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Chapter 2

Chapter 2 Economics.docx

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Harvard University
Economics 10a
Gregory Mankiw

Chapter 2 Economics: Thinking LikeAn Economist • The scientific method is applicable to economics • History gives economists insight into the economy of the past, allowing them to evaluate the economic theories of the present • Assumptions can simplify the complex world and make it easier to understand • Scientific thinking is deciding which assumptions to make • Economists use different assumptions when studying the short-run and the long-run effects of a change in the quantity of money • Models simplify reality to improve our understanding of it o Circular-flow diagram: a visual model of the economy that shows how dollars flow through markets among households and firms  Firms produce goods and services using inputs (like land, labor, and capital) • Inputs are called factors of production  Households own the factors of production and consume all the goods and services that the firms produce  Firms and households interact in two types of markets: • Market for goods and services: households are buyers of the output of goods and firms are sellers of the services they produce • Markets for the factors of production: households are sellers of inputs and firms are the buyers of the inputs that they use to produce goods and services o 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  An outcome is said to be efficient if the economy is getting all it can from the scarce resources it has available • Points on the curve represent efficient levels of production • Points inside the curve are inefficient • Points outside of the curve are impossible because resources are scarce  Opportunity cost: The cost of something is what you give up to get it (trade- off) • The opportunity cost of the thing on the x axis is the slope of the
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