Economic Models

In this chapter,we will look at  three economic models that are crucially important in their own right and also illustrate why such models are so useful.

1. Production Possibility Frontier 

The idea behind this model is to improve our understanding of trade-offs by considering a simplified economy that produces only two goods.This simplification enables us to show the trade off graphically.

The hit movie Cast Away, starring Tom Hanks, was an update of the classic story of Robinson Crusoe.As in the original story of Robinson Crusoe,the character played by Hanks had limited resources:the natural resources of the island, a few items he managed to salvage from the plane,and of course his own time and effor.With only this resources,he had to make life.
  As a result, any economy-wheter it contains only one man- faces trade-offs.For example if he devotes resources to cach fish,he can't use these same resources to gather coconut.Economists use the model known as Production Possibility Frontier.

    

It shows the maximum quantitiy of one good that can be produced given the quantitiy of the another good produced. Feasible production is shown by the area inside or on the curve.Production at point x is feasible but not efficient.Point A,B,C are feasible and efficient, but point Y is not feasible.

 INCREASING OPPORTİNİTY  COST

Economists believe that opportunity costs are usually increases.The reason is that when only a small amount of good is produced ,the economy can use resources that are especially well suited for that production.

Economic Growth

We define economic growth as the growing ability of the economy to produce goods and services. ıt results in an outward shifft of the production possibility frontier because production possibilities are expanded.The economy can now produce more of everything.For example,if production is initially at point A, it could move to point e.

2.Comparative Advantage and Gain from Trade

An individual has a comparative advantage in producing a good or service if the opprtunity cost of producing the good is loweer for that individual than for other people. The model provides a clear illustration of the gains from trade:by aggreing to specialize and provide goods to each other, the castaway can produce more and therefore both be better  off than if they tried to be self-sufficient.

3.The Circular-flow Diagram 

The circular flow diagram is a mod

el that represents the transactions in an economy by flows around a circle.This model contains only two kinds of inhabitants: household and firms.

The model represents the flows of money and goods and services in the economy.In the markets for goods and services households purchase goods and services from firms,generating a flow of money to the firms and flow of goods and services to the households.The money flows back to households as firms purchase factors of production from the household in factor markets.

Positive vs. Normative Economics

Positive economics: is the branch of economic analyses that describes the way the economy actually works.
Normative Economics: makes prescriptions about the way the economy should work.

When and Why Economists Disagree?

Economists disagree for two main reasons.One,they may disagree about which simplifications to make in a model.Two,economists may disagree about values.