01

Limits, Alternatives, and Choices

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

LO1

Introduction

• Economics defined:

• Economic wants exceed productive capacity.

• A social science concerned with making optimal choices under conditions of scarcity.

• The study of allocating scarce resources over unlimited wants.

1-2

LO1

Scarcity and Choice

• Opportunity cost: what is foregone when a choice is made; the next best alternative

1-3

LO1

Purposeful Behavior

• Rational self-interest: assumption that decision-makers pursue opportunities to increase their utility by comparing costs and benefits

• Utility: the pleasure or satisfaction derived from consuming a good or service

• Individuals allocate their time, energy, and money to maximize utility

• Self-interest is not the same as selfishness

1-4

LO1

Marginal Analysis

• Marginal benefit

• Marginal cost

• Marginal means “extra”

• Comparison between marginal benefit and marginal cost

1-5

LO2

Theories, Principles, and Models

• The scientific method:

• Economic Principles (or Economic Laws): well-tested, widely-accepted theory; a statement about economics behavior that enables forecasts of probable effects of certain actions

• Generalizations

• Other-things-equal assumption

• Graphical expression

Observe Formulate a hypothesis Test the hypothesis

Accept, reject, or modify the hypothesis

Continue to test the hypothesis, if necessary

1-6

LO3

Microeconomics and Macroeconomics

• Microeconomics

• Decision making by individual units

• Macroeconomics

• Aggregate

1-7

LO3

Positive and Normative Economics

• Positive economics

• Deals with economic facts

• Normative economics

• A subjective perspective of the economy

1-8

LO4

Individual’s Economizing Problem

• Limited income

• Unlimited wants

• A budget line: a schedule or curve that shows various combinations of two products a consumer can purchase with a specific money income.

• Attainable and unattainable options

• Tradeoffs and opportunity costs

• Make the best choice possible1-9

LO4

Individual’s Economizing Problem

6543210

02468

1012

DVDs$20

Books$10

$120 Budget 12

10

8

6

4

2

02 4 6 8 10 12 14Quantity of Paperback Books

Qu

anti

ty o

f D

VD

s

Income = $120

Pdvd = $20= 6

Income = $120

Pb = $10= 12

Attainable

Unattainable

1-10

Budget Line

• Demonstrates:– Attainable/Unattainable combinations– Tradeoffs and Opportunity Costs: 1DVD for 2

books (1book for ½ DVD); trade-off is the slope of the budget line

– Limited income forces individual to make choices

– Income changes: increased income shifts budget line outward

LO4

Global Perspective

1-12

LO4

Society’s Economizing Problem

• Economic resources (“Factors of Production” or “Inputs”)

• Land: all natural resources

• Labor: all physical and mental talents and activities of individuals used in producing products

• Capital: all manufactured aids used to produce products; capital does not directly satisfy consumer wants; Investment

• Entrepreneurial Ability: bringing the other resources together to produce products efficiently. 1-13

LO4

Society’s Economizing Problem

• Entrepreneur:

• Takes initiative

• Makes decisions

• Innovates

• Takes risk

1-14

LO5

Production Possibilities Model

• Simplified model of the macroeconomy that illustrates production choices

• Assumptions:

• Full employment

• Fixed resources*

• Fixed technology*

• Two goods

• *Looking at the economy at a point in time1-15

LO5

Production Possibilities Table

Type of Product

Pizzas (in hundred thousands)

Industrial Robots (in thousands)

Production Alternatives

A B C D E

10 9 7 4 0

0 1 2 3 4

Plot the Points to Create the Graph…

1-16

LO5

Production Possibilities Curve

Pizzas

Ind

ust

rial

Ro

bo

ts

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

AB

C

D

E

U

Shows the limit of attainable outputs, given the assumptions. To obtain more of one good, some of the other must be given up.

1-17

Law of Increasing Opportunity Cost

• The more of a product that is produced, the greater is its marginal opportunity cost.– Curve: PPC is bowed out from (concave to)

the origin; the slope gets steeper moving from point A to point E

– Why? Economic resources are not completely adaptable to alternative uses

Optimal Allocation

LO5

a

b

c

d

e

MB = MC

MC

MB

15

10

5

01 2 3

Quantity of Pizza

Mar

gin

al B

enef

it &

Mar

gin

al C

ost

1-19

LO6

A Growing Economy

• Read: “Consider This…”: The Economics of War, pg. 14

• Economic Growth

• More resources

• Improved resource quality

• Technological advances

1-20

LO6

A Growing Economy

Pizzas

Ind

ust

rial

Ro

bo

ts

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

AB

C

D

E

EconomicGrowth

Now Attainable

A’

B’

C’

D’

E’

1-21

LO6

Present Choices, Future Possibilities

Goods for the Present

Goo

ds f

or t

he F

utur

e

Goo

ds f

or t

he F

utur

e

Goods for the Present

P

F

CurrentCurve

CurrentCurve

FutureCurve

FutureCurve

Presentville Futureville

1-22

LO6

International Trade

• Specialization

• Increased production possibilities

1-23

Homework

• Pages 20-21

• Questions: #2, 10

• Problems: # 3, 5, 6, 7, 8

• Read: Last Word, Pitfalls to Sound Economic Reasoning

• If you need an Algebra refresher, refer to the Chapter 1 appendix

1-24