Economists

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