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ECON 1BB3 (338)
Chapter 2

Econ Chapter 2.docx

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Bridget O' Shaughnessy

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 understand  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 long term Models:  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 and firms  Firms produce goods and services using factors of production  Factors of production are inputs such as labour, land (natural resources), and capital (buildings and machines)  Households own the factors of production and consume all of the goods and services that the firms produce  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 dollars 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
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