Chapter 1 Limits, Alternatives, and Choices 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 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 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 Microeconomics Positive Economics 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 $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 Entrepreneurial Ability Factors of production 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

Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable C’ Industrial Robots U D’ Under or Unemployment E’ 0 1 2 3 4 5 6 7 8 9 Pizzas 1-17

The Future Economy Consequences of unemployment Economic growth More resources Better quality resources Technological advances 1-18

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 1-19

International Trade Production point Consumption point Specialization Preview 1-20

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 1-21

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 Next Chapter Preview… The Market System and the Circular Flow 1-24