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Thinking Like An Economist In this chapter, look for the answers to
2 Thinking Like An Economist these questions:
What are economists’ two roles? How do they differ?
P R I N C I P L E S O F What are models? How do economists use them?
ECONOMICS
FOURTH EDITION How is the Production Possibilities Frontier related
to opportunity cost? What other concepts does it
N. GREGORY MANKIW illustrate?
What is the difference between microeconomics and
Premium PowerPoint®Slides macroeconomics? Between positive and normative?
by Ron Cronovich
2008 update
Modified by Joseph Tao-yi Wang CHAPTER 2 THINKING LIKE AN ECONOMIST 1
©2008 South-Western, a part of Cengage Learning, all rights reserved
Economists play two roles: Assumptions simplify the complex world,
• Scientists: try to explain the world make it easier to understand.
• Policy advisors: try to improve it Example: To study international trade,
In the first, economists employ the assume two countries and two goods.
scientific method, Unrealistic, but simple to learn and
the dispassionate development and testing of gives useful insights about the real world.
theories about how the world works. Model: a highly simplified representation of
a more complicated reality.
Economists use models to study
economic issues.
CHAPTER 2 THINKING LIKE AN ECONOMIST 2 CHAPTER 2 THINKING LIKE AN ECONOMIST 3
Observation, Theory, and More Observation? Or,
Observation, Theoretical Models, and
Experiments! A road map
• Experimental Economics: a growing field
• Vernon Smith: 2002 Nobel Prize Winner
A controlled experiment is a highly simplified
environment of a more complicated reality.
Just as a model is a highly simplified
representation of a more complicated reality.
4 CHAPTER 2 THINKING LIKE AN ECONOMIST 5
A model of human
anatomy from high
school biology class
A model airplane
CHAPTER 2 THINKING LIKE AN ECONOMIST 6 CHAPTER 2 THINKING LIKE AN ECONOMIST 7
The model teeth at the The Production Possibilities Frontier (PPF):
dentist’s office
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.
CHAPTER 2 THINKING LIKE AN ECONOMIST 8 CHAPTER 2 THINKING LIKE AN ECONOMIST 9
Producing one computer requires 100 hours labor.
Producing one ton of wheat requires 10 hours labor. Point Production Wheat
on (tons)
Employment of graph Com- Wheat 6,000
labor hours Production puters 5,000 E
Computers Wheat Computers Wheat A 500 0 4,000 D
B 400 1,000 3,000 C
A 50,000 0 500 0 C 250 2,500
B 40,000 10,000 400 1,000 D 100 4,000 2,000
1,000 B
C 25,000 25,000 250 2,500 E 0 5,000 0 A
D 10,000 40,000 100 4,000 0 100 200 300 400 500 600
E 0 50,000 0 5,000 Computers
CHAPTER 2 THINKING LIKE AN ECONOMIST 11
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A. On the graph, find the point that represents Point F: Wheat
(100 computers, 3000 tons of wheat), label it F. 100 computers, (tons)
Would it be possible for the economy to produce 3000 tons wheat 6,000
this combination of the two goods? 5,000
Why or why not? Point F requires 4,000
40,000 hours 3,000
B. Next, find the point that represents of labor. F
(300 computers, 3500 tons of wheat), label it G. Possible but 2,000
Would it be possible for the economy to produce not efficient: 1,000
this combination of the two goods? could get more 0
of either good 0 100 200 300 400 500 600
w/o sacrificing Computers
any of the other.
12 13
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' Points on the PPF (like A – E)
Point G: Wheat • possible
300 computers, (tons)
3500 tons wheat 6,000 • efficient: all resources are fully utilized
Point G requires 5,000 Points under the PPF (like F)
65,000 hours 4,000 G • possible
of labor. 3,000 • not efficient: some resources underutilized
Not possible 2,000 (e.g., workers unemployed, factories idle)
because 1,000 Points above the PPF (like G)
economy 0
only has 0 100 200 300 400 500 600 • not possible
50,000 hours. Computers
14 CHAPTER 2 THINKING LIKE AN ECONOMIST 15
*
+
*
+
Recall: The opportunity cost of an item Wheat The slope of a line
is what must be given up to obtain that item. (tons) –1000 equals the “rise
Moving along a PPF involves shifting resources 6,000 slope = 100 = –10 over the run” –
(e.g., labor) from the production of one good to 5,000 the amount the line
4,000 rises when you
the other. move to the right
Society faces a tradeoff: Getting more of one 3,000 by one unit.
good requires sacrificing some of the other. 2,000 Here, the
The slope of the PPF tells you the opportunity 1,000 opportunity cost of
cost of one good in terms of the other. 0 a computer is
0 100 200 300 400 500 600 10 tons of wheat.
Computers
CHAPTER 2 THINKING LIKE AN ECONOMIST 16 CHAPTER 2 THINKING LIKE AN ECONOMIST 17
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In which country is the opportunity cost of cloth lower? England, because its PPF is not as steep as France’s.
FRANCE ENGLAND FRANCE ENGLAND
Wine Wine Wine Wine
600 600 600 600
500 500 500 500
400 400 400 400
300 300 300 300
200 200 200 200
100 100 100 100
0 0 0 0
0 100 200 300 400 0 100 200 300 400 0 100 200 300 400 0 100 200 300 400
Cloth Cloth Cloth Cloth
18 19
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With additional Wheat The PPF could be a straight line, or bow-shaped
Economic
resources or an (tons) Economic Depends on what happens to opportunity cost
growth shifts
improvement in 6,000 growth shifts as economy shifts resources from one industry
the PPF
technology, 5,000 the PPF to the other.
outward.
the economy can outward.
produce more 4,000 • If opp. cost remains constant,
computers, 3,000 PPF is a straight line.
more wheat, 2,000 (In the previous example, opp. cost of a
or any combination 1,000 computer was always 10 tons of wheat.)
in between. 0 • If opp. cost of a good rises as the economy
0 100 200 300 400 500 600 produces more of the good, PPF is bow-shaped.
Computers
CHAPTER 2 THINKING LIKE AN ECONOMIST 20 CHAPTER 2 THINKING LIKE AN ECONOMIST 21
(+
- ..'/
(+
- ..'/
r r At A, opp. cost of
As the economy e At point A, e A At A, opp. cost of
e e mtnbikes is low.
shifts resources B most workers are B mtnbikes is low.
from beer to producing beer,
mountain bikes: even those that
• PPF becomes are better suited
steeper to building
• opp. cost of mountain bikes.
mountain bikes So, do not have to
increases give up much beer
Mountain to get more bikes. Mountain
Bikes Bikes
CHAPTER 2 THINKING LIKE AN ECONOMIST 22 CHAPTER 2 THINKING LIKE AN ECONOMIST 23
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