ch _ thinking like an economist

8/3/2019 Ch _ Thinking Like an Economist

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Ch

Thinking like anEconomist


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Thinking like an Economist

Every field of study has its own language &its way of thinking.

The whole purpose of this chapter is to makeyou aware of the language of economics.

In order to think like an economist, it isimportant to understand the basics ofeconomics.


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The Scientific Method ofEconomics


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Scientific Method of Economics In economics, just as in science,

First, theories are devised,

then data is collected,

then data is analysed to check theacceptability of the theory.

Thus, there occurs an interplay betweentheory and observation in economics.


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Scientific Method of Economics Major difference between science and

economics is,

Scientific theories can be tested in a lab,but economic theories cannot

The study of economics just has todepend on the data which is available inthe world.


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Scientific Method of Economics Economists study historical episodes

and minutely observe its after effects.

e.g.: recession in USA, sub primecrises, war among some majorcountries, etc.


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Role of Assumptions It is important to understand that every

economic theory is based on certainassumptions.

These assumptions might not be true in realworld, but yet they are framed to understand acomplex concept in a simple manner.

The important point is to understand why aparticular assumption is made.


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Economic Models Economic models are generally

diagrams or equations that are devisedto understand a a particular concept ina simpler way.

Again, these models are based oncertain assumptions.


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The Circular flow Diagram This the basic model to understand how

the economy operates.

For simplicity, the model divides theeconomy into two participants:

Firms

Households


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The Circular flow Diagram To understand interactions between

firms and households the markets are

divided into two types: Market for goods and services

Market for factors of production

There are two circular loops in thisdiagram.


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The Circular flow Diagram The inner loop [the flow of inputs and

outputs] Households own land, labour and capital.

Firms buy these and use them as factors ofproduction in order to produce goods and

services. These goods and services are sold in the

market by the firms and are purchased by thehouseholds.


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The Circular flow Diagram The Outer loop [the flow of money]

Households spend money to buy goods

and services.

This money is revenue for the firm.

The firm uses uses this revenue to make

payments for the factors of production. Eg: rent to land owners, wages to workers


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The Circular flow Diagram The remaining part of the revenue is used

as profit by the owners of the firm, who

are the members of householdsthemselves.

Thus households get income in terms ofrent, wages and profits


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The Production Possibilities

Frontier The production possibilities frontier is a graph

that shows various combination of goods or

output that the country can produce with itsavailable resources.

For simplicity, we assume that the economy

produces only two goods: Cars

computers


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The Production Possibilities

Frontier Each point on the frontier describes the

amount of cars and computersproduced using the available resources.

When the economy is working on anypoint on the frontier, the economy isworking at efficient level.


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The Production PossibilitiesFrontier

When the economy is working on thepoint below the frontier, it is working

inefficiently as resources are underutilised.

No economy can work at a point abovethe frontier with its domestic resources,at a given point of time.


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Trade-offs:

The production possibilities frontier shows the

trade-off that the economy faces.

Opportunity Cost:

The cost of something is what you give to get it.

The frontier shows the opportunity cost of onegood measured in terms of another.


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The opportunity cost is reflected in theshape of the frontier.

As the economy decides to produce more& more cars, it has to give up on producingcomputers to a large extent.

And hence the frontier becomes steeperand steeper.


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Shift in Production PossibilitiesFrontier

Trade-offs shown in the frontier can change overthe time.

Suppose, due to technological advancement, thecomputer industry is able to produce morecomputers with same resources available. [4000

instead of 3000]

This advancement will cause a shift in thefrontier.


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Micro Economics & MacroEconomics

Economics can be studied at two levels,micro and macro.

Micro economics:

Micro economics is the study of economic

behavior of firms and house holds(individual units).


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Macro economics:

Macro economics is the study of economywide phenomena.

It includes study of total aggregate output,

income, employment, consumption,investment & prices of economy as awhole.


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Micro & macro economics are inter wined.

It is because the decision made by the firmsand households affect the over all economy.

Also, individual firms & household should beaware of the inflation, interest rates, etc of theeconomy.


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Economist As A Policy Adviser


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Economist as a Policy Adviser

An economist who is well versed in his field, cantake the role of an policy adviser as well.

Economist as a policy adviser gives such opinions& advices through which the economy can beimproved.

Thus, when economists are trying to explain theworld, they are scientists& when they are tryingto improve, they are policy advisers.


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The Positive and NormativeAnalysis

Positive Statements:

These statements make a claim about how

the world is.

They are descriptive.

eg-Minimum wage laws causeunemployment.


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Normative Statements:

These statements make a claim about howthe world should be

They are descriptive

Eg- The government should raise minimumwage.


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Positive Statements are judged on thebasis of facts

Normative statements are judged on

the basis of facts and values.


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Why Economist Disagree

Differences in scientific judgments

Difference in values

Perception versus reality

ch _ thinking like an economist

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