Chapter 2 Summary Micro Economics,
Understanding Economic Models
course and shall be used as just small summaries to go over what is taught over a chapter. Not all points may be covered but it is done toe
the best of the ability of the individual who wrote these notes of summary. Have fun Studying!!!!
Thinking like an Economist
1. Before we get to the basic economic models, we have to understand how
economics is approached by everyone. Economics like to act like scientists, they
like to use the scientific method to deal with everything. Meaning they like to
model most economic situations with positive ways of thinking. Thinking
positively if you remember from chapter 1, just means that you are stating what
is going on, they are objective (they have no opinion). When Economists use
their skills to forecast what should happen in the economy, then that is
normative thinking. When Economists think normatively, they are acting more
like policy advisors rather than "economic scientists".
a. Economists think positively and use models to simplify the real world
and make it easier to understand. However these models have many
assumptions because they cannot account for everything that goes on.
b. When Economists think normatively, they are not being objective as they
have an opinion; they are acting as policy advisors instead.
Circular Flow Diagram
2. The first model that is noted in the textbook is called the circular flow diagram. It is a
basic diagram that splits the economy into two basic decision makers; the household
and the firms.
a. The households are essentially those who consume goods and services from
companies, we as individuals are these household. Think of yourself, you are a
household because you buy that computer that a company makes; you buy that
mysterious meat burger that McDonalds make. The firms are those companies and organizations that make products and services and sell it to people who will
b. However, this model economy isn’t a one way street. Not only are the
households buying and firms selling, the households also sell and firms also buy.
The households can sell their factors of production, if you remember what the
factors of production are (land, labour, capital and Entrepreneurship) ,
households can sell their time to the companies and work for them to create their
products and services. The firms will consume these factors of production and
give compensation to the households for making their product. An example would
be how you will work at McDonalds and flip burgers, your time spent there to flip
McDonalds burgers will be bought by McDonalds and you get 10 bucks and hour
for what you did for the firm (McDonalds).
c. As you can see there is a cycle in this simple economy. There are two markets in
this cycle. The market for products and services like what was explained in
bullet (A) above, the firms make something and the households consume what
was made. The market for factors of production, is where the households sell
their factors of production (ie: time and effort which is labour) and the firms buy
their factors of production to create a product. This is a never ending cycle!
Production Possibilities Frontier (PPF)
3. The production possibility frontier is a graph that basically simplifies the economy into a
world where only 2 goods are produced by one firm. a. If we remember the first and second economic principle, there is a scarce
amount of resource available to produce goods. Let’s say a company can
produce Digimon cards and Yugioh, the company only has 8 hours a day. It can
only spend so much time making Yugioh cards and so much time making Digi
cards. The PPF shows the different good output combinations he will have based
on how the company uses its time to make each type of card.