Thinking Like an Economist

December, 2021

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Focus of this Chapter

What are economists’ two roles? How do they differ?

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Focus of this Chapter

What are economists’ two roles? How do they differ?

What are models? How do economists use them?

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Focus of this Chapter

What are economists’ two roles? How do they differ?

What are models? How do economists use them?
What is the difference between microeconomics and
macroeconomics? Between positive and normative?

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Economists as Scientists and Advisors

Economists play two roles:

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Economists as Scientists and Advisors

Economists play two roles:

1 Scientists: try to explain the world.

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Economists as Scientists and Advisors

Economists play two roles:

1 Scientists: try to explain the world.
2 Policy advisors: try to improve it.

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Economists as Scientists and Advisors

Economists play two roles:

1 Scientists: try to explain the world.
2 Policy advisors: try to improve it.
Economists in their role as scientists employ the scientific method,
the dispassionate development and testing of theories about how the
world works.

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Assumptions and Models

Assumptions simplify the complex world, make it easier to

understand.

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Assumptions and Models

Assumptions simplify the complex world, make it easier to

understand.
Example: To study international trade, assume two countries and two
goods.

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Assumptions and Models

Assumptions simplify the complex world, make it easier to

understand.
Example: To study international trade, assume two countries and two
goods.
Unrealistic, but simple and gives useful insights about the real world.

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Assumptions and Models

Assumptions simplify the complex world, make it easier to

understand.
Example: To study international trade, assume two countries and two
goods.
Unrealistic, but simple and gives useful insights about the real world.
Model: a highly simplified representation of a more complicated
reality. Economists use models to study economic issues.

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Assumptions and Models

Assumptions simplify the complex world, make it easier to

understand.
Example: To study international trade, assume two countries and two
goods.
Unrealistic, but simple and gives useful insights about the real world.
Model: a highly simplified representation of a more complicated
reality. Economists use models to study economic issues.
While building a model, economists assume away many of the details
of the economy that are irrelevant for studying the question at hand.

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Model 1: The Circular-Flow Diagram

The Circular-Flow Diagram: a visual model of the economy, shows

how dollars flow through markets among households and firms.

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Model 1: The Circular-Flow Diagram

The Circular-Flow Diagram: a visual model of the economy, shows

how dollars flow through markets among households and firms.
Two types of “actors”:

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Model 1: The Circular-Flow Diagram

The Circular-Flow Diagram: a visual model of the economy, shows

how dollars flow through markets among households and firms.
Two types of “actors”:
households
firms
Two markets:

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Model 1: The Circular-Flow Diagram

The Circular-Flow Diagram: a visual model of the economy, shows

how dollars flow through markets among households and firms.
Two types of “actors”:
households
firms
Two markets:
market for goods and services
market for factors of production

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The Circular Flow

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Model 2: The Production Possibilities Frontier

The 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.

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Model 2: The Production Possibilities Frontier

The 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.
Note that Figure 2 is bowed outward which means that opportunity
cost of a car in terms of the number of computers is not constant in
this economy.

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Model 2: The Production Possibilities Frontier

The 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.
Note that Figure 2 is bowed outward which means that opportunity
cost of a car in terms of the number of computers is not constant in
this economy.
Opportunity cost of a car is highest when the economy is producing
many cars and few computers, such as at point E, where the frontier is
steep.

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Model 2: The Production Possibilities Frontier

The 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.
Note that Figure 2 is bowed outward which means that opportunity
cost of a car in terms of the number of computers is not constant in
this economy.
Opportunity cost of a car is highest when the economy is producing
many cars and few computers, such as at point E, where the frontier is
steep.
When the economy is producing few cars and many computers, such as
at point F, the frontier is flatter, and the opportunity cost of a car is
lower.

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The Production Possibilities Frontier

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Microeconomics and Macroeconomics

Microeconomics: the study of how households and firms make

decisions and how they interact in markets.

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Microeconomics and Macroeconomics

Microeconomics: the study of how households and firms make

decisions and how they interact in markets.
Macroeconomics: the study of economywide phenomena, including
inflation, unemployment, and economic growth.

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The Economist as Policy Adviser

Economist as Scientists: When economists are trying to explain the

world, they are scientists. As scientists, economists make positive
statements.

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The Economist as Policy Adviser

Economist as Scientists: When economists are trying to explain the

world, they are scientists. As scientists, economists make positive
statements.
Economist as Policy Adviser: When they are trying to help improve
it, they are policy advisers.As policy advisors, economists make
normative statements.

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Positive Vs Normative Economics

Positive statements: Claims that attempt to describe the world as it

is.

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Positive Vs Normative Economics

Positive statements: Claims that attempt to describe the world as it

is.
Example: Minimum wage laws cause unemployment.

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Positive Vs Normative Economics

Positive statements: Claims that attempt to describe the world as it

is.
Example: Minimum wage laws cause unemployment.
We can, confirm or refute positive statements by examining evidence.

December, 2021 11 / 15
Positive Vs Normative Economics

Positive statements: Claims that attempt to describe the world as it

is.
Example: Minimum wage laws cause unemployment.
We can, confirm or refute positive statements by examining evidence.
Normative Statements: Claims that attempt to prescribe how the
world should be.

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Positive Vs Normative Economics

Positive statements: Claims that attempt to describe the world as it

is.
Example: Minimum wage laws cause unemployment.
We can, confirm or refute positive statements by examining evidence.
Normative Statements: Claims that attempt to prescribe how the
world should be.
Example: Government should raise the minimum wage.

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Positive Vs Normative Economics

Positive statements: Claims that attempt to describe the world as it

is.
Example: Minimum wage laws cause unemployment.
We can, confirm or refute positive statements by examining evidence.
Normative Statements: Claims that attempt to prescribe how the
world should be.
Example: Government should raise the minimum wage.
Evaluating normative statements involves values as well as facts.

December, 2021 11 / 15
Positive Vs Normative Economics

Positive statements: Claims that attempt to describe the world as it

is.
Example: Minimum wage laws cause unemployment.
We can, confirm or refute positive statements by examining evidence.
Normative Statements: Claims that attempt to prescribe how the
world should be.
Example: Government should raise the minimum wage.
Evaluating normative statements involves values as well as facts.
Normative statements cannot be judged using data alone. Deciding
what is good or bad policy is not just a matter of science. It also
involves our views on ethics, religion, and political philosophy.

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Positive Vs Normative Economics

Positive statements: Claims that attempt to describe the world as it

is.
Example: Minimum wage laws cause unemployment.
We can, confirm or refute positive statements by examining evidence.
Normative Statements: Claims that attempt to prescribe how the
world should be.
Example: Government should raise the minimum wage.
Evaluating normative statements involves values as well as facts.
Normative statements cannot be judged using data alone. Deciding
what is good or bad policy is not just a matter of science. It also
involves our views on ethics, religion, and political philosophy.
Note that positive views about how the world works affect normative
views about what policies are desirable.

December, 2021 11 / 15
Positive Vs Normative Economics

Positive statements: Claims that attempt to describe the world as it

is.
Example: Minimum wage laws cause unemployment.
We can, confirm or refute positive statements by examining evidence.
Normative Statements: Claims that attempt to prescribe how the
world should be.
Example: Government should raise the minimum wage.
Evaluating normative statements involves values as well as facts.
Normative statements cannot be judged using data alone. Deciding
what is good or bad policy is not just a matter of science. It also
involves our views on ethics, religion, and political philosophy.
Note that positive views about how the world works affect normative
views about what policies are desirable.

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Positive Vs Normative Statements Examples

Which of the following statements are positive and which are normative?

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Positive Vs Normative Statements Examples

Which of the following statements are positive and which are normative?
Smoking increases chances of cancer.

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Positive Vs Normative Statements Examples

Which of the following statements are positive and which are normative?
Smoking increases chances of cancer.
Cigarettes should be banned by the government.

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Positive Vs Normative Statements Examples

Which of the following statements are positive and which are normative?
Smoking increases chances of cancer.
Cigarettes should be banned by the government.
Government should print less money.

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Positive Vs Normative Statements Examples

Which of the following statements are positive and which are normative?
Smoking increases chances of cancer.
Cigarettes should be banned by the government.
Government should print less money.
Increase in public spending on education leads to increase in
productivity.

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Positive Vs Normative Statements Examples

Which of the following statements are positive and which are normative?
Smoking increases chances of cancer.
Cigarettes should be banned by the government.
Government should print less money.
Increase in public spending on education leads to increase in
productivity.

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Why Economists Disagree

Why do economists so often appear to give conflicting advice to

policymakers? There are two basic reasons:

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Why Economists Disagree

Why do economists so often appear to give conflicting advice to

policymakers? There are two basic reasons:
Economists may disagree about the validity of alternative positive
theories about how the world works.

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Why Economists Disagree

Why do economists so often appear to give conflicting advice to

policymakers? There are two basic reasons:
Economists may disagree about the validity of alternative positive
theories about how the world works.
Economists may have different values and therefore different normative
views about what policy should try to accomplish.

December, 2021 13 / 15
Why Economists Disagree

Why do economists so often appear to give conflicting advice to

policymakers? There are two basic reasons:
Economists may disagree about the validity of alternative positive
theories about how the world works.
Economists may have different values and therefore different normative
views about what policy should try to accomplish.
Because of differences in scientific judgments and differences in
values, some disagreement among economists is inevitable.
Economists agree with one another far more than is sometimes
understood.

December, 2021 13 / 15
Why Economists Disagree

Why do economists so often appear to give conflicting advice to

policymakers? There are two basic reasons:
Economists may disagree about the validity of alternative positive
theories about how the world works.
Economists may have different values and therefore different normative
views about what policy should try to accomplish.
Because of differences in scientific judgments and differences in
values, some disagreement among economists is inevitable.
Economists agree with one another far more than is sometimes
understood.

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Why Economists’ Advice Is Not Always Followed

Discuss.

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References

1 N. Gregory Mankiw (2012), Principles of Economics, 6th edition.

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