Chapter 2 - Thinking Like an Economist
In this chapter, look for the answers to these questions:
What are economists’ two roles? How do they differ?
What are models? How do economists use them?
What are the elements of the Circular-Flow Diagram? What concepts does the diagram
How is the Production Possibilities Frontier related
to opportunity cost? What other concepts does it illustrate?
What is the difference between microeconomics and macroeconomics? Between positive and
The Economist as Scientist
Economists play two roles:
1. Scientists: try to explain the world
2. Policy advisors: try to improve it
In the first, economists employ the scientific method, the dispassionate development and
testing of theories about how the world works.
Assumptions & Models
Assumptions simplify the complex world, make it easier to understand.
Example: To study international trade, assume two countries and two goods.
Unrealistic, but simple to learn and gives useful insights about the real world.
Model: a highly simplified representation of a more complicated reality. Economists use
models to study economic issues.
Factors of Production
Factors of production: the resources the economy uses to produce goods & services, including
capital (buildings & machines used in production) The Production Possibilities Frontier
The Production Possibilities Frontier (PPF): a graph that shows the combinations of two goods
the economy can possibly produce given the available resources and the available technology
Two goods: computers and wheat
One resource: labour (measured in hours)
Economy has 50,000 labour hours per month available for production.
Producing one computer requires 100 hours labour.
Producing one ton of wheat requires 10 hours labour.
A. On the graph, find the point that represents (100 computers, 3000 tons of wheat), label it F.
Would it be possible for the economy to produce this combination of the two goods? Why or why not?
B. Next, find the point that represents (300 computers, 3500 tons of wheat), label it G. Would it be
possible for the economy to produce this combination of the two goods? The PPF and Opportunity Cost
Recall: The opportunity cost of an item is what must be given up to obtain that item.
Moving along a PPF involves shifting resources (e.g., labor) from the production of one good to
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.
In which country is the opportunity cost of cloth lower?
Economic Growth and the PPF
With additional resources or an improvement in technology, the economy can produce more
computers, more wheat, or any combination in between. The Shape of the PPF
The PPF could be a straight line, or bow-shaped
Depends on what happens to opportunity cost as economy shifts resources from one industry
to the other.
If opp. cost remains constant,
PPF is a straight line.
(In the previous example, opp. cost of a computer was always 10 tons of wheat.)