According to thinking like an economist, economists increasingly believe that the key to progress in macroeconomics lies in

Definition of scientific method - the dispassionate development and test of theories about how the world works

Example: Is printing too much money related to high prices? Make observations to see if they are related or not.

However, controlled experiments in economics are difficult. Like evolutionary biologists and astronomers, economists just have to take the data they’re given. Most of that data will be put into historical context.

Economists, like other scientists, make assumptions to make the world easier to understand and to study.

Example: Examine two countries and two goods rather than the whole world and all its goods.

Models are tools economists use, absent intricacies and complicating details, to try to understand and explain the world.

1. Circular Flow Diagram

A visual model of the economy with two economic agents (in its simplest form)—households and firms—that shows how dollars flow through markets among those agents. (See Figure 2-1)

Households own all the factors of production and sell them in resource markets to firms, who use those inputs to produce goods and services to sell in product markets.

The inner loop is goods and services; the outer loop is money.

Factors of production are transformed into goods and services, and the revenue firms receive pays income to households in the forms of wages, rent, interest, and profit.

Definition of factors of production - inputs like land, labor, and capital (buildings and machines) which firms use to produce goods and services

Definition of markets for goods and services - markets in which firms are the sellers and households are the buyers; also called “product markets”

Definition of markets for factors of production - markets in which firms are the buyers and households are the sellers; also called “resource markets”