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Lecture 2

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Peter Sinclair

Chapter 2 Thinking Like an Economist In this chapter look for the answers to these questions: •what are economists' two roles? How do they differ? •What are models? How do economists use them? •How is the Production Possibilities Frontier related to opportunity cost? What other concepts does it illustrate? •What is the difference between microeconomics and macroeconomics? Between positive and normative? The Economist as Scientist Economists play two roles: 1. Scientists: try to explain the world 2. Policy advisors: try to improve it In the first, economists employ the scientific method , the dispassionate development and testing of theories about how the world works. Assumptions & Models Assumptions simplify the complex world, make it easier to understand. Example: To study international trade, assume two countries and two goods. Unrealistic, but simple to learn and gives useful insights about the real world. Model: a highly simplified representation of a more complicated reality. Economists use models to study economic issues. Our Second Model: (The Production Possibilities Frontier) The Production Possibilities Frontier (PPF) : a graph that shows the combinations of two goods the economy can possibly produce given the available resources and the available technology Example: Two goods: computers and wheat One resource: labour (measured in hours) Economy has 50,000 labour hours per month available for production. Active Learning: Points off the PPF A. On the graph, find the point that represents (100 computers, 3000 tons of wheat), label it F. Would it be possible for the economy to produce this combination of the two goods?Why or why not? B. Next, find the point that represents (300 computers, 3500 tons of wheat), label it G. Would it be possible for the economy to produce this combination of the two goods? What we know so far about the PPF: Points on the PPF (like A E ) possible efficient: all resources are fully utilized Points under the PPF (like F ) possible not efficient: some resources underutilized (e.g., workers unemployed, factories idle) Points above the PPF (like G ) not possible The PPF and Opportunity Cost Recall: The opportunity cost of an item is what must be given up to obtain that item. •Moving along a PPF involves shifting resources (e.g., labor) from the production of one good to the other. •Society faces a tradeoff: Getting more of one good requires sacrificing some of the other. •The slope of the PPF tells you the opportunity cost of one good in terms of the other. -always inverse of each other Here, the 途 iseis a negative number, because, as you move to the right, the line falls (meaning wheat output is reduced). Moving to the right involves shifting resources from the production of wheat (which causes wheat output to fall) to the production of computers (which causes computer production to rise). Producing an additional computer requires the resources that would otherwise produce 10 tons of wheat. The PPF shows the tradeoff between the outputs of different goods at a given time, but the tradeoff can change over time. For example, over time, the economy might get more workers (or more factories or more land). Or, a more efficient technology might be invented. Both events an increase in the economy途 resources or an improvement in technology cause an expansion in the set of opportunities. That is, both allow the economy to produce more of one or both goods. This is a simple example of economic growth, an important subject that gets its own chapter in the macroeconomics portion of the textbook. In the example shown on this slide, economic growth causes a parallel outward shift of the PPF. Since the new PPF is parallel to the old one, the tradeoff between the two goods is the same. However, this need not always be the case. For example, if a new technology had more impact on the computer industry than on the wheat industry, then the horizontal (computer) intercept would increase more than the vertical (wheat) intercept, and the PPF would become flatter: the opportunity cost of computers would fall, because the technology has made them relatively cheaper (relative to wheat). Going into more detail here is probably beyond the scope of this chapt
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