Thinking Like an Economist

Micro Economics For Managers

Dr. Neha Shah
 Thinking 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.
 Economist as a scientist
• WHAT IS SCIENCE?
Any system of knowledge that is concerned with the
physical world and its phenomena and that entails
unbiased observations and systematic
experimentation. In general, a science involves a
pursuit of knowledge covering general truths or the
operations of fundamental laws.

• The economic way of thinking . . .

– Involves thinking analytically and objectively.
– Makes use of the scientific method.
 Economist as a scientist

• The economic way of thinking . . .

– Involves thinking analytically and objectively.
– Makes use of the scientific method.
• Observations,
• Theory
• Experiments
• Assumptions
 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.
 Economic 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
 The First Model: Circular Flow of
Income
• The circular-flow diagram is a visual model of the
economy that shows how rupees flow through
markets among households and firms.
Model-1: Circular Flow of Income

MARKETS
Revenu FOR Spending
e GOODS AND SERVICES
•Firms sell Goods
Good
sand •Households and
service
services buy sbough
sold
t

FIRMS HOUSEHOLDS
•Produce and sell •Buy and
goods and consume
goods and
services
•Hire and use services
•Own and sell
factors
of factors
of
production production

Factors MARKETS Labor, land,

of
productio FOR and capital
n FACTORS OF PRODUCTION
Wages, rent, •Households sell Income
and •Firms buy
profit = Flow of inputs
and
outputs
= Flow of dollars

Copyright © 2004 South-Western

 The Second Model: Production Possibility
Frontier
• The production 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.
 Model-2: The Production Possibilities Frontier

Quantity of
computers
produced

3,000 D

C
2,200
A
2,000
Production
possibilities
frontier
1,000 B

0 300 600 700 1,000 Quantity of

Cars Produced
Copyright©2003 Southwestern/Thomson
 Model-2: The Production Possibilities Frontier

Quantity of
computers
produced 4,000

3,000

C
2,200 D
A
2,000
Production
possibilities
frontier
1,000 B

0 300 600 700 1,000 Quantity of

Cars Southwestern/Thomson
Copyright©2003 Produced
 The Economist as a 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.
 Positive versus Normative 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
 Classify each of the statements positive or
normative.
1. Prices are rising because of high tariff on petroleum products.
2. The government should bring petroleum products under the
GST regime.
3. There is a correlation between Increase in minimum wage
and unemployment
4. The government should increase minimum wage so as to
improve buying capacity of the working class
5. Effluent taxes and marketable pollution permits represent a
better approach to pollution control than imposition of
pollution ceiling.
6. A large fiscal deficit has an adverse impact on the economy.

Micro Economics For Managers - Dr. Neha Shah

 Why 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.