Chapter 2 Powerpoint

A model is a formal statement
of a theory.
Components of a theory or
economic model:
 Variables are measures that can change over
time or across observations.
 Assumptions regarding relationships among
variables.
 Implications
 Testable hypotheses
Ockham’s razor is …
... the proposition that irrelevant
details in theories (models) should
be eliminated.
 The value of a model or theory derives

from its ability to explain the world
around us.
The Scientific method entails
evaluating whether models and
theories are consistent with
empirical evidence.
 Models and theories that conflict with the

evidence are either discarded or
amended to be consistent.
The King’s Game:
I’m the King and your job is to entertain me.
Use the scientific method to develop and

refine a theory regarding the rule I used to
order the cards in a deck.
King’s Game
 2 of hearts
 3 of clubs
 4 of hearts
 6 of spades
 7 of diamonds
 8 of spades
 J of diamonds
 Q of clubs
 K of hearts
 Ace of clubs
 5 of hearts
 2 of spades
Two Roles of Economists
 When they are trying to explain the

world, they are scientists.
 When they are trying to change the
world, they are policymakers.
Positive versus Normative
Analysis
 Positive statements are statements

that describe the world as it is.
 Normative statements are statements
about how the world should be.
Positive or Normative
Statements?
An increase in the minimum wage

will cause a decrease in employment
among the least-skilled.
Positive or Normative
Statements?
The income gains from a higher

minimum wage are worth more than
any slight reductions in employment.
Why Economists Disagree
 They may disagree on theories

about how the world works.
 They may hold different values

and, thus, different normative
views.
Production is the process of
using inputs to make goods
and services available.
These inputs or factors of production are ...
 Labor, referring to all human resources.
 Land, referring to all natural resources, including
the environment.
 Capital, meaning the durable goods that have been
produced and in turn are used to produce other
goods and services.
 Intermediate inputs, meaning goods that have been
produced and, in turn, are used up in the production
process.
Technology is the knowledge
of how inputs can be used to
produce goods and services.
Production Possibilities Model
 Quantity and quality of inputs are fixed.

 Two outputs: food (F) and clothing (C).
 Technology is fixed.
 Some inputs are relatively better
adapted to the production of one good
rather than the other.
The production possibility frontier (PPF) shows the
maximum quantity of one good that can be
produced given fixed quantities of all the others.
Production clothing
a Figure 1
Possibilities 15
14 b
Food Clothing c
12
a 0 15
b 1 14 9 d
c 2 12
e
d 3 9 5
e 4 5
f
f 5 0
1 2 3 4 5 food
An allocation of resources is efficient
in production if it is not possible to
produce more of one good without
producing less of some other good.
Insights from the PPF model
 Scarcity ... The quantities of the goods that can be
produced fall short of what is desired .
 Choice …There are mutually exclusive
combinations of goods among which society must
choose.
 Opportunity cost … When there is efficiency in
production, the only way to have more of one good
is to have less of another.
Another Production Possibilities Model
 There are 600 units of labor, the only input.

 Two outputs: food (F) and clothing (C).
 Technology is fixed; each unit of labor is able to
produce either af units of food or ac units of clothing
output produced per unit of labor
Clothing ac = 1.0 unit of clothing per unit of labor
Food af = 0.5 units of food per unit of labor
Clothing ac = 1.0 unit of clothing per unit of labor
Food af = 0.5 units of food per unit of labor
Given 600 units of labor, the

implied production
possibilities are as follows:
Food Clothing
0 600
100 400
200 200
300 0
Clothing = 1.0 unit of clothing per unit of labor
Food = 0.5 units of food per unit of labor
Implied Production
C
Possibilities 600
Food Clothing 500
0 600 400
100 400 300
200 200 200
300 0 100
50 100 150 200 250 300 F

C Figure 3.a
1200
1000
800
 C   200
600
400 m
200 n
 F  100
100 200 300 400 500 600 F
 C  200
   2 units of C per unit of F
F 100
C Figure 3.b
Labor increases from
1200 600 to 1000 units.
1000
800
600
400
200
100 200 300 400 500 600 F

C Figure 3.b
Labor increases from
1200 600 to 1000 units.
1000
800
600
400
200
100 200 300 400 500 600 F

Figure 3.c
Clothing output per unit of labor
increases from 1 to 2 units
C
1200
1000
800
600
400
200
100 200 300 400 500 600 F

Figure 3.c
C
1200
1000
800
600
400
200
100 200 300 400 500 600 F

Figure 3.c
C
1200
1000  F  100
800
600  C  400
400
200
100 200 300 400 500 600 F
C
  4 units of C per unit of F
F
Figure 3.d
The productivity of labor increases
100%, both with respect to the

production of F and C
C
1200
1000
800
600
400
200
100 200 300 400 500 600 F

Figure 3.d
The productivity of labor increases
100%, both with respect to the

production of F and C
C
1200
1000
800
600
400
200
100 200 300 400 500 600 F

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A model is a formal statement

 The value of a model or theory derives

 Models and theories that conflict with the

I’m the King and your job is to entertain me.

Use the scientific method to develop and

 When they are trying to explain the

 Positive statements are statements

An increase in the minimum wage

The income gains from a higher

 They may disagree on theories

 They may hold different values

 Quantity and quality of inputs are fixed.

 There are 600 units of labor, the only input.

Given 600 units of labor, the

Food = 0.5 units of food per unit of labor

100 400 300

200 200 200

50 100 150 200 250 300 F

100 200 300 400 500 600 F

100 200 300 400 500 600 F

100 200 300 400 500 600 F

100 200 300 400 500 600 F

100 200 300 400 500 600 F

100%, both with respect to the

100 200 300 400 500 600 F

100%, both with respect to the

100 200 300 400 500 600 F

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