Chapter 2: Thinking Like an Economists

Economic Models

- Built with assumption - diagrams & equation - omit many detail - allows to see what's really important -simplify reality to improve our understanding of it

Circular-flow Diagram

- Visual model of the economy - Shows how dollars flow through markets among household and firms - Markets for goods and services: Firms = seller ; Household = buyers - Markets for factors of production: Firms = buyers ; Household = sellers

Production Possibilities Frontier

- a graph - combo of output that the economy can possibly produce - given the factors of production and production technology - points outside the frontier are not feasible given the economy's resources. - the economy can produce any combo on or inside the frontier - if the point is out, the point is infeasible - if the point is inside the shade or below the line, it is inefficient - if the point is on the line, it is efficient

Positive Statements

- attempt to describe the world as it is - descriptive - confirm or refute by examining evidence

Normative Statements

- attempt to prescribe how the world should be - prescriptive

Role of Assumption

1. Makes it easier to understand 2. The art in scientific thinking: deciding which assumptions to make

Classify the following topics as relating to microeconomics or macroeconomics. 1. A family's decision about how much income to save. 2. The effect of government regulations on auto emissions. 3. The impact of higher national saving on economic growth. 4. A firm's decision about how many workers to hire. 5. The relationship between the inflation rate and changes in the quantity of money.

1. Microeconomics 2. Microeconomics 3. Macroeconomics 4. Microeconomics 5. Macroeconomics

Classify each of the following statements as positive or normative. 1. Society faces a short-run tradeoff between inflation and unemployment. 2. A reduction in the rate of money growth will reduce the rate of inflation. 3. The Federal Reserve should reduce the rate of money growth. 4. Society ought to require welfare recipients to look for jobs. 5. Lower tax rates encourage more work and more saving.

1. Positive 2. Positive 3. Normative 4. Normative 5. Positive

Macroeconomics

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

Microeconomics

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

Which of the following is positive, rather than a normative, statement?

A. Law X will reduce national income. B. Law X is a good piece of legislation. C. Congress ought to pass the law X. D. The President should veto law X. Answer: A

An economic model is

A. a mechanical machine that replicates the functioning of the economy. B. a fully detailed, realistic description of the economy. C. a simplified representation of some aspect of the economy. D. a computer program that predicts the future of the economy. Answer: C

A point inside the production possibilities frontier is

A. efficient, but not feasible. B. feasible, but not efficient. C. both efficient and feasible. D. neither efficient nor feasible.. Answer: B

An economy produces hot dogs and hamburgers. If a discovery of the remarkable health benefits of hot dogs were to change consumers' preferences, it would

A. expand the production possibilities frontier. B. contract the production possibilities frontier. C. move the economy along the production possibilities frontier. D. move the economy inside the production possibilities frontier. Answer: C

The circular-flow diagram illustrates that, in markets for the factors of production,

A. households are seller, and firms are buyers. B. households are buyers, and firms are sellers. C. households and firms are both buyers. D. households and firms are both sellers. Answers: A

All of the following topics fall within the study of microeconomics EXCEPT

A. the impact of cigarette taxes on the smoking behavior of teenagers. B. the role of Microsoft's market power in the pricing of software. C. the effectiveness of antipoverty programs in reducing homelessness. D. the influence of the government budget deficit on economic growth. Answer: D