Chapter 1 Limits, Alternatives, and Choices McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives Economics defined The economic perspective Microeconomics vs. macroeconomics Resource scarcity and the economizing problem Production possibilities model 1-2

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 entails making decisions to achieve maximum utility/profit Individuals and utility the pleasure or satisfaction obtained from consuming a good or service Firms and profit Different preferences and circumstances (including errors) lead to different choices 1-6

Marginal Analysis Marginal benefit Marginal cost Comparison of marginal benefit and marginal cost Most decisions concern a change in current conditions The marginal cost of an action should not exceed its marginal benefits 1-7

Economic Models The scientific method Economic principles a. Observation of facts. b. Formulations of explanations of cause and effect relationships (hypotheses). c. Testing of the hypotheses. d. Acceptance, rejection, or modification. e. The continued testing. Economic principles explain and/or predict the behavior of individuals and institutions Simplification of reality Other-things-equal assumption 1-8

Macro vs. Micro Microeconomics Macroeconomics Positive v.s. Normative Specific economic units Concerned with the individual industry, firm or household and the price of specific products and resources. Macroeconomics Aggregate; the economy as a whole includes measures of total output, total employment, total income, aggregate expenditures, and the general price level. Positive v.s. Normative ‘what is’ v.s. ‘what ought to be’ Scientific v.s. value judgement Theoritical v.s. policy economics 1-9

Individual’s Economizing Problem Limited income v.s. Unlimited wants Wants are virtually unlimited. Wants include necessities and luxuries Wants change, especially as new products are introduced Even the wealthiest have wants that extend beyond their means Involve tradeoffs & opportunity costs Make best choice possible 1-10

A Budget Line $120 Budget 12 10 8 6 4 2 DVDs $20 Books $10 2 4 6 8 10 12 6 5 4 3 2 1 Income = $120 Pdvd = $20 = 6 Unattainable Quantity of DVDs Income = $120 Pb = $10 = 12 Attainable 2 4 6 8 10 12 14 Quantity of Paperback Books 1-11

Society’s Economizing Problem Scarce resources Land Labor Capital E.g. tools, equipment, factories, transportation, etc. Entrepreneurial Ability a. Combines resources needed for production. b. Makes basic business policy decisions. c. Is an innovator for new products, production techniques, organizational forms. d. Bears the risk of time, effort, and funds. 1-12

Production Possibilities Model Illustrate production choices Assumptions: Full employment Fixed resources Fixed technology Two goods 1-13

Production Possibilities Table Production Alternatives Type of Product A B C D E Pizzas (in hundred thousands) 1 2 3 4 Industrial Robots (in thousands) 10 9 7 4 Plot Points to Create Graph… 1-14

Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable A Economic Growth B C’ C Industrial Robots D’ D Now Attainable Attainable E E’ 0 1 2 3 4 5 6 7 8 9 Pizzas 1-15

Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable A Law of Increasing Opportunity Cost B C’ C Industrial Robots D’ Shape of the Curve D Attainable E E’ 0 1 2 3 4 5 6 7 8 9 Pizzas 1-16

The Future Economy Consequences of unemployment Economic growth More resources Better quality resources Technological advances 1-17

Future Possibilities Compare Two Hypothetical Economies Presentville Curve Future Curve F Goods for the Future Goods for the Future P Current Curve Current Curve Goods for the Present Goods for the Present Presentville Futureville 1-18

Optimal Allocation of Resources MC a c 15 10 5 MB = MC e Marginal Benefit & Marginal Cost b d MB 1 2 3 Quantity of Pizza 1-19