principles of microeconomics - lecture - understanding how economists think

8/9/2019 Principles of Microeconomics - Lecture - Understanding How Economists Think

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Understanding How Economists Think

Chapter 2

Dr. Katherine Sauer

Principles of Microeconomics


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I. An Economist as a Scientist

Economists approach the study of the economy with

scientific objectivity.

- observe the world

- devise theories and formulate hypotheses

- collect data- test hypotheses


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Like all scientists, economists make appropriate

assumptions and build simplified modelsin order tounderstand the world around them.


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The economists lab is the world.

- cant design experiments for the whole economy

- can study the results of random events and policy

changes

The economy is a moving target.

- constantly changing

- true in the past may not be true in the future

There is an approach that can help you to understand the

economy, even if you cant predict its future.


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II. An Economist as a Policy Adviser

When economists are trying to explain the world, they are

scientists.

When they are trying to help improve it, they are policy

advisers.

Why is unemployment higher for teenagers than for older

workers?

What should the government do to improve the economic

well-being of teenagers?


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To help clarify the two roles that economists play, let's

examine the use of language.

Because scientists and policy advisers have different

goals, they use language in different ways.- objective vs subjective

Ex: The cost of Metros tuition is too high.

Ex: Metros tuition has increased since last year.


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1. Ask yourself Is the claim positive or normative?

A positive statement is a claim about what is, was, or will

be.

- objective (no value judgment/approval/disapproval)

- can be verified with data- can be false

- can be a prediction

A normative statement is a claim expressing a valuejudgment.

- subjective (value judgment)

- can not be verified


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Examples:

The cost of Metros tuition is too high.

Metros tuition has increased since last year.

Many economists believe that international trade is an

opportunity for an economy.

The US trade deficit is a problem.

The US exports more than it imports.


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2. Once you have determined if a claim is positive or

normative:

If it is positive:

- What evidence is there to support the claim?

- How reliable is the evidence?- Are there other ways of interpreting the evidence?

If it is normative:

- Is the normative claim based on positive claims?

- Are those claims supported by reliable evidence?


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How do economists affect policy?

~ Federal, State, and Local governments directly employ

economists.

~ Their research and writings often affect policy indirectly.

~ Sometimes their advice is not taken.

Making economic policy in a representative

democracy is a messy process.

- economic advice is only one part of the

information considered by policymakers


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Sometimes Economists Disagree

~ disagree about the validity of alternative positive

theories

Ex: a change in the tax code that would eliminatea tax on income and create a tax on consumption

- some think this would increase household

savings

- others think it would have little effect on

saving behavior


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~ have different values and therefore different normative

prescriptions

Ex: Suppose that Peter and Paula both take the same

amount of water from the town well.

To pay for maintaining the well, the town taxes itsresidents.

Peter has income of $50,000 and is taxed $5,000,

which is 10% of his income.

Paula has income of $10,000 and is taxed $2,000,

which is 20% of her income.


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Is this policy fair?

If not, who pays too much and who pays too little?

Does it matter whether Paula's low income is due to a

medical disability or to her decision to pursue a career

in acting?

Does it matter whether Peter's high income is due to a

large inheritance or to his willingness to work long

hours at a dreary job?

These are difficult questions on which people are likely

to disagree.


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III. The Circular Flow Diagram

{All economic models have assumptions. Models donotinclude every feature of the real world.}

Assumptions:

-2 types of economic actors- firms do all production

- households own all factors

- 2 types of markets

firms

households

goods &

services

factors of

production


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market for goods

& services

market for factors

of production

goods & services

land, labor, capitalfactors of production

products

revenue spending

wages, rent, profits income


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What could be added to this model to make it more likethe real world (and more complex)?

Even though the model is simple and missing many

features of the real world, how well does it capture the

essence of the flow of money and goods and services in

the economy?


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IV. The Production Possibilities Frontier (PPF) represents

the maximum output that an economy can produce with a

given level of resources and a given level of technology

Assumptions:

- 2 goods

- fixed level of factors

- fixed level of technology

{later we will change the level of factors and levelof technology and see how the PPF is changed}


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quantity of

consumer goods

quantity of

military

goods

PPF


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CG

MG

Points on the PPF are efficient.

Being efficient means

- all resources are employed

- resources arent being used

wastefully

A

B

C

D


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CG

MGPoints inside the PPF are

inefficient.- unemployed,

underemployed,

or wasted resources

A

B

C

D

E


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CG

MG

Points outside the PPF are

currently unobtainable.

A

B

C

D

E

F

{Societys preferences will determine the level of economic output.}


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1. Efficiency implies that an economy cant produce

more of one good without producing less of another.

CG

MG

A

B

C

D

Ex: If the economy is currently

producing at B and wants to

move to C, then it must forgothe production of some military

goods in order to produce more

consumer goods.

loss of MG

gain of CG


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2. Inefficiency implies that an economy can produce

more of one good without producing less of another.

CG

MG

A

B

C

D

Ex: If the economy is currently

producing at E, if it fully andefficiently uses all available

resources, it can produce B or C

without giving up any consumer

goods or military goods.

E


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CG

MG If the economy is

producing at point C and

moves to point B:

25 units of consumer

goods must be sacrificed

to gain 70 units of

military goods.

A

B

C

D

E

F175

150

80

75 100 110

3. Opportunity cost and the PPF


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CG

MGOpportunity cost is

whatever must be givenup to get something.

The total opportunity cost

of the additional 70

military goods is 25

consumer goods.

A

B

C

D

E

F175

150

80

75 100 110


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CG

MGThe opportunity cost of one

additional unit of military

goods isAB

C

D

E

F175

150

80

75 100 110

loss of 25 consumer goods

gain of 70 military goods

= 0.357 consumer goods


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General formula:

Opportunity Cost = loss of Z = ? units of Z

of 1 unit of A gain of A


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Calculate the total and per unit opportunity cost of

moving from point B to point D.

Calculate the total and per unit opportunity cost of

moving from point E to point B.


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4.Changes in the PPF

What happens if the level of resources or technology

changes?

The PPF will shift.

quantity of

good X

quantity of

good Y

PPF1

PPF2

Ex: - increase in resources

- increase in general

technology


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quantity of

good X

quantity of

good Y

PPF1

PPF2

Ex: - increase in resources used in the

production of good Y only

- increase in technology for producinggood Y only


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PPFs can have two shapes: bowed out or straight line

Straight line PPFs happen when the inputs go equallywell into the outputs

Y

X10 20 30 40

- constant opportunity

costs as you move fromleft to right


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Bowed outPPFs reflect that not all inputs go equally well

into all outputs.

Y

X10 20 30 40

- increasing opportunity

costs as you move from

left to right


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Summary

Economists try to address their subject with a scientists

objectivity.

Sometimes economists are called upon to be policy

advisers.


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A positive statement is an assertion about how the

world is.

A normative statement is an assertion about how theworld ought to be.


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One simple model of the economy as a whole is the

circular-flow diagram.

The Production Possibilities Frontier can be used to

illustrate efficiency, inefficiency, and unobtainable

outcomes for a nations output.


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On a half sheet of paper,

1. Note the concept from todays lecture that you find the

most fuzzy.

2. In your own words, describe how economists think.

principles of microeconomics - lecture - understanding how economists think

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