1. Copyright 2008 The McGraw-Hill Companies 1-1 1 Limits, Alternatives, and Choices

2. Copyright 2008 The McGraw-Hill Companies 1-2 Chapter Objectives Economics Defined –Economic Perspective Role of Economic Theory Microeconomics and Macroeconomics Scarce Resources –The Economizing Problem Production Possibilities O 1.1

3. Copyright 2008 The McGraw-Hill Companies 1-3 What is Economics?? A social science that deals with how people use scarce resources to produce and distribute goods and services

4. Copyright 2008 The McGraw-Hill Companies 1-4 Scarcity, the Central Theme of Economics Scarcity means that while we have unlimited wants, our resources are limited Due to scarcity, choices must be made Economics deals with how we make such choices

5. Copyright 2008 The McGraw-Hill Companies 1-5 What are the 4 factors of production? (resources, also called inputs) Land and natural resources Labor Capital (note we mean physical capital such as tools, machinery, etc, not money) Entrepreneurship Note that the purchase of capital goods is referred to as investment

6. Copyright 2008 The McGraw-Hill Companies 1-6 Assumptions about making choices Self interest motivation: in other words, we assume the most important person in your life is YOU! Purposeful behavior: attempting to maximize your utility Rationality, weighing the benefits and costs of your actions O 1.2

7. Copyright 2008 The McGraw-Hill Companies 1-7 Costs include the opportunity costs Opportunity costs, the highest valued option given up when a choice is made

8. Copyright 2008 The McGraw-Hill Companies 1-8 The Economic Perspective Marginal Analysis –Marginal Benefits –Marginal Costs O 1.3

9. Copyright 2008 The McGraw-Hill Companies 1-9 Benefits of taking economics? The economy is a part of our lives Better understanding of human behavior More informed voter Relates to other fields of study Its fun!!!!

10. Copyright 2008 The McGraw-Hill Companies 1-10 Costs of taking economics? Its Difficult!!! Less precision in the social sciences Can be mathematical

11. Copyright 2008 The McGraw-Hill Companies 1-11 Macro and Microeconomics Macroeconomics –The Aggregate economy: Deals with the behavior of the economy as a whole: topics like unemployment in the economy, or the rate of inflation, or growth in our GDP, etc.

12. Copyright 2008 The McGraw-Hill Companies 1-12 Macro and Microeconomics Microeconomics –Individual Units Deals with the behavior of individual firms and households: topics such as the price of oil, or wages of steelworkers, or sales of dvd’s.

13. Copyright 2008 The McGraw-Hill Companies 1-13 Theories Principles and Models The Scientific Method Economic Principle –Generalizations –Other-Things-Equal Assumption (ceteris paribus) –Graphical Expression O 1.4

14. Copyright 2008 The McGraw-Hill Companies 1-14 Economics as a “Science” Social sciences, difficult to perform lab experiments of theories Important to understand the difference between positive and normative economics

15. Copyright 2008 The McGraw-Hill Companies 1-15 Positive and Normative economics Positive Economics A subset of economics that analyzes the way the economy actually operates: deals with what is: focuses on cause and effect relationships

16. Copyright 2008 The McGraw-Hill Companies 1-16 Positive and Normative economics Normative Economics A subset of economics founded on the value judgements and leading to assertions of what should or ought to be

17. Copyright 2008 The McGraw-Hill Companies 1-17 Individual’s Economizing Problem Limited Income Unlimited Wants A Budget Line Attainable and Unattainable Combinations Tradeoffs & Opportunity Costs Choice Income Change O 1.5 W 1.1

18. Copyright 2008 The McGraw-Hill Companies 1-18 Individual’s Economizing Problem Average Income, Selected Nations Per Capita Income 2004 Switzerland United States Japan France South Korea Mexico Brazil China Pakistan Nigeria Rwanda Liberia Source: World Bank $48,230 41,400 37,180 30,090 13,980 6,770 3,090 1,290 600 390 220 110 Country GLOBAL PERSPECTIVE

19. Copyright 2008 The McGraw-Hill Companies 1-19 Individual’s Economizing Problem 65432106543210 0 2 4 6 8 10 12 DVDs $20 Books $10 12 10 8 6 4 2 0 2 4 6 8 10 12 14 $120 Budget Income = $120 P dvd = $20 = 6 Income = $120 P b = $10 = 12 Attainable Unattainable Quantity of Books Quantity of DVDs

20. Copyright 2008 The McGraw-Hill Companies 1-20 What is a Production Possibilities Frontier (PPF)? (also called a production possibilities curve) A graph that shows the maximum combinations of goods that can be produced when resources and technology are used efficiently

21. Copyright 2008 The McGraw-Hill Companies 1-21 For simplicity, lets take a world with only 2 products Lets use beer and pizza (a typical college campus?)

22. Copyright 2008 The McGraw-Hill Companies 1-22 A typical PPF has the following shape:. Pizza Beer The curve has a negative slope. The curve is concave to the origin.

23. Copyright 2008 The McGraw-Hill Companies 1-23 All points on the curve correspond to full use of resources. Pizza Beer A B

24. Copyright 2008 The McGraw-Hill Companies 1-24 Points outside the the PPF are not feasible with existing resources. Pizza Beer.A.A

25. Copyright 2008 The McGraw-Hill Companies 1-25 Periods of unemployment or inefficiency in production correspond to points under the PPF. Pizza Beer.A.A

26. Copyright 2008 The McGraw-Hill Companies 1-26 Shape of the PPF? Why Concave? If PPF a straight line, we have constant opportunity costs If PPF concave, we have increasing opportunity costs

27. Copyright 2008 The McGraw-Hill Companies 1-27 Consider a straight line PPF Beer Pizza Beer given up, the opportunity cost, remains constant

28. Copyright 2008 The McGraw-Hill Companies 1-28 Concave shape, increasing opportunity costs. Pizza Beer Beer given up, the opportunity cost, is increasing

29. Copyright 2008 The McGraw-Hill Companies 1-29 What is the Law of Increasing Opportunity Costs? The opportunity cost of producing a good increases as more of the good is produced

30. Copyright 2008 The McGraw-Hill Companies 1-30 Why does the Law of Increasing Opportunity costs hold? Because resources are not perfectly adaptable to all products

31. Copyright 2008 The McGraw-Hill Companies 1-31 Causes of rightward shifts in PPF’s? Increase in resources Increased productivity Improved technology

32. Copyright 2008 The McGraw-Hill Companies 1-32 Can a PPF shift inward (to the left)? YES!! For just the opposite reasons as an outward shift such as a loss of resources

33. Copyright 2008 The McGraw-Hill Companies 1-33 Economic growth and the Capital Consumer goods tradeoff: Consumer goods Capital goods A B From which point would an economy grow faster, A or B?? Answer is A, with more capital goods

34. Copyright 2008 The McGraw-Hill Companies 1-34 Production Possibilities Model (using the books example) Full Employment Fixed Resources Fixed Technology Two Goods –Consumer Goods (Pizzas) –Capital Goods (Industrial Robots)

35. Copyright 2008 The McGraw-Hill Companies 1-35 Production Possibilities Model Production Possibilities Table Type of Product Pizzas (in hundred thousands) Industrial Robots (in thousands) Production Alternatives ABCDE 109740 01234 Plot Points to Create Graph…

36. Copyright 2008 The McGraw-Hill Companies 1-36 Production Possibilities Model Pizzas Industrial Robots 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 A B C D E Economic Growth Now Attainable A’ B’ C’ D’ E’ Production Possibilities Curve G 1.1

37. Copyright 2008 The McGraw-Hill Companies 1-37 Production Possibilities Model Pizzas Industrial Robots 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 A B C D E Law of Increasing Opportunity Cost A’ B’ C’ D’ E’ Production Possibilities Curve Shape of the Curve W 1.2

38. Copyright 2008 The McGraw-Hill Companies 1-38 Production Possibilities Model Pizzas Industrial Robots 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’ Production Possibilities Curve U

39. Copyright 2008 The McGraw-Hill Companies 1-39 Present Choices & Future Possibilities Goods for the Present Goods for the Future Goods for the Present PresentvilleFutureville P F Current Curve Current Curve Future Curve Future Curve Compare Two Hypothetical Economies Implications of International Trade G 1.2

40. Copyright 2008 The McGraw-Hill Companies 1-40 Marginal benefits and costs From a PPC, can we tell which combination of the 2 products is best or optimal? We would need to be able to evaluate the marginal benefits and costs of the products, produce to the point where MB=MC.

41. Copyright 2008 The McGraw-Hill Companies 1-41 Production Possibilities Model 15 10 5 0 1 2 3 a b c d e MB = MC MC MB Optimal Allocation of Resources Quantity of Pizza Marginal Benefit & Marginal Cost

42. Copyright 2008 The McGraw-Hill Companies 1-42 Pitfalls to Sound Economic Reasoning Biases Loaded Terminology Fallacy of Composition Post Hoc Fallacy Correlation but not Causation Last Word

43. Copyright 2008 The McGraw-Hill Companies 1-43 The Fallacy of Composition The often mistaken belief that what is true for a part is necessarily true for the whole  Examples: If one student stands up in class, they can see the board better—so if all students stand up will they all see better?  If I had a million dollars, I am rich, so if we all had a million dollars, would be all be rich?

44. Copyright 2008 The McGraw-Hill Companies 1-44 Post Hoc Fallacy Post hoc, ergo propter hoc, meaning “after this, therefore because of this” Just because one thing happens after another does not mean the first caused the second to occur.

45. Copyright 2008 The McGraw-Hill Companies 1-45 Correlation and causation  A war breaks out in Timbuktu today and the U.S. stock market falls—did the war cause the market to fall?  The economy began growing in 1992 about the same time Clinton was elected president. Does this mean that the Clinton election improved the economy?

46. Copyright 2008 The McGraw-Hill Companies 1-46 Key Terms economics economic perspective opportunity cost utility marginal analysis scientific method economic principle other-things-equal assumptionother-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 curveproduction possibilities curve law of increasing opportunity costslaw of increasing opportunity costs economic growth

47. Copyright 2008 The McGraw-Hill Companies 1-47 Next Chapter Preview… The Market System and the Circular Flow