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

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

3. Economics Defined Economic wants exceed productive capacity
Social science concerned with making optimal choices under conditions of scarcity 3
1-3

4. Economics Defined Society has productive resources
land, labor, capital
help to produce goods and services
wants exceed capacity of scarce resources 4

5. The Economic Perspective
Thinking like an economist
Key features:
Scarcity and choice
Purposeful behavior
Marginal analysis 5
1-4

6. Scarcity and Choice Resources are scarce limited goods and services
Choices must be made
scarcity restricts options and demands choices
There is no free lunch
someone bears the cost 6
1-5

7. Opportunity Cost
obtaining one thing foregoes the opportunity to obtain another thing
study/work
CDs/Books
TV/work-out 7

8. Purposeful Behavior Rational self-interest
assumption that people pursue opportunities to increase utility: pleasure or happiness obtained form consuming a good or service
we use our time and $ to maximize satisfaction (utility)
cost benefit analysis reflects purposeful or rational decisions
doesn’t mean we are immune from faulty logic
effects of emotion, keeping up w/ the Jones’ (envy), influence of advertisement
purposeful simply means decisions made with an outcome in mind 8
1-6

9. Purposeful Behavior self interest doesn’t necessitate greed
charitable acts make us feel good increases our satisfaction 9

10. Marginal Analysis marginal (“extra or additional”)
comparison of marg. benefit/marg. cost
example: what school to attend? expand the business or not? study for an extra hr. for exam?
marginal benefit of extra carat diamond ring 10
1-7

11. Economic Models The scientific method
observe real-world behavior and outcomes
based on observations, formulate possible explanation of cause/effect (hypotheses)
test explanation and compare outcomes
accept/reject/modify hypoth.
when favorable results accumulate it becomes a economic theory
Economic law widely accepted theory
Economic Principle : statement about behavior that enable prediction of the probable effects of certain actions 11
1-8

12. Principles
Generalizations: expressed as tendencies of typical or average consumers, workers, or firms
price-quantity principle (P drops, buy more)
Ceteris Paribus (other thins equal assumption)
factors other than being considered do not change
variable not being considered are held constant
Graphical Expression
economic models are expressed using graphs
supply/demand, price-quantity, marginal cost, opportunity cost 12

13. Macro vs. Micro Microeconomics
concerned with individual units: personal household, firm, industry
Macroeconomics
economy as a whole or its basic subdivision or aggregate (collection of specific economic units)
ex. government, households, business sectors
teated as if they were individual units, lumping together all consumers, firms, etc.
aggregates seek to obtain an overview
examines: total output, total employment, total incomes 13
1-9

14. Normative / Positive Normative Economics
includes value judgements, what the economy should be like
policy actions required to achieve a desired goal
N. Econ. focus on desirability of certain aspects of the econ.
Positive Economics
focused on facts and cause/effect relationships
avoids judgements of value, attempts to establ. scientific statements about behavior
deals with what the economy is really like 14

15. Individual’s Economizing Problem
Limited income
finite amt. of income
need to make choices
Unlimited wants - necessities/luxuries
some desires are cultural or connected to society
requires us to economize
pick and chose goods with most utility to us 15
1-10

16. Economizing Problem A budget line Tradeoffs & opportunity costs
schedule or curve that shows various combinations of 2 products a consumer can purchase with specific $ income
Tradeoffs & opportunity costs
budget line identifies trade-offs that arise b/c of limited income
Make best choice possible
limit $ forces people to make choices
requires evaluation of many benefits/marginal costs in order to maximize utility
Increase in income shifts budget line R, decrease shifts line to the L 16

17. A Budget Line
$120 Budget 12 10 8 6 4 2
DVDs
$20
Books
$10 6 5 4 3 2 1 2 4 6 8 10 12
Income = $120
Pdvd = $20
= 6
Unattainable
Quantity of DVDs
Income = $120
Pb = $10
= 12
Attainable
Quantity of Paperback Books 17
1-11

18. Society’s Economizing Problem
Scarce natural, human and manufact. resources
Land: all nat’l resources (minerals, arable land, H2O, etc)
Labor: physical/mental talent of individuals
Capital: machines, buildings, etc. (not $)
Entrepreneurial Ability: individuals that combine resources to produce a good or service
strategic business decisions
innovator
risk bearer
Factors of production- the combination of the 4 factors of production 18
1-12

19. Production Possibilities Model
Illustrate production choices
Assumptions:
Full employment: all available resources are employed
Fixed resources: quantity/Quality of resources are fixed
Fixed technology: state of tech. is constant
Two goods: typically one cons. good (pizza) and one capital good (robot) 19
1-13

20. 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

21. Product. Poss. Table
lists combo of goods that can be produced w/ specific set of resources
shift of consumer goods to satisfy wants has a cost: over time potential for future production is lost (more now=fewer later)
forgoing current consumption, frees up resources that can increase production of capital goods
leads to increase in future production, greater future consumption (less now=more later)

22. PP Table
Generalization: at any given time an economy must sacrifice some of one good for more of another good
scarcity prohibits more of both

23. Production Possibilities Curve
graphing the PP Table illustrates the PP Curve
displays the combo. of goods/services at full employment while assuming fixed availability of supplies & resources & constant tech.
curve is a “constraint” b/c it shows limits of obtainable outputs
Law of Increasing Opportunity Costs
for society, as production of a particular good increases, the opportunity coast of producing an additional unit increases
reflected in the shape of the curve-steeper as we move along the curve

24. Economic Rationale
for law of increasing opp. costs is that economic resources are not copletely adaptable to alternative uses
better at producing one type of good than another
lack of perfect flexibility, or interchangeability, on the part of resources is the cause of increased opportunity costs to society
Optimal Allocation : occurs when Marginal Benefit (MB) = Marginal Cost (MC)
economic activity should be expanded as long as MB exceeds MC

25. Production Possibilities CurveA’ 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’
Pizzas 25
1-15

26. Production Possibilities CurveA’ 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’
Pizzas 26
1-16

27. Production Possibilities CurveA’ 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’
Pizzas 27
1-17

28. The Future Economy Consequences of unemployment reduces the P.P. Curve
curve would shift to the Left
move towards full employ. would yield greater output on one or both products
Economic growth
Increase in resources
increases potential output (economic growth)
immigration, birth rate, increase the amount of workers and entrepreneurs
Better quality resources
irrigation creates more arable land
Technological advances
new/better goods and imporved ways to manufact. them
leads to decrease in computer $, led to increase in use 28
1-18

29. Economic Growth increase in number of supplies & resources
improvement in resource quality (education)
technical advances
results in better output for both consumption goods and capital goods 29

30. Future Possibilities Presentville Futureville Future Future Curve
Goods for the Future
Goods for the Future P
Current
Curve
Current
Curve
Goods for the Present
Goods for the Present
Presentville
Futureville 30
1-19

31. Specialization & Trade
enable nations to get more of a desired good
David Riccardo (Comparative Advantage)
same effect on the economy as having more/better resources for discovering improved product. techniques. (both increase # of capital & consumer goods available to society)
way for economy to circumvent the output limits imposed by the domestic P.P. Curve
International Specialization is directing resources to output that a nation is highly efficient at producing 31

32. Optimal Allocation of ResourcesMC a c 15 10 5
MB = MC e
Marginal Benefit & Marginal Cost b d MB
Quantity of Pizza 32
1-21

33. LAST Word: Pitfalls to Sound Economic Reasoning
Biases
Loaded terminology
Fallacy of composition
assumption that what is true for one individual or part of a whole is necessarily true for a group of individuals or the whole
ex. single cattle ranch increases heard (doesn’t change cost of beef), all ranchers increase size of stock price will decline
ex. stock sales (indiv./all shareholders) 33
1-22

34. event A precedes event B, A is the cause of B
Post hoc fallacy
event A precedes event B, A is the cause of B
“after this therefore because of this” fallacy
Correlation but not causation
just because two variable move together doesn’t mean one causes the other
could be pure coincidence, may result due to variable Z 34

35. Key Terms budget line economics economic resources
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 35
1-23

36. The Market System and the Circular Flow36
1-24