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Chapter 2: Thinking Like An Economist

Economic models like the circular-flow diagram and production possibilities frontier are used to visualize and understand the economy. The circular-flow diagram shows how dollars and resources flow between households and firms through factor and product markets. The production possibilities frontier illustrates the tradeoffs involved in allocating limited resources between different goods. Microeconomics analyzes decision-making by households and firms and their interactions in markets, while macroeconomics studies economy-wide measures like growth, inflation, and unemployment. Positive statements describe the world as it is, whereas normative statements make prescriptive claims about how the world should be.

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Sarah Farrell
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38 views

Chapter 2: Thinking Like An Economist

Economic models like the circular-flow diagram and production possibilities frontier are used to visualize and understand the economy. The circular-flow diagram shows how dollars and resources flow between households and firms through factor and product markets. The production possibilities frontier illustrates the tradeoffs involved in allocating limited resources between different goods. Microeconomics analyzes decision-making by households and firms and their interactions in markets, while macroeconomics studies economy-wide measures like growth, inflation, and unemployment. Positive statements describe the world as it is, whereas normative statements make prescriptive claims about how the world should be.

Uploaded by

Sarah Farrell
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
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Chapter 2: Thinking Like an Economist

1. Economic Models
a. Circular-Flow Diagram – a visual model of the economy that shows how dollars flow through
markets among households and firms
i. Firms produce goods and services using inputs, such as labor, land, and capital; these
inputs are called the factors of production
ii. Households own the factors of production and consume all the goods and services that
the firms produce
iii. In the markets for goods and services, households are buyers, and firms are sellers
1. Households buy the output of goods and services that firms produce
iv. In the markets for the factors of production, households are sellers, and firms are buyers
1. Households provide the inputs that firms use to produce goods and services
v. The factors of production flow from households to firms, and goods and services flow
from firms to households
vi. Spending on goods and services flows from households to firms, and income in the form
of wages, rent, and profit flows from firms to households
b. Production Possibilities 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
i. The economy can produce at any point on or inside the production possibilities frontier
but not outside
ii. An outcome is said to be efficient if the economy is getting all it can from the scarce
resources it has available
1. Points on (rather than inside) the production possibilities frontier represent
efficient levels of production
iii. The opportunity cost equals the slope of the production possibilities frontier
2. Microeconomics – the study of how households and firms make decisions and how they interact in markets
3. Macroeconomics – the study of economy-wide phenomena, including inflation, unemployment, and
economic growth
4. Positive Statements – claims that attempt to describe the world as it is
5. Normative Statements – claims that attempt to prescribe how the world should be

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