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ECN 104
Tsogbadral Galaabaatar

Chapter 2: Thinking Like an Economist ECN 104 – Introductory Economics The economist as scientist • Scientific Method: the dispassionate development and testing of theories on the workings of the universe. • Since experiment is very difficult to conduct in economics, economists use historical events as natural experiment. • Example: decrease in housing sales after interest rate hike. 2 Assumptions and Economic Models • Assumption is used to simplify complexity of the world. • Example: To study consumption behavior, we may assume there are only two goods. Unrealistic, but will give a valuable insight on consumption behavior . • Economic model is an explanation of workings of an economic phenomenon, based on simplifying assumptions. 3 The Circular-Flow Diagram • Circular-Flow Diagram is diagram that visualizes the organization of the economy. • There are two types of decision makers. • Households and firms • There are two markets. • Good/service market and market for factors of production. • Factors of production are the inputs that are necessary for production such as land, labour and capital. 4 The Circular-Flow Diagram • In the market for goods and services, households are buyers and firms are sellers. • In the market for factors of production, households are sellers and firms are buyers. • If you trace a loonie in the economy for period of time, it will be used in transactions in the above two markets repeatedly. 5 The Circular-Flow Diagram Revenue Markets for Spending Goods & Goods & Goods & Services sold Services Services bought Firms Households Factors of Labour, land, production Markets for capital Factors of Wages, rent, Production Income profit Production Possibilities Frontier • Production Possibilities Frontier (PPF) is a graph that represents all the possible combinations of goods the economy can produce. • We assume that there are two goods. • Since the factors of production are limited in quantity, not every combination of goods is feasible . 7 Production Possibilities Frontier • Production plans A, B are feasible . Car • Output C is not feasible, the C economy can’t produce this A combination. • Output B is B efficient, we getting the most out of scarce resources. Potato 8 PPF and opportunity cost • Opportunity cost is what you have to give up in order to obtain something. • If economy moves from one efficient point to other on the PPF , it faces a trade-off. Increasing the produc
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