Thinking Like An Economist 2 Thinking Like An Economist Economics P R I N C I P L E S O F N. Gregory Mankiw Besides introducing students to the economic way of thinking, this chapter introduces the Production Possibilities Frontier, the first of many graphs covered in the textbook. The PPF will be used extensively in Chapter 3 (Interdependence and the Gains from Trade). It would be helpful to ask your students to bring calculators to class on the day you cover this chapter (as well as Chapter 3). Premium PowerPoint Slides by Ron Cronovich

In this chapter, look for the answers to these questions: What are economists’ two roles? How do they differ? 경제학자들의 두 가지 역할 What are models? How do economists use them? 경제모형 What are the elements of the Circular-Flow Diagram? What concepts does the diagram illustrate? 경제순환모형도 How is the Production Possibilities Frontier related to opportunity cost? What other concepts does it illustrate? 생산가능곡선과 기회비용의 관계, 생산가능곡선이 보여주는 다른 개념들 What is the difference between microeconomics and macroeconomics? Between positive and normative? 미시경제학과 거시경제학, 실증경제학과 규범경제학의 차이 1

The Economist as Scientist Economists play two roles: 경제학자들은 두 가지 역할을 수행 1. Scientists: try to explain the world 과학자로서 세상을 설명 2. Policy advisors: try to improve it 정책조언자로서 세상을 개선 In the first, economists employ the scientific method, the dispassionate development and testing of theories about how the world works. 과학적 방법론을 채용하여, 세상이 어떻게 돌아가는지에 관한 이론을 개발하고 검증 THINKING LIKE AN ECONOMIST 2

Assumptions & Models Assumptions simplify the complex world, make it easier to understand. 가정은 복잡한 세상을 단순화하여 이해하기 쉽게 만든다 Example: To study international trade, assume two countries and two goods.국제무역을 연구하기 위해 2국가, 2재화를 가정 Unrealistic, but simple to learn and gives useful insights about the real world. 비현실적이지만 배우기 쉽고 현실세계에 관한 유용한 통찰력을 제공 Model: a highly simplified representation of a more complicated reality. 경제모형은 복잡한 현실을 매우 단순화시켜 나타낸 것 Economists use models to study economic issues. 경제학자들은 경제문제를 연구하기 위해 경제모형을 사용 THINKING LIKE AN ECONOMIST 3

Some Familiar Models A road map THINKING LIKE AN ECONOMIST 4

Some Familiar Models A model of human anatomy from high school biology class THINKING LIKE AN ECONOMIST 5

Some Familiar Models A model airplane THINKING LIKE AN ECONOMIST 6

Some Familiar Models The model teeth at the dentist’s office Don’t forget to floss! THINKING LIKE AN ECONOMIST 7

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 경제순환모형도는 어떻게 돈이 시장을 통해서 가계와 기업 간에 흘러 다니는지를 보여주는 시각적 경제모델 Two types of “actors”: households firms Two markets: the market for goods and services 재화와 서비스 시장 the market for “factors of production” 생산요소 시장 THINKING LIKE AN ECONOMIST 8

Factors of Production Factors of production: the resources the economy uses to produce goods & services, including 재화와 서비스를 생산하는 데 사용하는 자원으로 다음을 포함 labor land capital (buildings & machines used in production) The “definition” of capital shown on this slide (“buildings and machines”) is the same that appears in the corresponding section of the chapter. A more formal definition will be provided in subsequent chapters. THINKING LIKE AN ECONOMIST 9

FIGURE 1: The Circular-Flow Diagram Households: Own the factors of production, sell/rent them to firms for income 생산요소를 소유하고 기업에 판매/임대하여 소득을 얻음 Buy and consume goods & services 재화와 서비스를 구매하여 소비 Firms Households Firms: Buy/hire factors of production, use them to produce goods and services 생산요소를 구매/고용, 사용하여 생산 Sell goods & services 재화와 서비스를 판매 This and the following slide build the Circular-Flow Diagram piece by piece. THINKING LIKE AN ECONOMIST 10

FIGURE 1: The Circular-Flow Diagram Revenue Markets for Goods & Services Spending G & S sold G & S bought Firms Households Wages, rent, profit Factors of production Income Labor, land, capital In this diagram, the green arrows represent flows of income/payments. The red arrows represent flows of goods & services (including services of the factors of production in the lower half of the diagram). To keep the graph simple, we have omitted the government, financial system, and foreign sector, as discussed on the next slide. You may wish to change the order in which the elements appear. To do so, look for “Custom Animation” in your version of PowerPoint. Markets for Factors of Production THINKING LIKE AN ECONOMIST 11

Our Second Model: The Production Possibilities Frontier The Production Possibilities Frontier (PPF): 생산가능곡선 a graph that shows the combinations of two goods the economy can possibly produce given the available resources and the available technology 가용한 자원과 기술이 주어졌을 때 한 경제가 생산할 수 있는 두 재화의 조합을 보여주는 그래프 Example: Two goods: computers and wheat One resource: labor (measured in hours) Economy has 50,000 labor hours per month available for production. 경제는 생산을 위해 가용한 월 50,000 시간의 노동을 보유 THINKING LIKE AN ECONOMIST 12

Employment of labor hours PPF Example Producing one computer requires 100 hours labor. Producing one ton of wheat requires 10 hours labor. E D C B A Wheat Computers Production Employment of labor hours 50,000 500 50,000 40,000 10,000 25,000 1,000 400 Suggestion: Show first row. Explain how we get the production numbers from the employment numbers. Then, show the rest of the employment numbers, and give students 3 minutes to compute the production numbers for each employment allocation. 2,500 250 4,000 100 5,000 13

PPF Example E D C B A Point on graph Production Com-puters Wheat A 500 B 400 1,000 C 250 2,500 D 100 4,000 E 5,000 E D C B A THINKING LIKE AN ECONOMIST 14

A C T I V E L E A R N I N G 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? This exercise leads students to discover for themselves that points under the PPF are possible but inefficient, while points above it are not possible. 15

A C T I V E L E A R N I N G 1 Answers Point F: 100 computers, 3000 tons wheat Point F requires 40,000 hours of labor. Possible but not efficient: could get more of either good w/o sacrificing any of the other. F 16

A C T I V E L E A R N I N G 1 Answers Point G: 300 computers, 3500 tons wheat Point G requires 65,000 hours of labor. Not possible because economy only has 50,000 hours. G 17

The PPF: What We Know So Far Points on the PPF (like A – E) possible efficient: all resources are fully utilized 모든 자원을 완전히 사용 Points under the PPF (like F) not efficient: some resources underutilized 일부 자원 미사용 (e.g., workers unemployed, factories idle) Points above the PPF (like G) not possible THINKING LIKE AN ECONOMIST 18

The PPF and Opportunity Cost Recall: The opportunity cost of an item is what must be given up to obtain that item. 어떤 것의 기회비용이 그것을 얻기 위해 포기해야 하는 것임을 기억 Moving along a PPF involves shifting resources (e.g., labor) from the production of one good to the other. PPF를 따라 이동하는 것은 한 재화의 생산에서 다른 재화로 자원을 이동함을 포함 Society faces a tradeoff: Getting more of one good requires sacrificing some of the other. 사회는 맞교환에 직면: 한 재화를 더 많이 얻으려면 다른 재화를 일부 포기해야 The slope of the PPF tells you the opportunity cost of one good in terms of the other. PPF의 기울기는 다른 재화로 본 한 재화의 기회비용을 말해 줌 THINKING LIKE AN ECONOMIST 19

The PPF and Opportunity Cost The slope of a line equals the “rise over the run,” the amount the line rises when you move to the right by one unit. –1000 slope = = –10 100 Here, the opportunity cost of a computer is 10 tons of wheat. Here, the “rise” is a negative number, because, as you move to the right, the line falls (meaning wheat output is reduced). Moving to the right involves shifting resources from the production of wheat (which causes wheat output to fall) to the production of computers (which causes computer production to rise). Producing an additional computer requires the resources that would otherwise produce 10 tons of wheat. THINKING LIKE AN ECONOMIST 20

A C T I V E L E A R N I N G 2 PPF and Opportunity Cost In which country is the opportunity cost of cloth lower? FRANCE ENGLAND This exercise reinforces the material on the preceding slide. It is especially useful if you plan to cover Chapter 3 (Interdependence and the Gains from Trade) after completing Chapter 2. 21

A C T I V E L E A R N I N G 2 Answers England, because its PPF is not as steep as France’s. FRANCE ENGLAND There are two ways to get the answer. 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. The question, however, does not ask for the numerical values of the opportunity cost of cloth in the two countries. It only asks which country has a lower opportunity cost of cloth. There is an easy way to determine the answer. Students must remember that the slope of the PPF equals the opportunity cost of the good measured on the horizontal axis. Then, students can simply “eyeball” the two PPFs to determine which is steepest. From the graphs show, it’s pretty easy to see that England’s PPF isn’t as steep, and therefore the opportunity cost of cloth is lower in England than in France. 22

Economic Growth and the PPF With additional resources or an improvement in technology, the economy can produce more computers, Economic growth shifts the PPF outward. more wheat, The PPF shows the tradeoff between the outputs of different goods at a given time, but the tradeoff can change over time. For example, over time, the economy might get more workers (or more factories or more land). Or, a more efficient technology might be invented. Both events – an increase in the economy’s resources or an improvement in technology – cause an expansion in the set of opportunities. That is, both allow the economy to produce more of one or both goods. This is a simple example of economic growth, an important subject that gets its own chapter in the macroeconomics portion of the textbook. In the example shown on this slide, economic growth causes a parallel outward shift of the PPF. Since the new PPF is parallel to the old one, the tradeoff between the two goods is the same. However, this need not always be the case. For example, if a new technology had more impact on the computer industry than on the wheat industry, then the horizontal (computer) intercept would increase more than the vertical (wheat) intercept, and the PPF would become flatter: the opportunity cost of computers would fall, because the technology has made them relatively cheaper (relative to wheat). Going into more detail here is probably beyond the scope of this chapter. or any combination in between. 자원을 더 투입하거나 기술이 진보하면 더 많이 생산할 수 있음 THINKING LIKE AN ECONOMIST 23

The Shape of the PPF The PPF could be a straight line, or bow-shaped 생산가능곡선은 직선일 수도 혹은 활 모양일 수도 있음 Depends on what happens to opportunity cost as economy shifts resources from one industry to the other. 한 산업에서 다른 산업으로 자원을 이동시킬 때 기회비용이 어떻게 되느냐에 의존 If opp. cost remains constant, PPF is a straight line. 기회비용이 일정하면 PPF는 직선 (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. 생산을 더 많이 할 때 기회비용이 증가하면 PPF는 활 모양 THINKING LIKE AN ECONOMIST 24

Why the PPF Might Be Bow-Shaped As the economy shifts resources from beer to mountain bikes: 맥주에서 산악자전거로 자원을 이동시키면 PPF becomes steeper PPF 더 가파르게 opp. cost of mountain bikes increases 산악자전거의 기회비용이 증가 Mountain Bikes Beer THINKING LIKE AN ECONOMIST 25

Why the PPF Might Be Bow-Shaped At A, opp. cost of mtn bikes is low. At point A, most workers are producing beer, even those that are better suited to building bikes. 대부분의 근로자들, 심지어 자전거 생산에 적합한 근로자들도 맥주를 생산 So, do not have to give up much beer to get more bikes. 따라서, 자전거를 더 만들기 위해 맥주를 많이 포기할 필요가 없음 (자전거 숙련공을 맥주→자전거로 이동) A Beer Here, we are using “workers” for the more general “resources,” to keep things simple and consistent with the previous examples. Mountain Bikes THINKING LIKE AN ECONOMIST 26

Why the PPF Might Be Bow-Shaped At B, most workers are producing bikes. The few left in beer are the best brewers. 맥주 생산에 남은 소수는 최고기술자들 Producing more bikes would require shifting some of the best brewers away from beer production, would cause a big drop in beer output. 자전거를 더 생산하면 맥주생산이 크게 감소 At B, opp. cost of mtn bikes is high. Beer B Mountain Bikes THINKING LIKE AN ECONOMIST 27

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. 근로자들이 서로 다른 기술을 가지고 있어서 다른 재화로 본 한 재화 생산의 기회비용이 다를 때 PPF는 활 모양 The PPF would also be bow-shaped when there is some other resource, or mix of resources with varying opportunity costs 다른 자원이 있어 기회비용이 변할 때도 PPF는 활 모양 (E.g., different types of land suited for different uses). The bow-shaped PPF is more realistic. However, the linear PPF is simpler to work with, and we can learn a lot about how the economy works using the linear PPF. In Chapter 3, we will use a linear PPF to show how trade can make two countries (or two individuals) better off. Note: In the “Problems and Applications” at the end of the chapter, problem 4 asks students to construct a PPF for an economy with three different workers (Larry, Moe, and Curly), each with a different opportunity cost. The PPF ends up having three line segments (one for each worker), which--very roughly--approximates a bow-shape. After students work through and understand this problem, it should not be hard for them to understand the following: the more different kinds of workers (or, more generally, resources) there are, the closer the PPF will resemble a smooth bow shape. In an actual economy like the U.S., there are millions of different workers with different opportunity costs, so a smooth bow-shaped PPF is a nearly perfect approximation to the actual PPF. THINKING LIKE AN ECONOMIST 28

The PPF: A Summary The PPF shows all combinations of two goods that an economy can possibly produce, given its resources and technology. PPF는 자원과 기술이 주어졌을 때 한 경제가 생산할 수 있는 두 재화의 모든 조합을 보여준다. The PPF illustrates the concepts of tradeoff and opportunity cost, efficiency and inefficiency, unemployment, and economic growth. PPF는 맞교환, 기회비용, 효율성과 비효율성, 실업 및 경제성장의 개념을 보여준다. A bow-shaped PPF illustrates the concept of increasing opportunity cost. 활 모양의 PPF는 기회비용 증가의 개념을 보여준다. THINKING LIKE AN ECONOMIST 29

Microeconomics and Macroeconomics Microeconomics is the study of how households and firms make decisions and how they interact in markets. 미시경제학은 가계와 기업들이 어떻게 의사결정을 내리며 그들이 시장에서 어떻게 상호작용 하는가를 연구 Macroeconomics is the study of economy-wide phenomena, including inflation, unemployment, and economic growth. 거시경제학은 인플레이션, 실업, 경제성장 같은 나라경제 전체에 관한 현상을 연구 These two branches of economics are closely intertwined, yet distinct – they address different questions. 경제학의 이 두 분야는 밀접하게 연관되어 있지만 분명히 구분됨 - 서로 다른 질문에 대답 THINKING LIKE AN ECONOMIST 30

The Economist as Policy Advisor As scientists, economists make positive statements, which attempt to describe the world as it is. 과학자로서 경제학자들은 실증적 주장을 한다: 세상을 있는 그대로 기술 As policy advisors, economists make normative statements, which attempt to prescribe how the world should be. 정책조언자로서 경제학자들은 규범적 주장을 한다: 세상이 어떻게 되어야 한다고 처방 Positive statements can be confirmed or refuted, normative statements cannot. 실증적 주장은 옳고 그름을 확인할 수 있지만 규범적 주장은 그럴 수 없음 Govt employs many economists for policy advice. E.g., the U.S. President has a Council of Economic Advisors, which the author of this textbook chaired from 2003 to 2005. 31 31

A C T I V E L E A R N I N G 3 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. 32

A C T I V E L E A R N I N G 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. 33

A C T I V E L E A R N I N G 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. 34

Why Economists Disagree Economists often give conflicting policy advice. 경제학자들은 종종 상충하는 정책조언을 함 They sometimes disagree about the validity of alternative positive theories about the world. 때로는 이 세상에 관한 실증적 이론의 타당성에 관해 의견이 불일치 They may have different values and, therefore, different normative views about what policy should try to accomplish. 가치관이 서로 다를 수 있고, 따라서 정책이 어떤 목적을 달성해야 하는지에 관한 규범적 견해가 서로 다름 Yet, there are many propositions about which most economists agree. 그렇지만 대부분의 경제학자들이 동의하는 많은 명제들이 있음 THINKING LIKE AN ECONOMIST 35

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%) This slide and the next show several of the 14 propositions appearing in Table 1 of the chapter. For the full list, see Table 1 in the chapter. Note: Some of the terms appearing in these statements have not yet been defined, so you may wish to define them to students as they appear on the screen. If you’re pressed for time, delete the following slide and refer your students to Table 1 in the chapter. continued… THINKING LIKE AN ECONOMIST 36

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%) …Continued from previous slide. THINKING LIKE AN ECONOMIST 37

FYI: Who Studies Economics? Ronald Reagan, President of the United States Barbara Boxer, U.S. Senator Sandra Day-O’Connor, Former Supreme Court Justice Anthony Zinni, Former General, U.S. Marine Corps Kofi Annan, Former Secretary General, United Nations Meg Witman, Chief Executive Officer, eBay Steve Ballmer, Chief Executive Officer, Microsoft Arnold Schwarzenegger, Governor of California, Actor Ben Stein, Political Speechwriter, Actor, Game Show Host Mick Jagger, Singer for the Rolling Stones John Elway, NFL Quarterback Tiger Woods, Golfer Diane von Furstenburg, Fashion Designer This FYI lists people who studied economics in college. It is a fun way to lighten up the lecture. On the other hand, if you’re running short on time, this is a good candidate to skip – students will readily find it when they read the chapter. (Due to space limitations, this slide omits a few of the names in the corresponding FYI box in the text.) 38 38

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. 39