Thinking Like an Economist

Graduate School of Management and Economics

Sharif University of Technology

Amineh Mahmoudzadeh
Fall 2021
 Look for the answers to these questions
• What are economists’ two roles? How do they differ?
• What are models? How do economists use them?
• What are the elements of the Circular-Flow Diagram?
What concepts does the diagram illustrate?
• How is the Production Possibilities Frontier related to
opportunity cost? What other concepts does it illustrate?
• What is the difference between microeconomics and
macroeconomics? Between positive and normative?
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The Economist as a Scientist

• Economists play two roles:

1. Scientists: try to explain the world
2. Policy advisors: try to improve it
• As scientists, economists employ the scientific method
▪ Dispassionate development and testing of theories about how the world
works

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The Economist as a Scientist

• Assumptions
▪ Simplify the complex world and make it easier to understand
▪ Example: to study international trade, assume two countries and two goods
• Economists use models to study economic issues
▪ Highly simplified representation of a more complicated reality

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The Economist as a Scientist

• Examples of models:
▪ The model teeth at the dentist’s office
▪ A model of human anatomy from high school biology class
▪ A road map

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The Economist as a Scientist

• Circular-flow diagram
▪ Visual model of the economy
▪ Shows how dollars flow through markets among households and firms
• Two decision makers
▪ Firms and Households
• Interacting in two markets
▪ Market for goods and services
▪ Market for factors of production (inputs)

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Figure 1: The circular flow

Households:
▪ Own the factors of production,
sell/rent them to firms for income
▪ Buy and consume goods & services

Firms Households

Firms:
▪ Buy/hire factors of production, use them to produce
goods and services
▪ Sell goods & services
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Figure 1:The circular flow

G & S sold Spending

Markets for Goods &
Revenue Services G & S bought

Firms Households

Factors of production Markets for Factors of Income

Production
Wages, rent, profit Labor, land, capital
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The PPF

• Production possibilities frontier

▪ A graph: combinations of output that the economy can possibly produce
▪ Given the available
o Factors of production and technology
▪ Example:
o Two goods: computers and wheat
o One resource: labor (measured in hours)
o Economy has 50,000 labor hours per month available for production

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PPF Example

• Producing one computer requires 100 hours labor.

• Producing one ton of wheat requires 10 hours labor.
Employment of
Production
labor hours
Computers Wheat Computers Wheat
A 50,000 0 500 0
B 40,000 10,000 400 1,000
C 25,000 25,000 250 2,500
D 10,000 40,000 100 4,000

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E 0 50,000 0 5,000
PPF Example

Wheat
(tons)
Point Production
6,000
on
5,000 E graph Computers Wheat

4,000
D A 500 0
3,000 B 400 1,000
C
2,000 C 250 2,500

1,000 B D 100 4,000

A E 0 5,000
0
0 100 200 300 400 500 600
Computers
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Active Learning 1: Points off the PPF

On the graph above, find the point that represents (100 computers,
3000 tons of wheat), label it F.
▪ Would it be possible for the economy to produce this combination of the two
goods? Why or why not?
Next, find the point that represents (300 computers, 3500 tons of
wheat), label it G.
▪ Would it be possible for the economy to produce this combination of the two
goods?

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Active Learning 1: Answers

• Point F: 100 computers, Wheat

(tons)
3000 tons wheat 6,000
• Requires 40,000 hours of 5,000
labor 4,000

• Possible but not efficient: 3,000

F
could get more of either 2,000

good without sacrificing 1,000

any of the other 0

0 100 200 300 400 500 600
Computers

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Active Learning 1: Answers

• Point G: 300 computers, Wheat

(tons)
3500 tons wheat
6,000
• Requires 65,000 hours of 5,000
labor. 4,000 G
• Not possible because the 3,000
economy only has 50,000 2,000
hours 1,000
0
0 100 200 300 400 500 600
Computers

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The PPF: What We Know So Far

• Points on the PPF (like A – E): possible

▪ Efficient: all resources are fully utilized
• Points under the PPF (like F): possible
▪ Not efficient: some resources are underutilized (e.g., workers unemployed,
factories idle)
• Points above the PPF (like G)
▪ Not possible

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The PPF

• Moving along a PPF

▪ Involves shifting resources from the production of one good to the other
• Society faces a tradeoff
▪ Getting more of one good requires sacrificing some of the other
• The slope of the PPF
▪ The opportunity cost of one good in terms of the other

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The PPF and Opportunity Cost

• The slope of a line equals Wheat

(tons)
the “rise over the run.”
6,000 -1000
Slope= =-10
100
5,000

• Opportunity cost of 1 4,000

computer =10 tons of 3,000

2,000
wheat.
1,000
0
0 100 200 300 400 500 600
Computers
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Active Learning 2: PPF and Opportunity Cost

• In Which country is the opportunity cost of cloth lower?

FRANCE ENGLAND
Wine Wine
600 600

500 500
400 400
300 300
200 200
100 100
0 0
0 100 200 300 400 0 100 200 300 400
Cloth Cloth
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Active Learning 2: Answers

• England, because its PPF is not as steep as France’s

FRANCE ENGLAND
Wine Wine
600 600

500 500
400 400
300 300
200 200
100 100
0 0
0 100 200 300 400 0 100 200 300 400
Cloth Cloth
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Economic Growth and the PPF

• With additional resources or Wheat

(tons)
an improvement in 6,000 Economic growth
shifts the PPF
technology, the economy 5,000 outward.
can produce more 4,000
computers, more wheat or 3,000
any combination in 2,000
between. 1,000
0
0 100 200 300 400 500 600
Computers

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The Shape of the PPF

• Shape of the PPF

▪ Straight line: constant opportunity cost
o Previous example: the opportunity cost of 1 computer is 10 tons of wheat
▪ Bowed outward: increasing opportunity cost
o As more units of a good are produced, we need to give up increasing
amounts of the other good produced

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Why the PPF Might Be Bowed Outward

• As the economy shifts

Beer
resources from beer to
mountain bikes: PPF
becomes steeper and the
opportunity cost of
mountain bikes increases.

Mountain
Bikes
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Why the PPF Might Be Bowed Outward

• At point A, most workers

Beer
A At A opportunity cost
of mountain bikes is
are producing beer, even low.
those who are better suited
to building bikes. So, do
not have to give up much
beer to get more bikes.

Mountain
Bikes
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Why the PPF Might Be Bowed Outward

• At B, most workers are

Beer
A
producing bikes. The few left
in beer production are the best
brewers.
B
• Producing more bikes would
At B, opportunity
require shifting some of the cost of mountain
bikes is high
best brewers away from beer
production causing a big drop
in beer output. Mountain
Bikes
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Why the PPF Might Be Bowed Outward

• The PPF is bowed outward when:

▪ Different workers have different skills
▪ Different opportunity costs of producing one good in terms of the other
▪ There is some other resource, or mix of resources with varying opportunity
costs
o E.g., different types of land suited for different uses

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The Economist as a Scientist

• Microeconomics
▪ The study of how households and firms make decisions and how they
interact in markets
• Macroeconomics
▪ The study of economy-wide phenomena, including inflation, unemployment,
and economic growth

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The Economist as Policy Adviser

• Positive statements: descriptive

▪ Attempt to describe the world as it is
▪ Confirm or refute by examining evidence: “Minimum-wage laws cause
unemployment”
• Normative statements: prescriptive
▪ Attempt to prescribe how the world should be: “The government should
raise the minimum wage”

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Active Learning 3: Positive vs. Normative

Which of these statements are “positive” and which are “normative”? How can
you tell the difference?
a. Prices rise when the government increases the quantity of money.
b. The government should print less money.
c. A tax cut is needed to stimulate the economy.
d. An increase in the price of burritos will cause an increase in consumer
demand for music downloads.

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Active Learning 3: Answers

a. Prices rise when the government increases the quantity of money.

Positive – describes a relationship, could use data to confirm or
refute.

b. The government should print less money.

Normative – this is a value judgment, cannot be confirmed or
refuted.

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Active Learning 3: Answers

c. A tax cut is needed to stimulate the economy.

Normative – another value judgment.

d. An increase in the price of burritos will cause an increase in

consumer demand for music downloads
Positive – describes a relationship.

• Note that a statement need not be true to be positive.

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Why Economists Disagree

• Economists often give conflicting policy advice

▪ Can disagree about the validity of alternative positive theories about the
world
▪ May have different values and, therefore, different normative views about
what policy should try to accomplish
• Yet, there are many propositions about which most economists agree

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Ask The Experts - Ticket Resale

• “Laws that limit the resale of tickets for entertainment and sports
events make potential audience members for those events worse off
on average.”

• Source: IGM Economic Experts Panel, April 16, 2012.

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Propositions about Which Most Economists Agree (and percentage of
economists who agree)
1. A ceiling on rents reduces the quantity and quality of housing available. (93%)
2. Tariffs and import quotas usually reduce general economic welfare. (93%)
3. The United States should not restrict employers from outsourcing work to foreign countries. (90%)
4. The United States should eliminate agricultural subsidies. (85%)
5. Local and state governments should eliminate subsidies to professional sports franchises (85%)
6. Cash payments increase the welfare of recipients to a greater degree than do transfers-in kind of equal cash
value. (84%)
7. A large federal budget deficit has an adverse effect on the economy. (83%)
8. The United States should not ban genetically modified crops. (82%)
9. A minimum wage increases unemployment among young and unskilled workers. (79%)
10. Government subsidies on ethanol in the United States should be reduced or eliminated. (78%)

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Summary

• Economists are scientists

▪ Make appropriate assumptions and build simplified models
▪ The circular-flow diagram and the production possibilities frontier
• Microeconomists study decision making by households and firms and
their interactions in the marketplace
• Macroeconomists study the forces and trends that affect the economy
as a whole

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Summary

• A positive statement is an assertion about how the world is

• A normative statement is an assertion about how the world ought to
be
• As policy advisers, economists make normative statements
• Economists sometimes offer conflicting advice
▪ Differences in scientific judgments
▪ Differences in values

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