Chapter 2 explores how economists think and apply scientific methods, focusing on models such as the circular flow and production possibilities frontier. It distinguishes between microeconomics and macroeconomics and discusses the roles of positive and normative statements in economic analysis. Economists often disagree on policy advice due to differing theories and values but aim to offer objective analysis through simplified models.

1. Chapter 2Chapter 2
Thinking Like anThinking Like an
EconomistEconomist
©© 2002 by Nelson, a division of Thomson Canada Limited2002 by Nelson, a division of Thomson Canada Limited

2. In this chapter you will…In this chapter you will…

See how economists apply theSee how economists apply the
method of science.method of science.

Consider how assumptions andConsider how assumptions and
models can shed light on themodels can shed light on the
world.world.

Learn two simple models - theLearn two simple models - the
circular flow and productioncircular flow and production
possibilities frontier.possibilities frontier.

See how economists apply theSee how economists apply the
method of science.method of science.

Consider how assumptions andConsider how assumptions and
models can shed light on themodels can shed light on the
world.world.

Learn two simple models - theLearn two simple models - the
circular flow and productioncircular flow and production
possibilities frontier.possibilities frontier.

3. In this chapter you will…In this chapter you will…

Distinguish betweenDistinguish between
microeconomics andmicroeconomics and
macroeconomics.macroeconomics.

Learn the difference between andLearn the difference between and
normative statements.normative statements.

Examine the role of economists inExamine the role of economists in
making policy.making policy.

Consider why economistsConsider why economists
sometimes disagree with onesometimes disagree with one
another.another.

Distinguish betweenDistinguish between
microeconomics andmicroeconomics and
macroeconomics.macroeconomics.

Learn the difference between andLearn the difference between and
normative statements.normative statements.

Examine the role of economists inExamine the role of economists in
making policy.making policy.

Consider why economistsConsider why economists
sometimes disagree with onesometimes disagree with one
another.another.

4. Thinking Like an EconomistThinking Like an Economist
Every field of study has its own terminology
– Mathematics
• integrals  axioms  vector spaces
– Psychology
• ego  id  cognitive dissonance
– Law
• promissory  estoppels  torts  venues
– Economics
• supply  opportunity cost  elasticity 
consumer surplus  demand 
comparative advantage  deadweight loss
Every field of study has its own terminology
– Mathematics
• integrals  axioms  vector spaces
– Psychology
• ego  id  cognitive dissonance
– Law
• promissory  estoppels  torts  venues
– Economics
• supply  opportunity cost  elasticity 
consumer surplus  demand 
comparative advantage  deadweight loss

5. Thinking Like an EconomistThinking Like an Economist
Economics trains you to. . . .
– Think in terms of alternatives.
– Evaluate the cost of individual and
social choices.
– Examine and understand how certain
events and issues are related.
Economics trains you to. . . .
– Think in terms of alternatives.
– Evaluate the cost of individual and
social choices.
– Examine and understand how certain
events and issues are related.

6. THE ECONOMIST AS A SCIENTISTTHE ECONOMIST AS A SCIENTIST
The economic way of thinking . . .
– Involves thinking analytically and
objectively.
– Economists…
• Devise theories
• Collect data
• Analyze the data to verify or refute their
theories
– Economics makes use of the scientific
method.
The economic way of thinking . . .
– Involves thinking analytically and
objectively.
– Economists…
• Devise theories
• Collect data
• Analyze the data to verify or refute their
theories
– Economics makes use of the scientific
method.

7. The Scientific Method:The Scientific Method:
observation, theory, and moreobservation, theory, and more
observationobservation
• Uses abstract models to help explain how
a complex, real world operates.
• Develops theories, collects, and analyzes
data to evaluate the theories.
• Uses abstract models to help explain how
a complex, real world operates.
• Develops theories, collects, and analyzes
data to evaluate the theories.

8. The Role of AssumptionsThe Role of Assumptions
• Economists make assumptions in order to
make the world easier to understand.
• The art in scientific thinking is deciding
which assumptions to make.
• Economists use different assumptions to
answer different questions.
• Economists make assumptions in order to
make the world easier to understand.
• The art in scientific thinking is deciding
which assumptions to make.
• Economists use different assumptions to
answer different questions.

9. Economic ModelsEconomic Models
• Economists use models to simplify
reality in order to improve our
understanding of the world
• Two of the most basic economic
models include:
–The Circular Flow Diagram
–The Production Possibilities
Frontier
• Economists use models to simplify
reality in order to improve our
understanding of the world
• Two of the most basic economic
models include:
–The Circular Flow Diagram
–The Production Possibilities
Frontier

10. Our First Model: The Circular-FlowOur First Model: The Circular-Flow
DiagramDiagram
• The circular-flow diagram is a visual model of
the economy that shows how dollars flow
through markets among households and
firms.
• The circular-flow diagram is a visual model of
the economy that shows how dollars flow
through markets among households and
firms.

11. Figure 1: The Circular FlowFigure 1: The Circular Flow
Copyright © 2004 South-Western
Spending
Goods and
services
bought
Revenue
Goods
and services
sold
Labour, land,
and capital
Income
= Flow of inputs
and outputs
= Flow of dollars
Factors of
production
Wages, rent,
and profit
FIRMS
•Produce and sell
goods and services
•Hire and use factors
of production
•Buy and consume
goods and services
•Own and sell factors
of production
HOUSEHOLDS
•Households sell
•Firms buy
MARKETS
FOR
FACTORS OF PRODUCTION
•Firms sell
•Households buy
MARKETS
FOR
GOODS AND SERVICES

12. Our First Model: The Circular-FlowOur First Model: The Circular-Flow
DiagramDiagram
• Firms
– Produce and sell goods and services
– Hire and use factors of production
• Households
– Buy and consume goods and services
– Own and sell factors of production
• Firms
– Produce and sell goods and services
– Hire and use factors of production
• Households
– Buy and consume goods and services
– Own and sell factors of production

13. Our First Model: The Circular-FlowOur First Model: The Circular-Flow
DiagramDiagram
• Markets for Goods and Services
– Firms sell
– Households buy
• Markets for Factors of Production
– Households sell
– Firms buy
• Factors of Production
– Inputs used to produce goods and
services
– Land, labour, and capital
• Markets for Goods and Services
– Firms sell
– Households buy
• Markets for Factors of Production
– Households sell
– Firms buy
• Factors of Production
– Inputs used to produce goods and
services
– Land, labour, and capital

14. Our Second Model:Our Second Model:
The Production Possibilities FrontierThe Production Possibilities Frontier
• The production possibilities frontierproduction possibilities frontier is 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.
• The production possibilities frontierproduction possibilities frontier is 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.

15. Quantity of
Computers
Produced
Quantity of
Cars Produced
0
Figure 2-2:Figure 2-2: The Production Possibilities FrontierThe Production Possibilities Frontier
3000
2000
700
A
1000
300
B
2200
600
C
D
1000
Production
possibilities
frontier

16. • Concepts Illustrated by the Production
Possibilities Frontier
– Efficiency
– Tradeoffs
– Opportunity Cost
– Economic Growth
• Concepts Illustrated by the Production
Possibilities Frontier
– Efficiency
– Tradeoffs
– Opportunity Cost
– Economic Growth
Our Second Model:Our Second Model:
The Production Possibilities FrontierThe Production Possibilities Frontier

17. Figure 2-3. A Shift in the Production PossibilitiesFigure 2-3. A Shift in the Production Possibilities
FrontierFrontier
Quantity of
Computers
Produced
Quantity of
Cars Produced
3000
2000
700
A
0
4000
2100
750
E
1000

18. Microeconomics and MacroeconomicsMicroeconomics and Macroeconomics
• Microeconomics focuses on the individual
parts of the economy.
– How households and firms make
decisions and how they interact in
specific markets
• Macroeconomics looks at the economy as a
whole.
– Economy-wide phenomena, including
inflation, unemployment, and economic
growth
• Microeconomics focuses on the individual
parts of the economy.
– How households and firms make
decisions and how they interact in
specific markets
• Macroeconomics looks at the economy as a
whole.
– Economy-wide phenomena, including
inflation, unemployment, and economic
growth

19. THE ECONOMIST AS POLICYTHE ECONOMIST AS POLICY
ADVISERADVISER
• When economists are trying to explain the
world, they are scientists.
• When economists are trying to change the
world, they are policy advisor.
• When economists are trying to explain the
world, they are scientists.
• When economists are trying to change the
world, they are policy advisor.

20. PositivePositive VersusVersus Normative StatementsNormative Statements
• Positive statements are statements that
attempt to describe the world as it is.
– Called descriptive analysis
• Normative statements are statements
about how the world should be.
– Called prescriptive analysis
• Positive statements are statements that
attempt to describe the world as it is.
– Called descriptive analysis
• Normative statements are statements
about how the world should be.
– Called prescriptive analysis

21. • Positive or Normative Statements?
– An increase in the minimum wage will cause a
decrease in employment among the least-
skilled.
POSITIVE
– Higher federal budget deficits will cause
interest rates to increase.
POSITIVE
• Positive or Normative Statements?
– An increase in the minimum wage will cause a
decrease in employment among the least-
skilled.
POSITIVE
– Higher federal budget deficits will cause
interest rates to increase.
POSITIVE
Positive Versus Normative StatementsPositive Versus Normative Statements

22. • Positive or Normative Statements?
– The income gains from a higher minimum
wage are worth more than any slight
reductions in employment.
NORMATIVE
– State governments should be allowed to
collect from tobacco companies the costs of
treating smoking-related illnesses among the
poor.
NORMATIVE
• Positive or Normative Statements?
– The income gains from a higher minimum
wage are worth more than any slight
reductions in employment.
NORMATIVE
– State governments should be allowed to
collect from tobacco companies the costs of
treating smoking-related illnesses among the
poor.
NORMATIVE
PositivePositive VersusVersus Normative StatementsNormative Statements

23. Economists in OttawaEconomists in Ottawa
• Department of Finance: Design tax policy.
(www.fin.gc.ca)
• Industry Canada: Design and enforce anti-
monopoly laws. (www.ic.gc.ca)
• Department of Foreign Affairs and
International Trade: Negotiate trade
agreements with other countries. (www.
defait.gc.ca)
• Human Resources Development Canada:
Analyze data on workers to help formulate
labour-market policies. (www.hrdc.gc.ca)
• Department of Finance: Design tax policy.
(www.fin.gc.ca)
• Industry Canada: Design and enforce anti-
monopoly laws. (www.ic.gc.ca)
• Department of Foreign Affairs and
International Trade: Negotiate trade
agreements with other countries. (www.
defait.gc.ca)
• Human Resources Development Canada:
Analyze data on workers to help formulate
labour-market policies. (www.hrdc.gc.ca)

24. Economists in OttawaEconomists in Ottawa
• Environment Canada: Environmental
regulation. (www.ec.gc.ca)
• Canadian International Development
Agency: Advice on overseas development
projects. (www.acdi-cida.gc.ca)
• Statistics Canada: Collect data used by
other economists to give policy advice. (
www.statcan.ca)
• Bank of Canada: Analyze financial markets
and macroeconomic developments. (
www.bank-banque-canada.ca)
• Environment Canada: Environmental
regulation. (www.ec.gc.ca)
• Canadian International Development
Agency: Advice on overseas development
projects. (www.acdi-cida.gc.ca)
• Statistics Canada: Collect data used by
other economists to give policy advice. (
www.statcan.ca)
• Bank of Canada: Analyze financial markets
and macroeconomic developments. (
www.bank-banque-canada.ca)

25. Economists in the private sector…Economists in the private sector…
… publish reports that analyze current
issues such as poverty, unemployment,
and the deficit.
• C.D. Howe Institute (www.cdhowe.org)
• The Fraser Institute (
www.fraserinstitute.ca)
… publish reports that analyze current
issues such as poverty, unemployment,
and the deficit.
• C.D. Howe Institute (www.cdhowe.org)
• The Fraser Institute (
www.fraserinstitute.ca)

26. WHY ECONOMISTS DISAGREEWHY ECONOMISTS DISAGREE
• They may disagree about the validity
of alternative positive theories about
how the world works.
• They may have different values and,
therefore, different normative views
about what policy should try to
accomplish.
• They may disagree about the validity
of alternative positive theories about
how the world works.
• They may have different values and,
therefore, different normative views
about what policy should try to
accomplish.

27. Table 2-2. Ten Propositions About Which MostTable 2-2. Ten Propositions About Which Most
Economists AgreeEconomists Agree

28. SummarySummary
• Economists try to address their subjects
with a scientist’s objectivity.
– They make appropriate assumptions
and build simplified models in order to
understand the world around them.
– Two simple economic models are the
circular-flow diagram and the
production possibilities frontier.
• Economists try to address their subjects
with a scientist’s objectivity.
– They make appropriate assumptions
and build simplified models in order to
understand the world around them.
– Two simple economic models are the
circular-flow diagram and the
production possibilities frontier.

29. • Economics is divided into two subfields:
– Microeconomists study decision making
by households and firms in the
marketplace.
– Macroeconomists study the forces and
trends that affect the economy as a
whole
SummarySummary

30. • A positive statement is an assertion about
how the world is.
• A normative statement is an assertion
about how the world ought to be.
• When economists make normative
statements, they are acting more as policy
advisors than scientists.
• A positive statement is an assertion about
how the world is.
• A normative statement is an assertion
about how the world ought to be.
• When economists make normative
statements, they are acting more as policy
advisors than scientists.
SummarySummary

31. • Economists who advise policymakers
offer conflicting advice either because of
differences in scientific judgments or
because of differences in values.
• At other times, economists are united in
the advice they offer, but policymakers
may choose to ignore it.
• Economists who advise policymakers
offer conflicting advice either because of
differences in scientific judgments or
because of differences in values.
• At other times, economists are united in
the advice they offer, but policymakers
may choose to ignore it.
SummarySummary

32. AppendixAppendix
Graphing: A BriefGraphing: A Brief
ReviewReview

33. Graphs of a single variableGraphs of a single variable

34. Graphs of two variables: TheGraphs of two variables: The
Coordinate SystemCoordinate System

35. Curves in the Coordinate SystemCurves in the Coordinate System

36. Curves in the Coordinate SystemCurves in the Coordinate System

37. Slope = ∆Slope = ∆yy / ∆/ ∆xx

38. Cause and effectCause and effect

39. Cause and effectCause and effect

40. The EndThe End