Thinking like an Economist
Thursday, September 5, 2013
Economics is a social science.
-Studies human behavior and its consequences
-Uses scientific method (maybe)
Economists use models to understand the world.
A model is a simplified representation (in words, pictures and/
Or math) of a more complex reality.
By leaving out complex stuff, simplifications can be useful
-to isolate the important parts
-propose a model of the social process of interest.
-Derive implications of that model.
-Compare those implications to reality
-If model and reality are consistent, keep it. Otherwise, throw it out.
Economist often make a distinction between normative and positive analysis
what should be/ |what is
Model #1:The circular flow diagram
-How do we organize our thinking about all the different activities going on in the
-Circular flow diagram: we should think about
-who is participating in the economy
-how they get together
-what they do together
Things to remember about the model
-it’s a model
-every transaction has two sides
-every transaction benefits both sides
-every flow is equal in value FCV's Betty and Al If al and betty can agree to specialize and share the extra production of 20 fcvs, they will both
be better off.
• How will they agree?
• How will they divide the surplus?
• Command: A benevolent dictator orders them to specialize, and divides up the
production between them.
• How do they get information?
• (for example, gift giving, banquet, etc..)
• Time costs are high
• Hold up problem
• A market is a group of buyers and sellers for a particular good or service
• A competitive market is one in which there are so many buyers and sellers that any one
participant has negligable influence
• A perfectly competitive market is one in which
o The goods or services offered for sale are identical
o Both buyers and sellers are price takers. This means they act as if they can buy
or sell as much as they want at the going price.
• Competition markets exist. Perfectly competitive markets are easy to model.
• A monopoly is a market in which there is only one seller (the monopolist) • A monopsony is a market in which there is only one buyer (monopsonist)
• You should think of this as
We want to distinguish between market demand and individual demand
Market demand can be constructed by adding up individual demand across all individuals .
Law of demand: all other things equal/unchanged (ceteris paribus), the quantity demanded of a
good falls when the price rise
• Demand curves slope down
Demand but selling from producers
Law of supply: ceteris paribus, the quantity supplied of a good rise when the price rises.
• Supply curves slope up
Reason: factors of production are scarce, opportunity cost is increasing
• The equilibrium price of a good is the price at which q