THINKING LIKE AN ECONOMIST Chapter 2 Copyright © 2014 by Nelson Education Ltd.2-1

THINKING LIKE AN ECONOMIST

Chapter 2

Copyright © 2014 by Nelson Education Ltd. 2-1

THINKING LIKE AN ECONOMIST

Before delving into the substance and details of economics, it is helpful to have an overview of how economists approach the world.

This chapter, therefore, discusses the field’s methodology.

What is distinctive about how economists confront a question?

What does it mean to think like an economist?


THE ECONOMIST AS SCIENTIST

Economists try to address their subject with a scientist’s objectivity.


The Scientific Method

The scientific method involves observation, theory, and more observation.

Economists use theory and observation like other scientists, but they do face an obstacle that makes their task especially challenging: Experiments are often difficult in

economics.

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The Role of Assumptions

Assumptions can simplify the complex world and make it easier to understand.

The art in scientific thinking is deciding which assumptions to make.


Economic Models

Economists also use models to learn about the world that are most often composed of diagrams and equations.

Economic models omit many details to allow us to see what is truly important.

All the models are built with assumptions.


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


FIGURE 2.1:The Circular Flow


Our Second Model: The Production Possibilities Frontier

Production Possibility Frontier: a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology


FIGURE 2.2: The Production Possibilities Frontier


FIGURE 2.3:A Shift in the Production Possibilities Frontier


Microeconomics and Macroeconomics

Microeconomics: the study of how households and firms make decisions and how they interact in markets

Macroeconomics: the study of economy-wide phenomena, including inflation, unemployment, and economic growth


QuickQuiz

In what sense is economics like a science?

Draw a production possibilities frontier for a society that produces food and clothing.

Show an efficient point, an inefficient point, and an infeasible point.

Show the effects of a drought.

Define microeconomics and macroeconomics.

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THE ECONOMIST AS 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.


Positive versus Normative Analysis

Positive statements: claims that attempt to describe the world as it is

Normative statements: claims that attempt to prescribe how the world should be



Which of these statements are“positive”and which are “normative”? How can you tell the difference?

a. Prices rise when the government increases the quantity of money.

b. The government should print less money.

c. A tax cut is needed to stimulate the economy.

d. An increase in the price of burritos will cause an increase in consumer demand for video rentals.

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Active Learning Discussion Questions


a. Prices rise when the government increases the quantity of money.

Positive: describes a relationship, could use data to confirm or refute

b. The government should print less money.

Normative: this is a value judgment, cannot be confirmed or refuted

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Active Learning Answers


c. A tax cut is needed to stimulate the economy.

Normative: another value judgment

d. An increase in the price of burritos will cause an increase in consumer demand for video rentals.

Positive: describes a relationship

Note: A statement need not be true to be positive.

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Active Learning Answers

TABLE 2.1:Websites of Some Major Economic Organizations


Why Economists’ Advice Is Not Always Followed

Any economist who advises government knows that his or her recommendations are not always heeded.

In the real world, figuring out the right policy is only part of the job for the government.


QuickQuiz

Give an example of a positive statement and an example of a normative statement.

Name three parts of government that regularly rely on advice from economists.

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WHY ECONOMISTS DISAGREE

There are two basic reasons: They can disagree about

the validity of alternative positive theories about how the world works.

They can have different values and, therefore, different normative views about what a policy should

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Differences in Scientific Judgments

Economists often disagree about the direction in which truth lies.

For example, economists disagree about whether the government should levy taxes based on a household’s income or its consumption.


Differences in Values

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 its residents. Peter has income of $50 000 and is taxed $5000, or 10 percent of his income. Paula has income of $10 000 and is taxed $2000, or 20 percent of her income.

Is this policy fair?

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


Perception versus Reality

Because of differences in scientific judgments and differences in values, some disagreement among economists is inevitable.

But they do often share a common view.



1. A ceiling on rents reduces the quantity and quality of housing available. (93 percent)

2. Tariffs and import quotas usually reduce general economic welfare. (93 percent)

3. Flexible and floating exchange rates offer an effective international monetary arrangement. (90 percent)



4. Fiscal policy (e.g., tax cut and/or government expenditure increase) has a significant stimulative impact on a less than fully employed economy. (90 percent)

5. The government should not restrict employers from outsourcing work to foreign countries. (90 percent)

6. Economic growth in developed countries like Canada leads to greater levels of well-being. (88 percent)

7. Agricultural subsidies should be eliminated. (85 percent)


THE END

Chapter 2


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THINKING LIKE AN ECONOMIST Chapter 2 Copyright © 2014 by Nelson Education Ltd.2-1