Lesson 2 Economic Methods

Question 1

Challenge in scientific theory for economists

Answer 1

• Unable to conduct experiments bc it’s impractical
• Usually make do with given data + focus on natural experiments (war in Middle East stopping crude oil)

Question 2

Assumptions

Answer 2

Economists make assumptions to make world easier to understand
(assuming certain prices that rarely change are fixed)

Question 3

Models

Answer 3

1) Typically mathematical models with diagrams
2) built on assumptions, right model at right time

Question 4

Circular-flow Diagram

Answer 4

1) contains only firms + households
2) firms = produce goods + services using inputs (factors of production)
3) households own factors of production + consume services provided by firms

Question 5

Two types of markets for households/firms

Answer 5

1) Markets for goods/services = households r buyers + firms r sellers
Households get output
2) Markets for factors of production = households r sellers + firms r buyers
households provide inputs

Question 6

Outer vs Inner Loops

Answer 6

1) Inner loop = flow of inputs + outputs
2) Households sell the use of their labor + land in return for goods which households then buy
3) Outer loop = flow of money
4) Households spend money to buy goods + that money is used to pay for production + profit goes to owners WHO ARE HOUSEHOLD MEMBERS

Question 7

Limitations of Circular Flow diagram

Answer 7

1) doesn’t account for role of government or international trade

Question 8

Factors of production

Answer 8

1) labor, land, capital used by firms to produce services

Question 9

Production Possibilities Frontier

Answer 9

1) shows various combinations of output between 2 objects (in reality there are thousands of interactions) that economy can produce given its constraints
2) Can produce all of one, nothing of the other BUT prolly does a combination
3) economy cannot produce anything outside the graph
4) efficient –> ON graph vs inefficient INSIDE graph

Question 10

Trade-offs with production-possibilities frontier

Answer 10

1) once you’re on graph –> efficient so only way to improve is by doing a trade-off
2) PPF gives opportunity cost (to make 10 more cars you reduce 20 computers)
3) slope = represents the cost
4) PPF can shift based on new innovations

Question 11

PPF Bowed shape

Answer 11

1) Most PPFs are bowed
2) when economy uses most of its resources for one product (Computers) the remaining people (mechanics) aren’t that good SO reduced the # of mechanics isn’t gonna increase computer production by much

Question 12

Macro vs Micro

Answer 12

1) Micro = study of households + firms + interaction in specific markets
2) Macro = study of overall economy

Question 13

Positive vs Normative

Answer 13

1) Positive = descriptive, making claim about how world is (can be evaluated on facts) TESTABLE
2) Normative = make a claim of how world should be (needs to be evaluated on facts AND values)
Important to reduce bias by putting aside normative views

Question 14

Why do economists disagree

Answer 14

1) differences in scientific judgement
2) differences in values
3) perception vs reality

Question 15

Movements along curve vs shifts of curve

Answer 15

1) movement along curve –> when price changes (when variables on axis change)
2) shift of curve –> when a variable not named on axis changes

Question 16

Demand slopes meaning

Answer 16

1) steep demand curve (bigger #) = similar demand even with change in prices –> inelastic
2) flat demand curve (smaller #) = demand is greatly affected by prices (elastic)

Question 17

Difficulties with causality

Answer 17

1) Omitted Variables = confounding variable
C interfering with relationship btwn A and B
2) Reverse causality = may incorrectly assume that A causes B instead of B causing A

Question 18

Benefits of trade

Answer 18

allows people to live life outside their PPF (get more goods without working more bc of specialization)

Question 19

Comparative Advantage

Answer 19

Producer who gives up less of other good to produce Good X has smaller opportunity cost and therefore has comparative advantage

Question 20

Absolute Advantage

Answer 20

the ability to produce a good using fewer inputs than another producer

Question 21

Can someone have both absolute and comparative advantage in both goods

Answer 21

NO, they can have absolute advantage in both BUT impossible to have comparative advantage in both

Question 22

Gains from specialization + trade based on

Answer 22

COMPARATIVE ADVANTAGE
1) if ppl produce goods where have comparative advantage –> total production rises (pie is bigger SO everyone could be better off depending on how it is divided)

Question 23

When do both parties gain from trade

Answer 23

1) when price they trade at is btwn their opportunity costs
ex = Ruby’s opportunity cost is 2 oz potato/oz meat and Frank’s is 4 oz potato/oz meat SO price of trade is 3 (in middle)

Question 24

What happens if price of trade is above/below opportunity cost

Answer 24

1) If above opportunity cost –> everyone would sell product
2) If below opportunity cost –> everyone would buy product
Need a buyer AND seller

Question 25

Ex: Osaka mows lawn in 2 hours, Hari in 4 hours. Osaka could film an ad for 30K in those 2 hours and Hari could earn 50 in those 4 hours. Who has absolute advantage, comparative advantage, what should trade price be?

Answer 25

1) Osaka has absolute advantage mowing lawn since she can do it in less time (2 hours vs 4 hours)
2) Hari has comparative advantage mowing lawn since his opportunity cost is lower (50 vs 30,000)
3) Price for trade should be btwn opportunity costs so between 50 - 30,000 to ensure both are better off

Question 26

Imports vs Exports

Answer 26

1) Imports = good produced abroad + sold domestically (coming INTO country)
2) exports = goods produced domestically + sold abroad (going OUT of country)

Question 27

Ex with countries: American farmer can produce 2 tons of food a month and 1 car a month. Japan can produce 1 ton of food a month and one car. Identify who has absolute advantage, comparative advantage, and what they should specialize in

Answer 27

1) America has absolute advantage in producing food
2) To produce one car, America gives up 2 tons while Japan only gives up 1 ton SO Japan has comparative advantage with cars + America has comparative advantage with food
3) SO, America should produce extra food + trade it with Japan and Japan should produce extra cars and trade with America. Result = both countries enjoy more prosperity