CHAPTER 1 LIMITS, ALTERNATIVES, AND CHOICES Part One: An Introduction to Economics and the Economy CHAPTER 1 LIMITS, ALTERNATIVES, AND CHOICES

In this chapter you will learn: 1.1 The Ten Key Concepts to retain for a lifetime 1.2 The features of the economic way of thinking 1.3 The role of economic theory in economics 1.4 The distinction between microeconomics and macroeconomics 1.5 The nature of the economic problem and the categories of scarce resources 1.6 About production possibilities analysis, increasing opportunity costs, and economic growth ©2007 McGraw-Hill Ryerson Ltd. Chapter 1

Ten Key Concepts The Individual Facing Tradeoffs Opportunity Costs Choosing a Little More or Less The Influence of Incentives ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.1

Ten Key Concepts Interaction Among Individuals Specialization and Trade The Effectiveness of Markets The Role of Governments ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.1

Ten Key Concepts The Economy as a Whole and the Standard of Living Production and the Standard of Living Money and Inflation Inflation-Unemployment Tradeoff ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.1

The Economic Way of Thinking Scarcity and Choice Purposeful Behaviour Marginal Analysis: Benefits and Costs ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.2

Theories, Principles, and Models The scientific method: observe the world formulate hypotheses test by comparing actual outcomes to the hypothesized predictions accept, reject, or modify hypotheses as indicated continue testing against the facts theory or model law or principle ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.3

Theories, Principles, and Models Deriving Theories: Terminology Generalizations Other-Things-Equal Assumption Abstractions Graphical Expression ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.3

Macroeconomics and Microeconomics Macroeconomics examines: the whole economy the subdivisions or aggregates Microeconomics examines: individual units ( a household, firm, or industry) and their decision-making process ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.4

Positive and Normative Economics POSITIVE STATEMENTS… based upon facts and cause-and-effect relationships what is without value judgments NORMATIVE STATEMENTS… based upon subjective beliefs what ought to be Predictions are positive if they are based on what future facts will be ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.4

The Individual’s Economic Problem We all have a finite amount of income Most people have unlimited wants A consumer’s budget line Illustrated... ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.5

Figure 1-1 A Consumer’s Budget Line DVD ($20) Book ($10) Total Expenditure 6 120 = 120 + 0 5 2 120 = 100 + 20 4 3 120 = 80 + 40 120 = 60 + 60 8 120 = 40 + 80 1 10 120 = 20 + 100 12 120 = 0 + 120 Unattainable Attainable ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.5

Society’s Economic Problem: Scarce Resources Property Resources: Land Capital Human Resources: Labour Entrepreneurial Ability: takes initiative makes policy decisions innovates bears risk ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.6

The Production Possibilities Model Assumptions: full employment and productive efficiency fixed resources fixed technology two goods pizzas symbolize consumer goods industrial robots symbolize capital goods ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7

The Production Possibilities Curve Pizzas (00,000s) 1 2 3 4 Robots (000s) 10 9 7 ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7

The Production Possibilities Curve Pizzas (00,000s) 1 2 3 4 Robots (000s) 10 9 7 Production Possibilities Curve ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7

The Production Possibilities Curve Figure 1-2 A B attainable C W attainable but inefficient unattainable D E ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7

The Production Possibilities Curve Law of Increasing Opportunity Cost Opportunity cost increases with amount produced As we make more pizzas, the number of robots we have to give up (per pizza) increases Illustrated... ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7

The Law of Increasing Opportunity Cost Pizza (00,000s) 1 2 3 4 Robots (000s) 10 9 7 opportunity cost of 1st 100,000 pizzas = 1,000 robots opportunity cost of 2nd 100,000 pizzas = 2,000 robots opportunity cost of 3rd 100,000 pizzas = 3,000 robots opportunity cost of 4th 100,000 pizzas = 4,000 robots The more pizzas we make, the more each one costs in terms of machines foregone ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7

The Law of Increasing Opportunity Cost Shape of the Curve As we make more pizzas, the number of robots we have to give up (per pizza) increases Slope of the production possibilities curve gets steeper and steeper ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7

The Law of Increasing Opportunity Cost Additional pizza unit costs 1, 2, 3, 4 robot unit A B C The more pizza we make, the more machines we give up, the steeper the curve D E ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7

The Law of Increasing Opportunity Cost Shape of the Curve concave to the origin Economic Rationale resources are not completely adaptable to alternative uses ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7

Optimal Allocation Decide on optimal allocation by comparing Marginal (extra) Cost (MC) to Marginal Benefit (MB) Marginal Benefit is the extra benefit associated with consuming one more unit Marginal Cost is the extra opportunity cost of that extra unit ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7

Figure 1-3 Optimal Allocation: MB = MC Optimal allocation requires the expansion of a good’s output until its MC and MB are equal e MB=MC MB a b ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7

Unemployment, Growth, and the Future A Growing Economy increases in factor supplies advances in technology ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.8

Figure 1-5 Economic Growth and the Production Possibilities Curve Pizza 2 4 6 8 Robot 14 12 9 5 A’ B’ C’ D’ E’ ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.8

Figure 1-6 Present Choices and Future Possibilities FAVOURING PRESENT GOODS FAVOURING FUTURE GOODS Future Curve Future Curve Goods for the Future Goods for the Future Goods for the Present Goods for the Present ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.8

A Qualification: International Trade An individual nation is limited by the production possibilities curve But NOT when there is international specialization and trade! possible to consume ABOVE the production possibilities curve ©2007 McGraw-Hill Ryerson Ltd. Chapter 1.8

Chapter Summary 1.1 Ten Key Concepts to Retain for a Lifetime 1.2 The Economic Way of Thinking 1.3 Theories, Principles, and Models 1.4 Macroeconomics and Microeconomics 1.5 The Individual’s Economic Problem 1.6 Society’s Economic Problem 1.7 The Production Possibilities Model 1.8 Unemployment, Growth, and the Future ©2007 McGraw-Hill Ryerson Ltd. Chapter 1