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ECN 104 (388)
Chapter 2

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Ryerson University
ECN 104
Frank Trimnell

ECN – Chapter 2 Thinking like an Economist The Economist as Scientist  Economists play 2 roles: o Scientists: try to explain the world o Policy advisors: try to improve it The Scientific Method: Observation, Theory, and More Observation  Economist employ the scientific method, the dispassionate development and testing of theories about how the world works The Role of Assumptions  Assumptions simplify the complex world, make it easier to understand  Ex. to study international trade, assume 2 countries and 2 goods (unrealistic but simple to learn) Economic Models  Model: a highly simplified representation of a complicated reality o Composed of diagrams and equations o Economists use models to study economic issues Our First Model: The Circular-Flow Diagram  Circular-flow diagram: a visual model of the economy that shows how dollars flow through markets among households & firms  Two types of decision makers (“actors”): o Households o Firms  Two markets: o The market for goods and services  Households are buyers and firms are sellers o The market for factors of production  Households are sellers and firms are buyers  Factors of production: the resources the economy uses to produce goods & services o Includes: labour, land, capital (building & machines used in production) Our Second Model: The Production Possibilities Frontier (PPF)  Production possibilities frontier: a graph that shows the combinations of 2 goods the economy can possibly produce given the available resources and the available technology  Ex. two goods: computers and wheat o One resource: labour (hours) o Economy has 50,000 labour hours per month available for production  Recall: the opportunity cost of an item is what must be given up to obtain that item  Moving along a PPF involves shifting resources (ex. labour) from production of one good to the other  Society faces a tradeoff: getting more of one good requires sacrificing some of the other  The slope of the PPF tells you the opportunity cost of one good in terms of the other (rise/run)  The PPF could be a straight line or bow-shaped o If opportunity cost remains constant, PPF is a straight line o If opportunity cost of a good rises as the economy produces more of the good, PPF is bow-shaped  Why the PPF might be bow-shaped: o PPF is bow-sh
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