2-1 The Economist as Scientist

The Scientific Method: Observation, Theory, and More Observation

• The scientific method is a dispassionate development and testing of theories about how the world works.

• Issac Newton developed a theory in the 17th-century that stated that gravity applies to any two objects in the universe.

• Events in economics can be theorized and observed.

  • Ex. Someone could develop a theory that inflation surfaces when too much money is printed by the government. In order to test this theory, the economist would have to collect and analyze data, in relation to money and prices from different countries.

• While experimenting is quite common in most sciences, it's often impractical in economics. Although, theory and observation is a commonality between economists and other scientists.

• Economists use history as a source of evidence for their own natural experiments. They look into the past and see what went wrong, and evidently, what not to do.

  • Ex. Oil prices may skyrocket globally after the war in the Middle East interrupts the supply of crude oil. This can negatively affect the standards of living but it gives economists a better insight into how key natural resources are affected within economies.

The Role of Assumptions

• In economics, assumptions can be used to simplify the complex world.

• Economists use assumptions to form answers to different questions. The assumptions can include both short-run and long-run effects.

Economic Models

• Economists use diagrams and equations to learn more about the world. These models allow them to determine what matters most in an economy.

• Each model is slightly different, as they're built upon differing assumptions. Most models are simplified to improve people's ability to understand how economics functions.

Our First Model: The Circular-Flow Diagram

• Economists use models to gain a better understanding of how the economy -buying, selling, working, hiring, manufacturing, etc- works.

• Circular-flow diagram: a visual model of the economy that shows how dollars flow through markets among households and firms.

• A firm produces and sells goods, and services, while also hiring and using factors of production.

• Households include buying and consuming goods, and services, while also owning and selling factors of production.

• Markets for goods and services include selling firms and buying households.

• Markets for factors of production include selling households and buying firms.

Our Second Model: The Production Possibilities Frontier

• Production possibilities frontier: a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology.

• Resources are scarce, making it possible for an economy to be efficient if it uses all of the scarce resources available to it.

• It is believed that because of unemployment, the economy is producing less than it could from the available resources. If the economy moved in a more sufficient direction, it could go from producing 300 cars to 600 cars, and 1,000 computers to 2,200 computers.

• In order to produce more of one good, we must then produce less of another.

• The advancement in technology has led the economy to have a higher demand for producing computers for any given number of cars.

• Scarcity, efficiency, trade-offs, opportunity cost, and economic growth are powerful ideas that are highlighted to simplify a complex economy.

Microeconomics and Macroeconomics

• Economics can be studied on various levels: decisions made by individual households and firms, interactions between households and firms in markets that are specific to their goods and services, or the operation of the economy as a whole.

• Economics is typically separated into two subfields: microeconomics and macroeconomics.

• Microeconomics: the study of how households and firms make decisions and how they interact in markets.

• Macroeconomics: the study of economy-wide phenomena, including inflation, unemployment, and economic growth.

• A microeconomist, for example, could study how housing in NYC is affected by rent control or how the U.S. auto industry is affected by the impacts of foreign competition.

• A macroeconomist, for instance, could study the effects of borrowing by the federal government or how the economy's unemployment rate changes over time.

2-2 The Economist as Policy Adviser

• As policy advisers, economists are often asked to explain the cause of economic events such as: Why is the rate of unemployment higher for teens than for older workers? What could be done by the government to improve the well-being of teenagers?

• Explaining the world and how it works = scientists.

• Helping improve the world = policy advisers.

• Economists can be both scientists and policy advisers, or one of the two.

Positive versus Normative Analysis

• Scientist POV: Minimum-wage laws cause unemployment.

• Policy adviser POV: The government should raise the minimum wage.

• Positive statements: claims that attempt to describe the world as it is.

• Normative statements: claims that attempt to prescribe how the world should be.

• Positive statements can be confirmed or refuted by analyzing data on changes in minimum wages, as well as the rate of unemployment over time. Normative statements, on the other hand, include values and facts, meaning they cannot be judged through data.

• Normative statements focus more so on a person's values and views on ethics, religions, and political philosophy.

Economists in Washington

• Because economists often face trade-offs, their advice is typically not straightforward. President Harry Truman once observed this.

• A policy could risk its effectiveness of equality by increasing its efficiency. While the current generation could hurt from this policy, it could pay off in the long run, benefitting future generations.

• The Council of Economic Advisers includes three members and staff with nearly a dozen economists. They advise the president and help write the Economic Report of the President which appears annually.

• The Economic Report of the President: recent developments in the economy are discussed, as well as the addressing of the council's analysis of current policy issues.

• In the Office of Management and Budget, economists assist with formulating spending plans and regulatory policies.

• In the Department of Justice, economists enforce the nation's antitrust laws.

• In the Department of the Treasury, economists help design tax policies.

• In the Department of Labor, economists analyze data on workers and people searching for work, in order to help form labor-market policies.

• Economists are also employed and relied on by Congress. Congress relies on the Congressional Budget Office and the Federal Reserve. The Federal Reserve sets the nation's monetary policy and employs hundreds of economics throughout the world to analyze developments in each country.

Why Economists' Advice Is Not Always Followed

• A lot goes into presidential decisions. As a leader, the president will hear ideas from economic advisers about different policies, then turn to other advisors for input. These communication advisers will explain said policies and anticipate any misunderstandings, while press advisers will inform the president on how the news media will react and report on this proposal. They'll tell the president what sort of opinions may transpire on editorial pages in the nation. Legislative affair advisers then inform the president on Congress' view of the proposal, what Congress will suggest, and how likely it's for Congress to pass the president's proposal into law.

2-3 Why Economists Disagree

• Economists can seem to give conflicting advice because life isn't black and white. An economist may disagree about the validity of alternative positive theories that tell how the world works. Each economist tends to hold different values that form different normative views, which would lead to different government policies.

Differences in Scientific Judgments

• Economists often disagree with each other, since they each have different hunches about the validity of alternative theories.

• Some economists may advocate for a switch from the current income tax to a consumption tax, while others may advocate for the current income tax to remain the same. These two groups have separate positive views when it comes to saving responsiveness to tax incentives.

Difference in Values

• Policies cannot be judged upon merely scientific grounds, but also economist values and political philosophies.

Perception versus Reality

• Economists agree with each other more often than they disagree (they often come to a compromise).

  • Ex. 93% of economists agree that a ceiling on rents reduces the quantity and quality of housing available and that tariffs and import quotas usually reduce general economic welfare.

• "Ask the Experts" boxes in a book are often based on the IGM Economic Experts Panel which answers survey questions. They're asked whether they agree with the proposition, disagree with it, or are uncertain about where they stand on the issue.

2-4 Let's Get Going

• An economist must deeply understand symbols, history, math, philosophy, and politics.

Appendix

Graphing: A Brief Review

• Graphs help economists express concepts with numbers and variables that are related to one another.

• Graphs can express ideas in an easier way than equations or words could express it. They also analyze data, providing patterns to be found and interpreted.

• Economists can use Pie Charts, Bar Graphs, or Time-Series Graphs.

• The Coordinate System can be used in graphs to represent two variables, whether they're changing over time or across individuals.

• X-coordinates tell the location of a point on the horizontal axis.

• Y-coordinates tell the location of a point on the vertical axis.

• Grade point averages can be measured on a coordinate system.

  • Ex. If study time and GPA. moved up in the same direction, these two variables would create a positive correlation. If they were to move in opposite directions, meaning if party and grades were graphed and compared, lower grades would most likely be associated with more party time, equaling a negative correlation.

• A coordinate system could include curves. Demand curves can trace out the effect of a good's price on the quantity of the good consumers want to buy.

• When two variables move in opposite directions, they're negatively related.

• When two variables move in the same direction, they're positively related.

• When analyzing a graph in economics, it's important to realize the difference between movements along a curve and shifts of a curve.

• The curve can shift when a relevant variable that isn't labeled on the axis' changes.

• A slope can be used when examining how much a variable responds to changes in another variable.

• When calculating slope you can use the rise over run, or y divided x.