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ECN 204 Chapter Notes -Bankrate

Course Code
ECN 204
Paul Missios

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Ch 2 – Thinking Like An Economist 04/18/2014
Scientific method
Assumptions  Scientific thinking
The Circular-Flow Diagram
A visual model of the economy that shows how dollars flow through markets among households and firms
Economy is simplified to include only households and firms
Firms: Goods and services using inputs like labour, land (natural resources) and capital (buildings and
machines)  factors of production
Households: Own factors of production and consume goods and services produced by firms
Two types of markets
Markets for goods and services: households are buyers, firms are sellers
Markets for the factors of production: Households are sellers, firms are buyers; provide inputs that firms use
to produce goods and services
Inner loop represents the flows of inputs and outputs
Household sell use of their labour, land, capital to firms
Firms use factors to produce goods and service
Firms sell goods and services
Factors flow from households to firms and goods and services flow from firms to households
Outler loop represents the corresponding flow of dollars
Households spend to buy
Firms use earned money to buy factors of production
Spending on goods and services flows from households to firms

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Income in the form of wages, rent, profit flows from firms to households
The Production Possibilities Frontier
A graph that shows the combinations of output that the economy can possibly produce given the available
factors of production and the available production technology
Resources are scarce so not every conceivable outcome is feasible
Does not have enough factors of production
Can produce at any point within frontier but not outside
Efficient outcome  If economy is getting all it can from the resources it has available
Usually curved due to opportunity costs (ie. If you produce one more car, you sacrifice two computers;
resources are being allocated to other tasks)
When resources advance and production possibilities go up, one end of frontier remains the same (ie. You
still produce 1000 computers when you produce 100 cars) but curve will shift outward
Microeconomics: Study of how households and firms make decisions and how they interact in markets
Macroeconomics: Study of economy-wide ohenomena including inflation, unemployment, and
economic growth
Positive statements: Claims that attempt to describe the world as it is
Normative statements: Claims that attempt to prescribe how the world should be
“If all economists were laid end to end, they would not reach a conclusion.”
Economists may disagree about the validity of alternative positive theories about how the world works
Economists may have different values and, therefore, different normative views about what policy should try
and accomplish

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Ten Propositions about Which Most Economists Agree
1. A ceiling on rents reduces the quantity/quality of house available
2. Tariffs and import quotas usually reduce general economic welfare
3. Flexible and floating exchange rates offer an effective international monetary arrangement
4. Fiscal policy (ie. Tax cut an/or government expenditure increase) has a significant stimulative impact on
a less than fully employed economy.
5. If the federal budget is to be balanced, it should be done over the business cycle rather than yearly.
6. Cash payments increase the welfare of recipients to a greater degree than do transfers-in-kind of equal
cash value
7. A large federal budget deficit has an adverse effect on the economy
8. A minimum wage increases unemployment among young and unskilled workers.
9. The government should restructure the welfare system along the lines of “a negative income tax”
10. Effluent taxes and marketable pollution permits represent a better approach to pollution control than
imposition of pollution ceilings.
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