Assumptions: simplify the complex world and make it easier to understand.
Different assumption for short run and long run.
Models: omit details to show what is really important. (simplify)
Circular-flow diagram: a visual model of the economy that shows how dollars flow
through markets among households and firms.
Two decision makers:
• Produce goods and services using inputs of labor, land and capital (FOPs)
• Own FOP’s and consume goods and services that firms produce.
Interact in market for goods and services
Households are buyers and firms are sellers
And market for FOP’s
Households are sellers and firms are buyers
• Households provide inputs that firms need to produce goods and services.
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.