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Chapter 1

Limits,
Alternatives,
and Choices

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All


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
– 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
DVDs Books
$20 $10
10
60 Income = $120
=6

Quantity of DVDs
52 8 Pdvd = $20

44 6
Unattainable

36
Income = $120
28 4
Pb = $10
= 12

110 2 Attainable
012
0
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 0 1 2 3 4
(in hundred thousands)

Industrial Robots 10 9 7 4 0
(in thousands)

Plot Points to Create Graph…

1-14
Production Possibilities Curve
A’
14
13
B’ Unattainable
12
11
A
10
Economic
Industrial Robots
B C’
9
8
C
Growth
7
6
D’
5
D
4
3 Now Attainable
2 Attainable
1 E E’
0 1 2 3 4 5 6 7 8 9
Pizzas
1-15
Production Possibilities Curve
A’
14
13
B’ Unattainable
12
11
A
10
Law of Increasing
Industrial Robots
B C’
9
8
C Opportunity Cost
7
6
D’
5
D
Shape of
4
3
the Curve
2 Attainable
1 E E’
0 1 2 3 4 5 6 7 8 9
Pizzas
1-16
Production Possibilities Curve
A’
14
13
B’ Unattainable
12
11
10
Industrial Robots
C’
9
8
7
6 U
D’
5
Under or
4 Unemployment
3
2
1 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

Goods for the Future

Goods for the Future


Future Future
Curve Curve
F

Current P Current
Curve 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

Marginal Benefit & Marginal Cost


MC
a c
15
MB = MC

10 e

5
b d
MB

0 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 • budget line
• economic perspective • economic resources
• opportunity cost • land
• utility • labor
• marginal analysis
• capital
• scientific method
• economic principle • investment
• other-things-equal • entrepreneurial ability
assumption • factors of production
• macroeconomics • consumer goods
• aggregate
• capital goods
• microeconomics
• positive economics • production possibilities curve
• normative economics • law of increasing opportunity
• economizing problem costs
• economic growth 1-23
The Market
System and the
Circular Flow

1-24