The Economic Way of Thinking

1. The Economic Way of Thinking • The Scientific Methoduses abstract modelsto help understand how a complex real-world operates. • The Scientific Methoddevelops theory, collects and analyzesdata to prove the theory.

2. The Circular-Flow Model • Provides a simple way of describing all the economic transactions that occur in a Market Economy. • Emphasizes decentralization in that economic decisions are made by Households and Businesses in Product and Resource Markets.

3. Diagram: The Circular-Flow Model Product Markets $ $ Dollar Flow Real Flow Businesses Households $ $ Resource Markets

4. Microeconomics and Macroeconomics • Microeconomics focuses on “the individual parts of the economy.” • e.g. individual markets • e.g. price increase in the house market • Macroeconomicslooks at the “economy as a whole.” • e.g. aggregate of markets • e.g. average price increase for all goods

5. A Second Economic Model: Production Possibilities Frontier…. … is a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and technology.

6. Production Possibilities Frontier E 3000 A 2000 Computers F Cars 1000 0 700

7. Production Possibilities Frontier E 3000 A 2000 Computers F Cars 1000 0 700

8. Principles of Economics Illustrated by the Production Possibilities Frontier . . . • Efficiency • Tradeoffs • Opportunity Cost • Economic Growth

9. Production Possibilities Frontier E Efficient Resource Use 3000 A 2000 B? 1000 Computers F Cars 1000 0 300 700

10. Production Possibilities Frontier E Tradeoffs 3000 A 2000 C 1000 Computers F Cars 1000 0 700 900

11. Production Possibilities Frontier Opportunity Cost of next 200 cars is 1000 computers. Opportunity cost of 1 car is 5 computers E 3000 2000 A Opportunity Cost C 1000 Computers F Cars 1000 0 700 900

12. Production Possibilities Frontier Economic Growth 3000 2000 1000 Computers Cars 1000 0 300 700

13. Positive versus Normative Analysis • Positive: Statements or assertions dealing with matters of fact or questions about how things are (descriptive analysis). • Normative: Statements that reflect individual opinions (prescriptive analysis).

14. Positive orNormative Statements? • An increase in the minimum wage will cause a decrease in employment among the least skilled. • Higher federal budget deficits will cause interest rates to increase. • The income gains from a higher minimum wage are worth more than any slight reduction in employment. • Provincial governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor.

15. Economists in Government . . . • Department of Finance - formulate tax policy. • Industry Canada - design competition policy. • Foreign Affairs - assist with trade agreements. • Human Resources Development Canada - formulate labour market policies. • Bank of Canada - implement monetary policy. • Environment Canada - design environmental policy.

16. Economists in the Private Sector . . . • C.D. Howe Institute - suggest policy options. • Fraser Institute - suggest policy options. • Provide forecasts for companies. • Assist firms manage resources efficiently. • Assist with investment decisions.

17. Do Economists Always Agree With Each Other? Three reasons why they don’t: • Disagree about the validity of alternative positive theories • Each have different values, thus different normative views • Advice of charlatans or cranks complicates ability to agree

18. Thinking Like an Economist . . . • Economics uses the scientific approach. • Economics is divided into Microeconomics and Macroeconomics. • Economics is analyzed through both Positive and Normative statements.