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Module 002

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2 views

Module 002

Uploaded by

Hamza Malik Sahil
Copyright
© © All Rights Reserved
Available Formats
Download as KEY, PDF, TXT or read online on Scribd
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Microeconomics

Module No. 002


Thinking Like an Economist

By Muhammad Shahid Iqbal


Thinking Like an Economist
Every field of study has its own language and
its own way of thinking
Mathematics: integrals ❖ axioms ❖ vector
spaces
Psychology: ego ❖ id ❖ cognitive dissonance
Law: promissory ❖ estoppels ❖ torts ❖ venues
Economics supply ❖ opportunity cost ❖
elasticity ❖ consumer surplus ❖ demand ❖
comparative advantage ❖ deadweight loss
Economics trains you to. . . .
Think in terms of alternatives.
Evaluate the cost of individual and social
choices.
Examine and understand how certain events
and issues are related.
The Scientific Method: Observation,
Theory, and More Observation
Uses abstract models to help explain how a
complex, real world operates. Although economists
use theory and observation like other scientists,
they face an obstacle that makes their task
especially challenging
Develops theories, collects, and analyzes data to
evaluate the theories. To find a substitute for
laboratory experiments, economists pay close
attention to the natural experiments offered by
history.
Example: During war in the Middle East interrupts
the flow of crude oil, for economic scientists, the
event provides an opportunity to study the effects
of a key natural resource on the world’s economies.
The Role of Assumptions
Economists make assumptions in order to make the
world easier to understand. Suppose that we want
to study what happens to the economy when the
government changes the number of dollars in
circulation.
ECONOMIC MODELS
Economists also use models to learn about the
world, which are most often composed of diagrams
and equations.
Two of the most basic economic models include:
The Circular Flow Diagram
The Production Possibilities Frontier
The Circular Flow
The circular-flow diagram is a visual model of the
economy that shows how dollars flow through
markets among households and firms
This diagram is a schematic representation of the
organization of the economy. Decisions are made
by households and firms. Households and firms
interact in the markets for goods and services
(where households are buyers and firms are
sellers) and in the markets for the factors of
production (where firms are buyers and households
are sellers). The outer set of arrows shows the
flow of dollars, and the inner set of arrows shows
the corresponding flow of inputs and outputs.
Flow in an Economy

Reven Spendi
ue MARKE ng
TS
FOR
Goods GOODS Goods
Firms
& sell and
Households
servic buy Services
es bought
sold

HOUSEHOL
FIR
DS
Buy and
MS
Produce and consume
goods and
sell and services
goods services
Own and sell
Hire and use factors
of
factors
of production
production

Labor,
Factors
producti MARK and
land,
of
on
ETSF capital
FACTORS OFO
PRODUCTIONR
Households
Wages, rent, Inco
sell
Firms
interest me = Flow of
buy
and profit inputs
and
= outputs
Flow of
money
Flow in an Economy
The flow of goods, services, resources and
money payments are shown in circular flow
diagram.
In a simple economy, Household and Firms are
two major entities.
Firms use various economic resources like land,
labor and capital, which are provided by
households.
Firms make payment of money to the
households for receiving various resources.
The HH in turn make payments of money to
business organizations for receiving consumer
goods and services.
These two entities show interdependence
between themselves in a simple economy.
The Production Possibilities Frontier
The production possibilities frontier is 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.
let’s assume an economy that produces only two
goods—cars and computers. Together, the car
industry and the computer industry use all of the
economy’s factors of production.
The production possibilities frontier is a graph
that shows the various combinations of output—
in this case, cars and computers—that the economy
can possibly produce given the available factors of
production and the available production technology
that firms use to turn these factors into output.
The Production Possibilities Frontier
Concepts Illustrated by the Production Possibilities Frontier

Efficiency: An outcome is said to be efficient if the


economy is getting all it can from the scarce
resources it has available. Points on (rather than
inside) the production possibilities frontier
represent efficient levels of production. When the
economy is producing
at such a point,
say point A, there
is no way to produce
more of one good
without producing
less of the other.
Point D represents
an inefficient
outcome.
The Production Possibilities Frontier
Tradeoffs: The production possibilities frontier shows
one trade-off that society faces. Once we have
reached the efficient points on the frontier, the only
way of getting more of one good is to get less of the
others. When the economy moves from point A to
point B, for instance, society produces 100 more cars
but at the expense of producing 200 fewer computers.
Opportunity Cost: The cost of something is what
you give up to get it. This is called the opportunity
cost. The production possibilities frontier shows the
opportunity cost of one good as measured in terms of
the other good. When society moves from point A to
point B, it gives up 200 computers to get 100
additional cars. That is, at point A, the opportunity
cost of 100 cars is 200 computers
Economic Growth:
The Production Possibilities Frontier
The production possibilities frontier shows the
trade-off between the outputs of different goods at
a given time, but the trade-off can change over
time.
For example, suppose a
technological advance in
the computer industry
raises the number of
computers that a
worker can produce
per week. This
advance expands society’s
set of opportunities.
The Production Possibilities Frontier
For any given number of cars, the economy can
make more computers. If the economy does not
produce any computers, it can still produce 1,000
cars, so one endpoint of the frontier stays the
same. But the rest of the production possibilities
frontier shifts outward.
The figure illustrates economic growth. Society can
move production from a point on the old frontier to
a point on the new frontier. Which point it chooses
depends on its preferences for the two goods. In
this example, society moves from point A to point
G, enjoying more computers (2,300 instead of
2,200) and more cars (650 instead of 600).

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