Chapter 2: Thinking Like an Economist- Notes:
Natural Experiments: collecting data based on natural phenomena that occur (sometimes due to
government intervention). E.g. war in the Middle East allows for info to be collected about how
oil prices affect the world’s economies.
Role of Assumptions:
Assumptions are used in economics to simplify the complex world and make it easier to
Different assumptions need to be made depending on the study. E.g. if government chooses to
change the number of dollars in circulation, short term assumption could be that the prices will
stay fixed, but we may need to have completely flexible prices of all goods if we’re studying the
Used to simplify reality in order to improve our understanding of it.
All use assumptions, and omit many details
Circular Flow Diagram:
Visual model of the economy that shows how dollars flow through markets among households
Firms produce goods and services using factors of production
Factors of production are inputs such as labour, land (natural resources), and capital (buildings
Households own the factors of production and consume all of the goods and services that the
Households and firms interact in 2 types of markets:
o Market for goods and services: Households are buyers and firms are sellers
Households buy the output of goods and services that firms produce
o Market for the factors of production: households are sellers and firms are buyers
Households provide the inputs that the firms use to produce goods and services.
Inner loop of circular flow diagram shows flow of inputs and outputs. Outer shows flow of
Production Possibilities Frontier
Graph that shows the combinations of output that the economy can possibly produce given the
available factors of production and the available production of technology
An economy can produce at any point on or inside the production possibilities frontier, but
cannot produce at points outside the frontier. Outcome is efficient if it is getting all the production it can from its available resources (i.e.
points on the possibilities frontier, instead of inside it, are efficient levels of production).
Once we reach the efficient points on the frontier, the only way to get more of one good is to
reduce the number of the other good (e.g. of a trade-off in economics).
This trade-off is the opportunity cost of one of the goods (e.g. if the trade-off is that you g