Limits, Alternatives, and Choices

Chapter 1

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives

• Economics defined

• Role of economic theory

• Microeconomics vs. macroeconomics

• Resource scarcity and the economizing problem

• Production possibilities model1-2

Economics Defined

• Economic wants exceed productive capacity

• Social science concerned with making optimal choices under conditions of scarcity

1-3

The Economic Perspective

• Thinking like an economist

• Key features:–Scarcity and choice

–Purposeful behavior

–Marginal analysis

1-4

Scarcity and Choice

• Resources are scarce

• Choices must be made

• There is no free lunch

• Opportunity cost

1-5

Purposeful Behavior

• Rational self-interest

• Individuals and utility

• Firms and profit

• Desired outcomes

1-6

Marginal Analysis

• Marginal benefit

• Marginal cost

• Marginal means extra

• Comparison of marginal benefit and marginal cost

1-7

Economic Models

• The scientific method

• Cause and effect

• Economic principles

• Simplification of reality

• Other-things-equal assumption

• Graphical expression

1-8

Macro vs. Micro

• Macroeconomics–Aggregate

• Microeconomics–Individual Units

• Positive Economics

• Normative Economics

1-9

Individual’s Economizing Problem

• Limited income

• Unlimited wants

• A budget line

• Tradeoffs & opportunity costs

• Make best choice possible

• Change in income

1-10

A Budget Line

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02468

1012

DVDs$20

Books$10

12

10

8

6

4

2

02 4 6 8 10 12 14

$120 Budget

Income = $120

Pdvd = $20= 6

Income = $120

Pb = $10= 12

Attainable

Unattainable

Quantity of Paperback Books

Qu

anti

ty o

f D

VD

s

1-11

Society’s Economizing Problem

• Scarce resources–Land–Labor–Capital–Entrepreneurial Ability

• Factors of production

1-12

Production Possibilities Model

• Illustrate production choices

• Assumptions:–Full employment

–Fixed resources

–Fixed technology

–Two goods

1-13

Type of Product

Pizzas (in hundred thousands)

Industrial Robots (in thousands)

Production Alternatives

A B C D E

10 9 7 4 0

0 1 2 3 4

Plot Points to Create Graph…

Production Possibilities Table

1-14

Production Possibilities Curve

Pizzas

Ind

ust

rial

Ro

bo

ts

Attainable

0 1 2 3 4 5 6 7 8 9

14

13

12

11

10

9

8

7

6

5

4

3

2

1

Unattainable

AB

C

D

E

EconomicGrowth

Now Attainable

A’

B’

C’

D’

E’

1-15

Production Possibilities Curve

Pizzas

Ind

ust

rial

Ro

bo

ts

Attainable

0 1 2 3 4 5 6 7 8 9

14

13

12

11

10

9

8

7

6

5

4

3

2

1

Unattainable

AB

C

D

E

Law of IncreasingOpportunity Cost

A’

B’

C’

D’

E’

Shape of the Curve

1-16

Production Possibilities Curve

Pizzas

Ind

ust

rial

Ro

bo

ts

Under or Unemployment

0 1 2 3 4 5 6 7 8 9

14

13

12

11

10

9

8

7

6

5

4

3

2

1

Unattainable

A’

B’

C’

D’

E’

U

1-17

The Future Economy

• Consequences of unemployment

• Economic growth–More resources

–Better quality resources

–Technological advances

1-18

Future Possibilities

Goods for the Present

Goo

ds f

or t

he F

utur

e

Goo

ds f

or t

he F

utur

eGoods for the Present

P

F

CurrentCurve

CurrentCurve

FutureCurve

FutureCurve

Presentville Futureville

1-19

International Trade

• Production point

• Consumption point

• Specialization

• Preview

1-20

Optimal Allocation of Resources

15

10

5

0 1 2 3

a

b

c

d

e

MB = MC

MC

MB

Quantity of Pizza

Mar

gin

al B

enef

it &

Mar

gin

al C

ost

1-21

LAST Word: Pitfalls to Sound Economic Reasoning

• Biases

• Loaded terminology

• Fallacy of composition

• Post hoc fallacy• Correlation but not causation

1-22

Key Terms• economics• economic perspective• opportunity cost• utility• marginal analysis• scientific method• economic principle• other-things-equal

assumption• macroeconomics• aggregate• microeconomics• positive economics• normative economics• economizing problem

• budget line• economic resources• land• labor• capital• investment• entrepreneurial ability• factors of production• consumer goods• capital goods• production possibilities curve• law of increasing opportunity

costs• economic growth 1-23

The Market System and the Circular Flow

1-24