Chapter 2

production possibilities frontier, p. 26

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

circular-flow diagram, p. 24

a visual model of the economy that shows how dollars flow through markets among households and firmsIn this model, the economy is simplified to include only two types of decision makers—firms and households. Firms produce goods and services using inputs, such as labor, land, and capital (buildings and machines). These inputs are called the factors of production. Households own the factors of production and consume all the goods and services that the firms produce. Households and firms interact in two types of markets. In the markets for goods and services, households are buyers, and firms are sellers. In particular, households buy the output of goods and services that firms produce. In the markets for the factors of production, households are sellers, and firms are buyers. In these markets, households provide the inputs that firms use to produce goods and services. The circular-flow diagram offers a simple way of organizing the economic transactions that occur between households and firms in the economy.

normative statements, p. 30

claims that attempt to prescribe how the world should be

positive statements, p. 30

positive statements claims that attempt to describe the world as it is

macroeconomics, p. 28

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

microeconomics, p. 28

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

Summary of chapter 2

• Economists try to address their subject with a scientist's objectivity. Like all scientists, they make appropriate assumptions and build simplified models to understand the world around them. Two simple economic models are the circular-flow diagram and the production possibilities frontier. • The field of economics is divided into two sub-fields: microeconomics and macroeconomics. Microeconomists study decision making by households and firms and the interaction among households and firms in the marketplace. Macroeconomists study the forces and trends that affect the economy as a whole. • A positive statement is an assertion about how the world is. A normative statement is an assertion about how the world ought to be. When economists make normative statements, they are acting more as policy advisers than as scientists. • Economists who advise policymakers offer conflicting advice either because of differences in scientific judgments or because of differences in values. At other times, economists are united in the advice they offer, but policymakers may choose to ignore it.