CHAPTE

R 2
Thinking Like An
Economist
Microeonomics
PRINCIPLES OF

N. Gregory
Mankiw
Premium PowerPoint Slides
by Ron Cronovich
© 2009 South-Western, a part of Cengage Learning, all rights reserved
In this chapter,
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?
2
 The Economist as Scientist
 E very field of study has its own language and
its own way of thinking.
 Mathematicians: axioms, integrals, and vector
spaces.
 Psychologists: ego and cognitive dissonance.
 Economics :supply, demand, elasticity,
comparative advantage, consumer surplus.

THINKING LIKE AN ECONOMIST 3

 The Economist as Scientist
 Economists play two roles:
1. Scientists: try to explain the world
 The consequences of theTof the World Economic Crisis of 1929;
 The impact of oil shock in 1973;
 Analysis of the impact of 2008 financial crisis on the economic;
 Explaining the economic impact of COVID-19;
 The effect of the war in Ukraine on global activity;

Economists devise theories, collect data, and then analyze

these data in an attempt to verify or refute their theories

THINKING LIKE AN ECONOMIST 4

 The Economist as Scientist
 Economists play two roles:
2. Policy advisors: try to improve it
Economists are asked to recommend policies to
improve economic outcomes:
- Increase in Gross Domestic Product (GDP)
- Improve the economic well-being
- Reduce unemployment
- Improve innovation

THINKING LIKE AN ECONOMIST 5

In the U.S. government, a key role is played by the
Council of Economic Advisers, a branch of the
Executive Office (that is, the staff of the President)
whose sole purpose is to advise the White House
on economic matters and to prepare the annual
Economic Report of the President. Unlike most
employees in government agencies, the majority of
the economists at the Council are not long-term
civil servants; instead, they are mainly professors
on leave for one or two years from their
universities. Many of the nation’s best-known
economists have served on the Council of
Economic Advisers at some point during their
careers 6
Economists also play an important role in many other parts
of the U.S. government. They dominate the staff of the
Federal Reserve, a government agency that controls the
supply of money in the economy and is crucial to its
operation

It’s also worth noting that economists play an especially

important role in two international organizations
headquartered in Washington, D.C.: the International
Monetary Fund, which provides advice and loans to
countries experiencing economic difficulties, and the
World Bank, which provides advice and loans to promote
longterm economic development

THINKING LIKE AN ECONOMIST 7

 The Economist as Scientist

 In the first, economists employ the

scientific method,

the dispassionate development and testing

of theories about how the world works.

THINKING LIKE AN ECONOMIST 8

 Assumptions & Models
Assumptions :
 Assumptions : simplify the complex world, make it
easier to understand.
 Economists use assumptions to make things
simpler and focus attention on what really matters.
Example: To study international trade,
assume two countries and two goods.

THINKING LIKE AN ECONOMIST 9

 Assumptions & Models

Unrealistic, but simple to learn and gives useful

insights about the real world.

“ In reality, there are numerous countries, each of which

produces thousands of different types of goods. But by
considering a world with only two countries and two goods,
we can focus our thinking on the essence of the problem”.

THINKING LIKE AN ECONOMIST 10

 Assumptions & Models
 Ceteris paribus assumption
Ceteris paribus is a Latin phrase which means
“other things being equal”. This sentence
means that all other relevant factors remain
unchanged.
Economists often make use ceteris paribus to consider the possible
effects of a change in one variable when all other variables kept
constant

For instance, an increase in real disposable income would be expected to lead

to an increase in demand for gold watches, on the assumption that the other
factors influences on demand for gold watches are not changing.
11
 Assumptions & Models
 Model: a highly simplified representation of
a more complicated reality.
 High school biology teachers teach basic anatomy
with plastic replicas of the human body.
 These models have all the major organs which allow
teachers to show their students very simply how the
important parts of the body fit together
 Studying these models is useful for learning how the
human body works
12
 Some Familiar Models

A model of human
anatomy from high
school biology class

Economists use models to study economic

issues.
13
 Assumptions & Models
 Model
 Economists also use models to learn about the world,
but unlike plastic manikins, their models mostly consist
of diagrams and equations.
 Like a biology teacher’s plastic model, economic models
exclude many details which, are irrelevant to the
question at hand to allow us to see what is truly
important
 All models—in physics, biology, and economics—
simplify reality to improve our understanding of it

THINKING LIKE AN ECONOMIST 14

 Assumptions & Models
 Model
 In this course, we study two models

1. The Circular-Flow Diagram

2. The Production Possibilities Frontier

THINKING LIKE AN ECONOMIST 15

 Our First Model:
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:
 the market for goods and services
 the market for “factors of production”

THINKING LIKE AN ECONOMIST 16

 Factors of Production
 Factors of production: the resources the
economy uses to produce goods & services,
including
 labor
 land
 capital (buildings & machines used in
production)

THINKING LIKE AN ECONOMIST 17

FIGURE 1: The Circular-Flow Diagram

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

Firms Households

Firms:
Firms:
 Buy/hire
Buy/hire factors
factors of
of production,
production,

use
use them
them toto produce
produce goods
goods
and
and services
services
THINKING
 Sell
Sell goods
LIKE AN&
goods services
&ECONOMIST
services 18
 Our First Model:
The Circular-Flow Diagram
 Households and firms interact in the markets
for goods and services (where households
are buyers and firms are sellers).

THINKING LIKE AN ECONOMIST 19

 Our First Model:
The Circular-Flow Diagram
 Households and firms interact in the markets
for the factors of production (where firms
are buyers and households are sellers).

THINKING LIKE AN ECONOMIST 20

FIGURE 1: The Circular-Flow Diagram
Revenue Spending
Markets for
G&S Goods &
G&S
sold Services bought

Firms Households

Factors of Labor, land,

production Markets for capital
Factors of
Wages, rent, Production Income
profit
=Flow of inputs and output
THINKING LIKE AN ECONOMIST = Flow of dinars 21
 The inner loop represents the flows of inputs and
outputs. The households sell the use of their labor, land,
and capital to the firms in the markets for the factors of
production. The firms then use these factors to produce
goods and services, which in turn are sold to households
in the markets for goods and services. The outer loop of
the diagram represents the corresponding flow of dollars.
The households spend money to buy goods and
services from the firms. The firms use some of the
revenue from these sales to pay for the factors of
production, such as the wages of their workers. What’s
left is the profit of the firm owners, who are themselves
members of household

22
 Let’s take a tour of the circular flow by following a dinar bill
as it makes its way from person to person through the
economy. Imagine that the dinar begins at a household—
say, in your wallet. If you want to buy a cup of coffee, you
take the dollar to one of the economy’s markets for goods
and services, such as your local Starbucks coffee shop.
There, you spend it on your favorite drink. When the dinar
moves into the Starbucks cash register, it becomes revenue
for the firm. The dinar doesn’t stay at Starbucks for long,
however, because the firm uses it to buy inputs in the
markets for the factors of production. Starbucks might use
the dinar to pay rent to its landlord for the space it occupies
or to pay the wages of its workers. In either case, the dinar
enters the income of some household and, once again, is
back in someone’s wallet. At that point, the story of the
economy’s circular flow starts once again
23
 Second Model:
The Production Possibilities
Frontier
 The Production Possibilities Frontier (PPF):
a graph that shows the combinations of
two goods the economy can possibly produce
given the available resources and the available
technology
 Example:
 Two goods: computers and wheat
 One resource: labor (measured in hours)
 Economy has 50,000 labor hours per month
available for production.
THINKING LIKE AN ECONOMIST 24
 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
C 25,000 25,000
D 10,000 40,000
E 0 50,000
 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
E 0 50,000 0 5,000
 PPF Example
Wheat
Production
Point (tons)
on Com- 6,000
graph puters Wheat 5,000
E

4,000
D
A 500 0
B 400 1,000 3,000 C
C 250 2,500 2,000
D 100 4,000 B
1,000
E 0 5,000 A
0
0 100 200 300 400 500 600
Computers

THINKING LIKE AN ECONOMIST 27

 PPF Example
 The two (E and A) endpoints of the production
possibilities frontier represent these extreme
possibilities. hours per month available for
production:
 If the economy uses all its resources in the
agricultural sector, it produces 5,000 tons of
wheat and no computers (point E).
 If it uses all its resources in the computer
industry, it produces 3,000 computers and no
cars (point A).

THINKING LIKE AN ECONOMIST 28

The economy divides its
resources between the
Wheat
agricultural sector and the
computer industry , producing (tons)
some thons of wheat and some 6,000
computers. For example, it can E
5,000
produce 4,000 thons of wheat
and 100 computers, shown in 4,000 D
the figure by point D.
3,000 C
Or, by moving some of the
2,000
factors of production to the B
agricultural sector from the 1,000
computer industry, the economy A
can produce 2,500 thons of 0
wheat and 250 computers, 0 100 200 300 400 500 600
represented by point C.
Compu

29
ACTIVE LEARNING 1
Points off the PPF
A. On the graph, 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?
B. 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?

30
 ACTIVE LEARNING 1
Answers
Wheat
 Point F: (tons)
100 computers, 6,000
3000 tons wheat 5,000
 Point F requires 4,000
40,000 hours
3,000
of labor. F
Possible but 2,000
not efficient: 1,000
could get more 0
of either good 0 100 200 300 400 500 600
w/o sacrificing Computers
any of the other.
31
 PPF Example
 Point F represents an inefficient outcome. For some
reason, perhaps widespread unemployment, the
economy is producing less than it could from the
resources it has available: It is producing only 3,000
thons of wheat and 100 computers.
 If the source of the inefficiency is eliminated, the
economy can increase its production of both goods. For
example, if the economy moves from point F to point N,
its production of thons of wheat increases from 3,000 to
3,500, and its production of computers increases from
100 to 150.

THINKING LIKE AN ECONOMIST 32

ACTIVE LEARNING 1
Answers

33
ACTIVE LEARNING 1
Answers
Wheat
 Point G: (tons)
300 computers, 6,000
3500 tons wheat 5,000
4,000 G
 Point G requires
3,000
65,000 hours
of labor. 2,000
Not possible 1,000
because 0
economy 0 100 200 300 400 500 600
only has Computers
50,000 hours.
34
 PPF Example
 Because resources are scarce, not every conceivable
outcome is feasible.
 No matter how resources are allocated between the two
sectors, the economy cannot produce the amount of
wheats and computers represented by point G.
 Given the technology available for agricultural sector and
the computer industry, the economy does not have
enough of the factors of production to support that level
of output. With the resources it has, the economy can
produce at any point on or inside the production
possibilities frontier, but it cannot produce at points
outside the frontier
THINKING LIKE AN ECONOMIST 35
 The PPF: What We Know So
Far
Points on the PPF (like A – E)
 possible
 efficient: all resources are fully utilized
An outcome is said to be efficient if the
economy is getting all it can from the scarce
resources it has available.
Points on (rather than inside) the production
possibilities frontier represent efficient levels of
production

THINKING LIKE AN ECONOMIST 36

 The PPF: What We Know So
Far
Points under the PPF (like F)
 possible
 not efficient: some resources underutilized
(e.g., workers unemployed, factories idle)

For some reason, the economy is producing less

than it could from the resources it has available

THINKING LIKE AN ECONOMIST 37

 The PPF: What We Know So
Far
Points above the PPF (like G)
 not possible

Given the technology available, the economy does

not have enough of the factors of production to
support that level of output

THINKING LIKE AN ECONOMIST 38

 The PPF and Opportunity
Cost
 Recall: The opportunity cost of an item
is what must be given up to obtain that item.
 Moving along a PPF involves shifting resources
(e.g., labor) 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 tells you the opportunity
cost of one good in terms of the other.

THINKING LIKE AN ECONOMIST 39

 The PPF and Opportunity Cost
Wheat The slope of a line
(tons) equals the
–1000 “rise over the run,”
6,000 slope = = –10
100 the amount the line
5,000
rises when you
4,000
move to the right
3,000 by one unit.
2,000
Here, the
1,000
opportunity cost of
0 a computer is
0 100 200 300 400 500 600 10 tons of wheat.
Computers

THINKING LIKE AN ECONOMIST 40

 Y

A
Y1
B
Rise
Y2

X
X1 X2
Run

Slope= =

THINKING LIKE AN ECONOMIST 41

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 Cloth42
 The PPF: What We Know So
Far
 The hard way is to compute the slope of both PPFs.
 The slope of France’s PPF equals -600/300 = -2,
meaning that France must give up two units of wine to
get an additional unit of cloth.
 The slope of England’s PPF = -200/300 = -2/3, meaning
that England only must sacrifice 2/3 of a unit of wine to
get an additional unit of cloth.
 Thus, the opportunity cost of cloth is lower in England
than France.

THINKING LIKE AN ECONOMIST 43

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 Cloth44
 The PPF: What We Know So
Far
 The production possibilities frontier shows the
trade-off between the outputs of different goods at
a given time, but the trade-off can change over
time. There are basically two sources of a shift in
the Production Possibilities Frontier
– Factors of production: Additional resources
enables the economy to produce more of both
goods than before (extensive growth);
– Technology: A technological advance enables
the economy to produce more of both goods than
before (intensive growth). 45
Economic Growth and the PPF
With additional Wheat
(tons) Economic
Economic
resources or an
6,000 growth
growth shifts
shifts
improvement in
the
the PPF
PPF
technology, 5,000 outward.
outward.
the economy can 4,000
produce more
3,000
computers,
2,000
more wheat,
or any combination 1,000
in between. 0
0 100 200 300 400 500 600
Computers

THINKING LIKE AN ECONOMIST 46

 The Shape of the PPF
 The PPF could be a straight line, or bow-shaped
 Depends on what happens to opportunity cost
as economy shifts resources from one industry
to the other.
 If opp. cost remains constant,
PPF is a straight line.
(In the previous example, opp. cost of a
computer was always 10 tons of wheat.)
 If opp. cost of a good rises as the economy
produces more of the good, PPF is bow-shaped.

THINKING LIKE AN ECONOMIST 47

 PPF is bow-shaped
Although it’s often useful to work with the
simple assumption that the production
possibility frontier is a straight line,
economists believe that in reality
opportunity costs are typically increasing.
When only a small amount of a good is
produced, the opportunity cost of producing
that good is relatively low because the
economy needs to use only those
resources that are especially well suited for
its production.
48
 PPF is bow-shaped
For example

If an economy grows only a small amount of corn, that corn

can be grown in places where the soil and climate are
perfect for corn-growing but less suitable for growing
anything else, like wheat. So growing that corn involves
giving up only a small amount of potential wheat output.
Once the economy grows a lot of corn, however, land that
is well suited for wheat but isn’t so great for corn must be
used to produce corn anyway.

As a result, the additional corn production involves

sacrificing considerably more wheat production. In other
words, as more of a good is produced, its opportunity cost
typically rises because well-suited inputs are used up and
less adaptable inputs must be used instead
49
 Why the PPF Might Be Bow-
Shaped
As the economy

Beer
shifts resources
from beer to
mountain bikes:
 PPF becomes
steeper
 opp. cost of
mountain bikes
increases
Mountain
Bikes
THINKING LIKE AN ECONOMIST 50
 Why the PPF Might Be Bow-
Shaped
At point A, At
At A,
A, opp.
opp. cost
cost of
of

Beer
A mtn
mtn bikes
bikes is
is low.
low.
most workers are
producing beer,
even those that
are better suited
to building bikes.
So, do not have to
give up much beer to
get more bikes.
Mountain
Bikes
THINKING LIKE AN ECONOMIST 51
 The Shape of the PPF
 When the economy is using most of its resources
to make beers, the resources best suited to bikes
production are being used in the beer making.

 Because these workers probably aren’t very good

at making beers, increasing bike production by
one unit will cause only a slight reduction in the
number of beers produced. Thus, at point A, the
opportunity cost of a bike in terms of beers is
small, and the frontier is relatively flat

THINKING LIKE AN ECONOMIST 52

 Why the PPF Might Be Bow-
Shaped
At B, most workers

Beer
At
At B,
B, opp.
opp. cost
cost
are producing bikes.
of
of mtn
mtn bikes
bikes
The few left in beer is
is high.
high.
are the best brewers.
Producing more bikes B
would require shifting
some of the best
brewers away from
beer production,
would cause a big
drop in beer output. Mountain
Bikes
THINKING LIKE AN ECONOMIST 53
 The Shape of the PPF
 When the economy is using most of its resources
to make bikes, such as at point B, the resources
best suited to making bikes are already at work in
the bike industry.
 Producing an additional bike means moving some
of the best breweries out of the beer industry and
turning them into bike industry. As a result,
producing an additional bike requires a
substantial loss of beers produced. The
opportunity bike of a beer is high, and the frontier
is steep.
THINKING LIKE AN ECONOMIST 54
 Why the PPF Might Be Bow-
Shaped
 So, PPF is bow-shaped when different workers
have different skills, different opportunity costs
of producing one good in terms of the other.
 The PPF would also be bow-shaped when
there is some other resource, or mix of
resources with varying opportunity costs
(E.g., different types of land suited for
different uses).

THINKING LIKE AN ECONOMIST 55

 The PPF: A Summary
 The PPF shows all combinations of two goods
that an economy can possibly produce,
given its resources and technology.

 The PPF illustrates the concepts of

tradeoff and opportunity cost,
efficiency and inefficiency,
unemployment, and economic growth.
 A bow-shaped PPF illustrates the concept of
increasing opportunity cost.

THINKING LIKE AN ECONOMIST 56

 Microeconomics and
macroeconomics
Microeconomics is like grains of
sand while…

Picture credits: [Link]

 Microeconomics and
macroeconomics
In a microeconomics
approach, we analyze
individual behaviors on
markets, while…

Picture credits: [Link]

 Microeconomics and
Macroeconomics
 Microeconomics is the study of how households
and firms make decisions and how they interact
in markets.
 Macroeconomics is the study of economy-wide
phenomena, including inflation, unemployment,
and economic growth.
 These two branches of economics are closely
intertwined, yet distinct – they address different
questions.

THINKING LIKE AN ECONOMIST 59

 Microeconomics and
macroeconomics
Economics

Complementary to each other

Microeconomics Macroeconomics

Branch of economics that Branch of economics that

deals with the behavior of deals with aggregate
individual economic units— economic variables, such as
consumers, firms, workers, the level and growth rate of
and investors—as well as national output, interest
the markets that these rates, unemployment, and
units comprise. inflation.
 Microeconomics and
Macroeconomics
 A microeconomics might study the effects of
rent control on housing in Tunis City, the impact
of foreign competition on the textile industry in
Tunisia.

 A macroeconomics might study the effects of

borrowing by the Tunisian government, the
changes over time in the economy’s rate of
unemployment, or alternative policies to promote
growth in national living standards

THINKING LIKE AN ECONOMIST 61

 Microeconomics and
Macroeconomics
 Microeconomics and macroeconomics are
closely intertwined. Because changes in the
overall economy arise from the decisions of
millions of individuals, it is impossible to
understand macroeconomic developments
without considering the associated
microeconomic decisions

THINKING LIKE AN ECONOMIST 62

Let's check your understanding!
 Macroeconomics is a branch of economics
which examines

A. The economic behaviour of aggregates – income,

employment, and output – on a national scale.
B. The functioning of individual industries and the
behaviour of individual decision-making units, that
is, business firms and households.
 Macroeconomics is a branch of economics
which examines

A. The economic behaviour of aggregates –

income, employment, and output – on a
national scale.
B. The functioning of individual industries and the
behaviour of individual decision-making units, that
is, business firms and households.
 Which one of the following is a
microeconomic issue?

A. The government spends more than it receives in

tax revenue.

B. House prices rise more rapidly.

C. Unemployment rises.
D. The Bank of England raises interest rates.
E. Imports exceed exports.
 Which one of the following is a
microeconomic issue?

A. The government spends more than it receives in

tax revenue.

B. House prices rise more rapidly.

C. Unemployment rises.
D. The Bank of England raises interest rates.
E. Imports exceed exports.
 Microeconomics is not
about the behavior of:

A. Aggregated demand

B. Firms

C. Consumers.
 Microeconomics is not
about the behavior of:

A. Aggregated demand

B. Firms

C. Consumers.
 Positive and normative
analysis

 Positive analysis
- Positive statements are descriptive and attempt to
describe the world as it is.

- Positive analysis: analysis describing

relationships of cause and effect.
- Positive questions deal with explanation and
prediction.
THINKING LIKE AN ECONOMIST
 Positive and normative
analysis
 Normative analysis:
- Normative statements are prescriptive and
attempt to prescribe how the world should be.
- Analysis examining questions of what ought to
be.
- Normative analysis is often supplemented by
value judgments.

THINKING LIKE AN ECONOMIST

Identifying 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 video rentals.

72
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.

73
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 video rentals.
Positive – describes a relationship.
Note that a statement need not be true to be
positive.

74
 Which one of the following
is a normative statement?
A. Unemployment is higher this year than last.

B. Unemployment will rise.

C. Economists predict that unemployment will rise.

D. Raising taxes will cause unemployment to rise.

E. The government should cut taxes and therefore

reduce unemployment.
 Which one of the following
is a normative statement?
A. Unemployment is higher this year than last.

B. Unemployment will rise.

C. Economists predict that unemployment will rise.

D. Raising taxes will cause unemployment to rise.

E. The government should cut taxes and

therefore reduce unemployment.
 Why Economists Disagree
 We often ask to economists of make decision on
some of issues of public policy.
 What is the best policy for the government to pursue?
 Does must government reduce its deficit?
 Does must government reduce inflation?
These economic debates make appear differences
among economists who give conflicting policy advice

77
 Why Economists Disagree?
 Why do economists so often appear to give
conflicting advice to policymakers?

There are two basic reasons:

1. Economists may disagree about the validity
of alternative positive theories of how the
world works.
2. Economists may have different values and
therefore different normative views about
what government policy should aim to
accomplish.

THINKING LIKE AN ECONOMIST 78

 Why Economists Disagree?
1. They sometimes disagree about the validity of
alternative positive theories about the world.

For example
Economists disagree about whether the
government should tax a household’s
income (A) or its consumption (value-
added tax) (B).

THINKING LIKE AN ECONOMIST 79

 Why Economists Disagree?
A. Advocates of a switch from the current income tax to a
consumption tax believe that the change would
encourage households to save more because income
that is saved would not be taxed. Higher saving, in turn,
would free resources for capital accumulation, leading to
more rapid growth in productivity and living standards;
B. Advocates of the current income tax system believe that
household saving would not respond much to a change
in the tax laws. They think that a value-added generally
weighs more on individuals whose the average
income of household means are modest. An
economist who values a society characterized by more
social equality and income will therefore tend to oppose
a value added tax.
80
 Why Economists Disagree?

These two groups of economists hold

different normative views about the tax
system because they have different
positive views about saving’s
responsiveness to tax incentives.

THINKING LIKE AN ECONOMIST 81

 Why Economists Disagree?
2. They may have different values and, therefore,
different normative views about what policy
should try to accomplish.
For example
Suppose that Peter and Paula both take the same amount of water
from the town well. To pay for maintaining the well, the town taxes its
residents.
• Peter lives at the big house whom cost 2 millions dollars and pays a
property tax of 10,000 dollars per year.
• Paula has a small house whom cost 20,000 dollars and pays a
property tax of 1000 dollars per year.

THINKING LIKE AN ECONOMIST 82

 Why Economists Disagree?
 Is this policy equity ? If not, who pays too much and who
pays too little?

 Wouldn't it be better to replace the tax based on the value

of the property through a unique tax in exchange for the
use of the well?

 Additionally, Peter lives only and uses a few water than

Paula and her roommates who consume more.

THINKING LIKE AN ECONOMIST 83

 Why Economists Disagree?

 These are difficult questions about which

people are likely to disagree.

 If the town hired two experts to study how it

should tax its residents to pay for the well, we
would not be surprised if they offered
conflicting advice.

THINKING LIKE AN ECONOMIST 84

 Why Economists Disagree?
Yet, there are many propositions about
which most economists agree.
Examples :

In surveys of professional economists elaborated

by American Economic Association and published
in American Economic Review in 1992. The
authors asked to economists their propositions
about economic policy.
THINKING LIKE AN ECONOMIST 85
 Propositions about Which Most
Economists Agree (and % who
agree)
 A ceiling on rents reduces the quantity and
quality of housing available. (93%)
 Tariffs and import quotas usually reduce general
economic welfare. (93%)
 The United States should not restrict employers
from outsourcing work to foreign countries. (90%)
 The United States should eliminate agriculture
subsidies. (85%)
continued…
THINKING LIKE AN ECONOMIST 86
 Propositions about Which Most
Economists Agree (and % agreeing)
 The gap between Social Security funds and
expenditures will become unsustainably large
within the next fifty years if current policies remain
unchanged. (85%)
 A large federal budget deficit has an adverse effect
on the economy. (83%)
 A minimum wage increases unemployment among
young and unskilled workers. (79%)
 Effluent taxes and marketable pollution permits
represent a better approach to pollution control
than imposition of pollution ceilings. (78%)
THINKING LIKE AN ECONOMIST 87
CHAPTER SUMMARY

 As scientists, economists try to explain the world

using models with appropriate assumptions.
 Two simple models are the Circular-Flow Diagram
and the Production Possibilities Frontier.
 Microeconomics studies the behavior of
consumers and firms, and their interactions in
markets. Macroeconomics studies the economy
as a whole.
 As policy advisers, economists offer advice on how
to improve the world. 88