Chapter 2

Circular-Flow Diagram- a visual model of the economy that shows how dollars flow through markets among households and firms
Production Possibilities Frontier- a graph that shows the combinations of output that the economy can possible produce given the available factors of production and the available production technology
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
Positive Statements- claims that attempt to describe the world as it is
Normative Statements- claims that attempt to prescribe how the world should be

The Economist As Scientist
Economists view subject with objectivity devise theories, collect data, analyze data use scientific method
The Scientific Method: Observation, Theory, And More Observation interplay between theory and observation experiments difficult in economics: have to look to history allows us to examine present and predict future
The Role Of Assumptions economists make assumptions to make the world easier to understand two countries, two goods applying correct assumption to right data different assumptions for short0run and long-run effects of a change in the quantity of money
Economic Models models not often real but are accurate and helpful economists use diagrams and equations omit details to show what’s truly important models are built with assumptions
Our First Model: The Circular-Flow Diagram simplifies our thinking about economic activities explains generally how economy is organized and how participants interact two types of decision makers (households and firms) inputs=factors of production markets for goods and services vs markets for factors of production outer loop=corresponding flow of dollars excludes roles of gov and international trade
Our Second Model: The Production Possibilities Frontier graph that shows various combinations of output only two goods outcome is efficient if the economy is getting all it can from the scarce resources it has inefficient if not using all its resources to full availability tradeoff that society faces opportunity cost is what is given up when moving to produce more of one good than the other bowed outward, dependent on how much of each good the economy is producing can change over time
Microeconomics and Macroeconomics economics is studied on various levels don’t have to know one to study the other micro and macro are closely intertwined

The Economist As Policy Adviser economists are asked to explain causes of economic events asked to recommend policies to improve economic outcomes explain world=scientists improve world= policy advisors
Positive Versus Normative Analysis use language differently positive- claim about how world works normative- how you’d like to change the world difference in how we judge the statement’s validity good or bad policy depends on ethics, religions ,and political philosophy, not just science
P and N statements are related
Economists In Washington economists advice not always straightforward (people face tradeoffs) policy could increase efficiency at the cost of equity help future but hurt present since 1946, Council of Economic Advisers, 3 members and several dozen economists staff only write Economic Report of the President
Economists in the Department of Treasury, Justice, and Labor
Congressional Budget Office
Federal Reserve

Why Economists Disagree
“If all economists were laid end to end, they would not reach a conclusion” George Bernard Shaw 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
Differences In Scientific Judgments young science, much to be learned different hunches about validity of theories
Differences In Values disagree over public policy based off moral values can perfect science, but not the application
Perception Versus Reality
(pg. 33, list of things on which economists agree) economists may push for something the general public sees as undesirable (ex. eliminating a ceiling on rents), still need to convince everyone