Copyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-1CHAPTER3ThinkingLikeanEconomistCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-2Questions•Iseconomicsascience?•Whatdoeconomistsmeanbyamodel?•Whydoeconomistsusemathematicalmodelssomuch?•Whatpatternsandhabitsofthoughtmustyoulearntosuccessfullythinklikeaneconomist?Copyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-3Economics•isasocialscience–focusesonhumanbeingsandhowtheybehave•debateswithineconomicslastlongerthanthoseinnaturalsciences–lesslikelytoendinconsensus•economistsareunabletoundertakelarge-scaleexperiments•thesubjectsstudiedbyeconomists--people--havemindsoftheirown–expectationsofthefutureplayanimportantroleCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-4TheImportanceofExpectations:AnExample•Thestockmarketcrashof1929changedwhatAmericansexpectedaboutthefutureoftheeconomy•ExpectationsthatfutureincomewouldbelowerbecamerealizedspendingproductionlayoffsincomeCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-5Figure3.1-TheStockMarket,1928-1932Copyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-6Economics•isaquantitativescience–usesarithmetictomeasureeconomicvariablesofinterest–usesmathematicalmodelstorelateeconomicvariablesofinterest•involvesaparticularwayofthinkingabouttheworldusing–uniquetechnicallanguage–aspecificsetofdataCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-7Economists•useaspecialsetofanalogiesandmetaphorstodescribethefunctioningofthemacroeconomy–curves“shift”–moneyhasa“velocity”–thecentralbank“pushestheeconomyupthePhillipscurve”Copyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-8Figure3.2-PushingtheEconomyUpthePhillipsCurveCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-9DominantConcepts•theimageofthe“circularflowofeconomicactivity”•theuseoftheword“market”•theideaof“equilibrium”•useofgraphsanddiagrams–equationsdepictedbygeometriccurves–situationsofequilibriumoccurwherecurvescross–changesineconomydemonstratedbyshiftsinthecurvesCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-10TheCircularFlow•patternsofspending,income,andproductionflowingthroughtheeconomy–flowofpurchasingpowerCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-11TheCircularFlow•“incomeside”–firmsbuythefactorsofproductionfromhouseholds–moneypaymentsflowfromfirmstohouseholds•“expenditureside”–householdsbuygoodsandservicesfromfirms–moneypaymentsflowfromhouseholdstofirmsCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-12Figure3.3-TheCircularFlowDiagramCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-13CircularFlow•canbemadetobemorerealisticbyadding–thegovernment–financialmarkets–internationaltradeandfinanceCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-14Figure3.4-TheCircularFlowofEconomicActivityCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-15DifferentMeasuresoftheCircularFlow•“expenditureside”measure–consumption–investment–governmentpurchases–netexports•“incomeside”measure–purchasesoflabor,capital,andnaturalresourcesowneddirectlyorindirectlybyhouseholdsCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-16DifferentMeasuresoftheCircularFlow•“usesofincome”measure–wherehouseholdsdecidetousetheirincome•saving•taxes•consumptionCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-17Markets•areusedasametaphorforthecomplexprocessesofmatchingandexchangethattakeplaceintheeconomy–economistsassumethatbuyersandsellersarewell-informedaboutprevailingpricesandquantitiesCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-18Equilibrium•isapoint(orpoints)ofbalanceatwhichsomeeconomicquantityisneitherrisingnorfalling–onceequilibriumisidentified,economistscandeterminehowfasteconomicforceswillpushtheeconomytothepointsofequilibriumCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-19GraphsandEquations•analgebraicequationrelatingtwovariablescanalsoberepresentedasacurvedrawnonagraph•thesolutiontoasetoftwoequationsisthepointonagraphwherethetwocurvesthatrepresenttheequationsintersectCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-20Figure3.5-TwoFormsoftheProductionFunctionCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-21UsingGraphsInsteadofEquations•behavioralrelationshipsbecomecurvesthatshiftaroundonagraph•conditionsofeconomicequilibriumcanberepresentedbythepointswherethecurvesdescribingbehavioralrelationshipsintersectCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-22UsingGraphsInsteadofEquations•changesinthestateoftheeconomycanbeshownasmovementsintheintersectionofthecurvesCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.3-23BuildingModels•restricttheproblemtoonlyafewbehavioralrelationshipsandequilibriumconditions•capturetheserelationshipsandequilibriumconditionsinsimplealgebraicequations–usediagramstorepresenttheequations•applythemodeltotherealworldCopyright©2002byTheMcGraw-H