34 PART ONE INTRODUCTION present in the light of the past for the purposes of the future. No part of mans nature or his institutions must lie entirely outside his regard. He must be purposeful and disinterested in a simultaneous mood; as aloof and incorruptible as an artist, yet sometimes as near the earth as a politician. It is a tall order. But with practice, you will become more and more accustomed to thinking like an economist su ary Economists try to address their subject with a scientists. A positive statement is an assertion about how the objectivity. Like all scientists, they make appropriate world is. A normative statement is an assertion about assumptions and build simplified models in order to how the world ought to be. When economists make understand the world around them. Two simple normative statements, they are acting more as policy economic models are the circular-flow diagram and the advisers than scientists production possibilities frontier. Economists who advise policymakers offer conflicting The field of economics is divided into two subfields. advice either because of differences in scientific microeconomics and macroeconomics. microeconomists judgments or because of differences in values. At other study decisionmaking by households and firms and the times, economists are united in the advice they offer, but interaction among households and firms in the slicymakers may choose to ignore it marketplace. Macroeconomists study the forces and trends that affect the economy as a whole Key concepts circular-flow diagram, p. 23 microeconomics, p. 27 positive statements, p. 29 production possibilities fro ntier macroeconomics,P. 27 normative statements, p. 29 Questions for Review Explain what each subfield studies 3. Should an economic model describe reality exactly 7. What is the difference between a positive and 4. Draw and explain a production possibilities frontier for normative statement? Give an example of each an economy that produces milk and cookies. What 8. What is the Council of Economic advisers? happens to this frontier if disease kills half of the 9. Why do economists sometimes offer conflicting advice economys cow population? 5. Use a production possibilities frontier to describe the idea of"efficiency
34 PART ONE INTRODUCTION present in the light of the past for the purposes of the future. No part of man’s nature or his institutions must lie entirely outside his regard. He must be purposeful and disinterested in a simultaneous mood; as aloof and incorruptible as an artist, yet sometimes as near the earth as a politician. It is a tall order. But with practice, you will become more and more accustomed to thinking like an economist. ◆ Economists try to address their subject with a scientist’s objectivity. Like all scientists, they make appropriate assumptions and build simplified models in order to understand the world around them. Two simple economic models are the circular-flow diagram and the production possibilities frontier. ◆ The field of economics is divided into two subfields: microeconomics and macroeconomics. Microeconomists study decisionmaking by households and firms and the interaction among households and firms in the marketplace. Macroeconomists study the forces and trends that affect the economy as a whole. ◆ A positive statement is an assertion about how the world is. A normative statement is an assertion about how the world ought to be. When economists make normative statements, they are acting more as policy advisers than scientists. ◆ Economists who advise policymakers offer conflicting advice either because of differences in scientific judgments or because of differences in values. At other times, economists are united in the advice they offer, but policymakers may choose to ignore it. Summary circular-flow diagram, p. 23 production possibilities frontier, p. 25 microeconomics, p. 27 macroeconomics, p. 27 positive statements, p. 29 normative statements, p. 29 Key Concepts 1. How is economics like a science? 2. Why do economists make assumptions? 3. Should an economic model describe reality exactly? 4. Draw and explain a production possibilities frontier for an economy that produces milk and cookies. What happens to this frontier if disease kills half of the economy’s cow population? 5. Use a production possibilities frontier to describe the idea of “efficiency.” 6. What are the two subfields into which economics is divided? Explain what each subfield studies. 7. What is the difference between a positive and a normative statement? Give an example of each. 8. What is the Council of Economic Advisers? 9. Why do economists sometimes offer conflicting advice to policymakers? Questions for Review
CHAPTER 2 THINKING LIKE AN ECONOMIST Problems and Applications 1. Describe some unusual language used in one of the engineers develop an automobile engine with almost no other fields that you are studying. Why are these special emissions. terms useful? 6. Classify the following topics as relating to 2. One common assumption in economics is that the microeconomics or macroeconomics products of different firms in the same industry are a. a familys decision about how much income to save indistinguishable. For each of the following industries, b. the effect of government regulations on auto discuss whether this is a reasonable assumption a. steel c. the impact of higher national saving on economic b. novels c. wheat d. a firms decision about how many workers to hire d. fast food e. the relationship between the inflation rate and 3. Draw a circular-flow diagram. Identify the parts of the hanges in the quantity of money model that correspond to the flow of goods and services 7. Classify each of the following statements as positive or and the flow of dollars for each of the following normative Explain. activities a. Society faces a short-run tradeoff between inflation Sam pays a storekeeper $I for a quart of milk. and unemployment. b. Sally earns $4.50 per hour working at a fast food b. A reduction in the rate of growth of money will reduce the rate of inflation c. Serena spends $7 to see a movie c. The Federal Reserve should reduce the rate of d. Stuart earns $10,000 from his 10 percent ownership growth of money of Acme Industrial d. Society ought to require welfare recipients to look agine a society that produces military goods and consumer goods, which we'll call"guns"and"butter. e. Lower tax rates encourage more work and more a. Draw a production possibilities frontier for guns and butter. Explain why it most likely has a bowed 8. Classify each of the statements in Table 2-2 as positive, out shape. b. Show a point that is impossible for the economy to achieve. Show a point that is feasible but inefficient 9. If you were president, would you be more interested in c. Imagine that the society has two political parties, your economic advisers positive views or their the Doves(who want a smaller military). Showa called the Hawks(who want a strong military) normative views? Why? 10. The Economic Report of the President contains statistical oint on your production possibilities frontier that information about the economy as well as the Council of the Hawks might choose and a point the Doves Economic Advisers analysis of current policy issues might choose Find a recent copy of this annual report at your library d. Imagine that an aggressive neighboring countr and read a chapter about an issue that interests you. reduces the size of its military. As a result, both the Summarize the economic problem at hand and describe Hawks and the doves reduce their desired the councils recommended policy. production of guns by the same amount Which 11. Who is the current chairman of the Federal reserve party would get the bigger"peace dividend, Who is the current chair of the Council of economic measured by the increase in butter production? Advisers? Who is the current secretary of the treasury pla 12. Look up one of the Web sites listed in Table 2-1. What 5. The first principle of economics discussed in Chapter 1 recent economic trends or issues are addressed there? is that people face tradeoffs. Use a production possibilities frontier to illustrate societys tradeoff 13. Would you expect economists to disagree less about between a clean environment and high incomes. What public policy as time goes on? Why or why not? Can do you suppose determines the shape and position of their differences be completely eliminated? Why or the frontier? Show what happens to the frontier if why not
CHAPTER 2 THINKING LIKE AN ECONOMIST 35 1. Describe some unusual language used in one of the other fields that you are studying. Why are these special terms useful? 2. One common assumption in economics is that the products of different firms in the same industry are indistinguishable. For each of the following industries, discuss whether this is a reasonable assumption. a. steel b. novels c. wheat d. fast food 3. Draw a circular-flow diagram. Identify the parts of the model that correspond to the flow of goods and services and the flow of dollars for each of the following activities. a. Sam pays a storekeeper $1 for a quart of milk. b. Sally earns $4.50 per hour working at a fast food restaurant. c. Serena spends $7 to see a movie. d. Stuart earns $10,000 from his 10 percent ownership of Acme Industrial. 4. Imagine a society that produces military goods and consumer goods, which we’ll call “guns” and “butter.” a. Draw a production possibilities frontier for guns and butter. Explain why it most likely has a bowedout shape. b. Show a point that is impossible for the economy to achieve. Show a point that is feasible but inefficient. c. Imagine that the society has two political parties, called the Hawks (who want a strong military) and the Doves (who want a smaller military). Show a point on your production possibilities frontier that the Hawks might choose and a point the Doves might choose. d. Imagine that an aggressive neighboring country reduces the size of its military. As a result, both the Hawks and the Doves reduce their desired production of guns by the same amount. Which party would get the bigger “peace dividend,” measured by the increase in butter production? Explain. 5. The first principle of economics discussed in Chapter 1 is that people face tradeoffs. Use a production possibilities frontier to illustrate society’s tradeoff between a clean environment and high incomes. What do you suppose determines the shape and position of the frontier? Show what happens to the frontier if engineers develop an automobile engine with almost no emissions. 6. Classify the following topics as relating to microeconomics or macroeconomics. a. a family’s decision about how much income to save b. the effect of government regulations on auto emissions c. the impact of higher national saving on economic growth d. a firm’s decision about how many workers to hire e. the relationship between the inflation rate and changes in the quantity of money 7. Classify each of the following statements as positive or normative. Explain. a. Society faces a short-run tradeoff between inflation and unemployment. b. A reduction in the rate of growth of money will reduce the rate of inflation. c. The Federal Reserve should reduce the rate of growth of money. d. Society ought to require welfare recipients to look for jobs. e. Lower tax rates encourage more work and more saving. 8. Classify each of the statements in Table 2-2 as positive, normative, or ambiguous. Explain. 9. If you were president, would you be more interested in your economic advisers’ positive views or their normative views? Why? 10. The Economic Report of the President contains statistical information about the economy as well as the Council of Economic Advisers’ analysis of current policy issues. Find a recent copy of this annual report at your library and read a chapter about an issue that interests you. Summarize the economic problem at hand and describe the council’s recommended policy. 11. Who is the current chairman of the Federal Reserve? Who is the current chair of the Council of Economic Advisers? Who is the current secretary of the treasury? 12. Look up one of the Web sites listed in Table 2-1. What recent economic trends or issues are addressed there? 13. Would you expect economists to disagree less about public policy as time goes on? Why or why not? Can their differences be completely eliminated? Why or why not? Problems and Applications
APPENDIX GRAPHING A BRIEF REVIE W Many of the concepts that economists study can be expressed with numbers-the price of bananas, the quantity of bananas sold, the cost of growing bananas, and so Often these ted to one another. when the of bananas rises, people buy fewer bananas. One way of expressing the relationships among variables is with graphs Graphs serve two purposes. First, when developing economic theories, graphs offer a way to visually express ideas that might be less clear if described with equations or words. Second, when analyzing economic data, graphs provide a way of finding how variables are in fact related in the world. Whether we are working with theory or with data, graphs provide a lens through which a recog sizable forest emerges from a multitude of trees Numerical information can be expressed graphically in many ways, just as a hought can be expressed in words in many ways. A good writer chooses words that will make an argument clear, a description pleasing, or a scene dramatic. An effective economist chooses the type of graph that best suits the purpose at hand. In this appendix we discuss how economists use graphs to study the mathe- matical relationships among variables. We also discuss some of the pitfalls that can arise in the use of graphical methods. GRAPHS OF A SINGLE VARIABLE Three common graphs are shown in Figure 2A-1. The pie chart in panel (a) shows how total income in the United States is divided among the sources of income, in- Ing com pensation of employees, corporate profits, and so on. a slice of the pie represents each sources share of the total. The bar graph in panel (b)compares a measure of average income, called real gDP per person, for four countries. The height of each bar represents the average income in each country. The time-series graph in panel (c)traces the rising productivity in the U.S. business sector over time. The height of the line shows output per hour in each year. You have probably seen similar graphs presented in newspapers and magazines 36
APPENDIX GRAPHING: A BRIEF REVIEW Many of the concepts that economists study can be expressed with numbers—the price of bananas, the quantity of bananas sold, the cost of growing bananas, and so on. Often these economic variables are related to one another. When the price of bananas rises, people buy fewer bananas. One way of expressing the relationships among variables is with graphs. Graphs serve two purposes. First, when developing economic theories, graphs offer a way to visually express ideas that might be less clear if described with equations or words. Second, when analyzing economic data, graphs provide a way of finding how variables are in fact related in the world. Whether we are working with theory or with data, graphs provide a lens through which a recognizable forest emerges from a multitude of trees. Numerical information can be expressed graphically in many ways, just as a thought can be expressed in words in many ways. A good writer chooses words that will make an argument clear, a description pleasing, or a scene dramatic. An effective economist chooses the type of graph that best suits the purpose at hand. In this appendix we discuss how economists use graphs to study the mathematical relationships among variables. We also discuss some of the pitfalls that can arise in the use of graphical methods. GRAPHS OF A SINGLE VARIABLE Three common graphs are shown in Figure 2A-1. The pie chart in panel (a) shows how total income in the United States is divided among the sources of income, including compensation of employees, corporate profits, and so on. A slice of the pie represents each source’s share of the total. The bar graph in panel (b) compares a measure of average income, called real GDP per person, for four countries. The height of each bar represents the average income in each country. The time-series graph in panel (c) traces the rising productivity in the U.S. business sector over time. The height of the line shows output per hour in each year. You have probably seen similar graphs presented in newspapers and magazines. 36
CHAPTER 2 THINKING LIKE AN ECONOMIST (a)Pie Chart (b)Bar Graph (c)Time-Series Graph United Real GDP perStates Productivity I profits(12%) Person in 1997 $28,740) 30.000 United Kingdom 25,000 20.520 115 Interest income(6%) Mexico Rental 10000 $8,120) income(2%) 5.000 ($1950) 19601970198019902000 TYPES OF GRAPHS. The pie chart in panel(a)shows how U.S. national income is derived from various sources. The bar graph in panel (b)compares the average income in four igure 2A-1 countries. The time-series graph in panel(c) shows the growth in productivity of the U.S business sector from 1950 to 2000 GRAPHS OF TWO VARIABLES: THE COORDINATE SYSTEM Although the three graphs in Figure 2A-1 are useful in showing how a variable hanges over time or across individuals, such graphs are limited in how much they can tell us. These graphs display information only on a single variable. Econ- omists are often concerned with the relationships between variables. Thus, they need to be able to display two variables on a single graph. The coordinate systen makes this possible Suppose you want to examine the relationship between study time and grade point average For each student in your class, you could record a pair of numbers hours per week spent studying and grade point average. These numbers could then be placed in parentheses as an ordered pair and appear as a single point on the graph. Albert E. for instance, is represented by the ordered pair (25 hours/week, 3.5 GPA), while his"what-me-worry? "classmate Alfred E is represented by the ordered pair(5 hours/week, 2.0 GPA) We can graph these ordered pairs on a two-dimensional grid. The first number in each ordered pair, called the x-coordinate, tells us the horizontal location of the int. The second number, called the y-coordinate, tells us the vertical location of he point. The point with both an x-coordinate and a y-coordinate of zero is known as the origin. The two coordinates in the ordered pair tell us where the point is lo- cated in relation to the origin: x units to the right of the origin and y units above it Figure 2A-2 graphs grade point average against study time for Albert E Alfred E, and their classmates. This type of graph is called a scatterplot because it plots scattered points. Looking at this graph, we immediately notice that points farther to the right (indicating more study time)also tend to be higher (indicating a better grade point average). Because study time and grade point average typi cally move in the same direction, we say that these two variables have a positive
CHAPTER 2 THINKING LIKE AN ECONOMIST 37 GRAPHS OF TWO VARIABLES: THE COORDINATE SYSTEM Although the three graphs in Figure 2A-1 are useful in showing how a variable changes over time or across individuals, such graphs are limited in how much they can tell us. These graphs display information only on a single variable. Economists are often concerned with the relationships between variables. Thus, they need to be able to display two variables on a single graph. The coordinate system makes this possible. Suppose you want to examine the relationship between study time and grade point average. For each student in your class, you could record a pair of numbers: hours per week spent studying and grade point average. These numbers could then be placed in parentheses as an ordered pair and appear as a single point on the graph. Albert E., for instance, is represented by the ordered pair (25 hours/week, 3.5 GPA), while his “what-me-worry?” classmate Alfred E. is represented by the ordered pair (5 hours/week, 2.0 GPA). We can graph these ordered pairs on a two-dimensional grid. The first number in each ordered pair, called the x-coordinate, tells us the horizontal location of the point. The second number, called the y-coordinate, tells us the vertical location of the point. The point with both an x-coordinate and a y-coordinate of zero is known as the origin. The two coordinates in the ordered pair tell us where the point is located in relation to the origin: x units to the right of the origin and y units above it. Figure 2A-2 graphs grade point average against study time for Albert E., Alfred E., and their classmates. This type of graph is called a scatterplot because it plots scattered points. Looking at this graph, we immediately notice that points farther to the right (indicating more study time) also tend to be higher (indicating a better grade point average). Because study time and grade point average typically move in the same direction, we say that these two variables have a positive Rental income (2%) Corporate profits (12%) (a) Pie Chart (c) Time-Series Graph Real GDP per Person in 1997 United States ($28,740) 30,000 25,000 20,000 15,000 10,000 5,000 0 United Kingdom ($20,520) (b) Bar Graph Mexico ($8,120) India ($1,950) Compensation of employees (72%) Proprietors’ income (8%) Interest income (6%) Productivity Index 115 95 75 55 35 0 1950 1960 1970 1980 1990 2000 Figure 2A-1 TYPESOF GRAPHS. The pie chart in panel (a) shows how U.S. national income is derived from various sources. The bar graph in panel (b) compares the average income in four countries. The time-series graph in panel (c) shows the growth in productivity of the U.S. business sector from 1950 to 2000
38 PART ONE INTRODUCTION Figure 2A-2 Grade USING THE COORDINATE SYSTEM Grade point average is measured Average on the vertical axis and study ntal ax Albert e alfred e and their classmates are represented by (25,35) various points. We can see from the graph that students whe tudy more tend to get higher (5,2.0) 0 cOrrelation. By contrast, if we were to graph party time and grades, we would likely nd that higher party time is associated with lower grades; because these variables typically move in opposite directions, we would call this a negative correlation. In either case, the coordinate system makes the correlation between the two variables easy to see. CURVES IN THE COORDINATE SYSTEM Students who study more do tend to get higher grades, but other factors also in- fluence a student's grade. Previous preparation is an important factor, for instance, as are talent, attention from teachers, even eating a good breakfast. A scatterplot like Figure 2A-2 does not attempt to isolate the effect that study has on grades from the effects of other variables. Often, however, economists prefer looking at how one variable affects another holding everything else constant. To see how this is done, let's consider one of the most important graphs in eco- nomics-the demand curve. The demand curve traces out the effect of a goods on the quantity of the good consumers want to buy Before showing a demand curve. however, consider Table 2A-1, which shows how the number of novels that Emma buys depends on her income and on the price of novels. When novels are cheap, Emma buys them in large quantities. As they become more expensive, she borrows books from the library instead of buying them or chooses to go to the movies instead of reading. Similarly, at any given price, Emma buys more novels when she has a higher income. That is, when her income increases, she spends part of the additional income on novels and part on other goods We now have three variables-the price of novels, income, and the number of novels purchased-which is more than we can represent in two dimensions. To
38 PART ONE INTRODUCTION correlation. By contrast, if we were to graph party time and grades, we would likely find that higher party time is associated with lower grades; because these variables typically move in opposite directions, we would call this a negative correlation. In either case, the coordinate system makes the correlation between the two variables easy to see. CURVES IN THE COORDINATE SYSTEM Students who study more do tend to get higher grades, but other factors also influence a student’s grade. Previous preparation is an important factor, for instance, as are talent, attention from teachers, even eating a good breakfast. A scatterplot like Figure 2A-2 does not attempt to isolate the effect that study has on grades from the effects of other variables. Often, however, economists prefer looking at how one variable affects another holding everything else constant. To see how this is done, let’s consider one of the most important graphs in economics—the demand curve. The demand curve traces out the effect of a good’s price on the quantity of the good consumers want to buy. Before showing a demand curve, however, consider Table 2A-1, which shows how the number of novels that Emma buys depends on her income and on the price of novels. When novels are cheap, Emma buys them in large quantities. As they become more expensive, she borrows books from the library instead of buying them or chooses to go to the movies instead of reading. Similarly, at any given price, Emma buys more novels when she has a higher income. That is, when her income increases, she spends part of the additional income on novels and part on other goods. We now have three variables—the price of novels, income, and the number of novels purchased—which is more than we can represent in two dimensions. To Grade Point Average 2.5 2.0 1.5 1.0 0.5 40 Study Time (hours per week) 3.0 3.5 4.0 0 5 10 15 20 25 30 35 Alfred E. (5, 2.0) Albert E. (25, 3.5) Figure 2A-2 USING THE COORDINATE SYSTEM. Grade point average is measured on the vertical axis and study time on the horizontal axis. Albert E., Alfred E., and their classmates are represented by various points. We can see from the graph that students who study more tend to get higher grades