Microeconomics: Chapter Two
Thinking like an Economist
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 and 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.
Circular Flow Diagram:
The Circular-Flow Diagram: a visual model of the economy, shows how dollars flow through
markets among households and firms
Two types of “actors”:
the market for goods and services
the market for “factors of production”
Factors of production: the resources the economy uses to produce goods & services, including
capital (buildings & machines used in production) 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
Two goods: computers and wheat
One resource: labour (measured in hours)
Economy has 50,000 labour hours per month available for production.
The PPF: What we know about it so far
Points on the PPF (like A and B)
efficient: all resources are fully utilized