Chapter 1:

Limits, Alternatives,
and Choices

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
 OBJECTIVES

• Define economics and the features of the economic

perspective.
• Explain the role of economic theory in economics.
• Distinguish between microeconomics and
macroeconomics
• Discuss the categories of scarce resources and the
nature of the economic problem
• Describe production possibilities analysis, increasing
opportunity costs, and economic growth.
• (Appendix) About graphs, curves, and slopes as they
relate to economics.
 BASIC NEEDS
• AIR
• WATER
• FOOD
• SHELTER
• CLOTHING
WATER
FOOD
SHELTER
CLOTHING
NEEDS VS. WANTS
WANTS VS. MEANS
Wants and Means
• Economics is about wants and means:
• Society has the resources to make goods
and services that satisfy our many desires.
• However, our economic wants far exceed
the productive capacity of our limited
resources – our resources are scarce.
Scarcity means that society has limited
resources and therefore cannot produce all
the goods and services people want.
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The Economic Perspective
• Economics is the study of how people,
institutions, and society make choices under
conditions of scarcity.
• An economic perspective or economic
way of thinking takes the following concepts
into consideration:
• Scarcity and Choice
• Purposeful Behavior
• Marginalism: Benefits and Costs
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Scarcity and Choice
• Scarce economic resources mean limited
goods and services.
• When a good is produced, the resources
employed can no longer be used to make
another good.
• We must decide what we will have and what we
must forgo.

Opportunity cost is the value of the good,

service, or time forgone to obtain something else.
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1-12
 Purposeful Behavior
• Economics assumes that individuals act “rationally”
and in their own “self-interest.”
• Individual decisions are “purposeful” and seek to
maximize utility.
• Consumers are purposeful in deciding what goods and services
to buy.
• Business firms are purposeful in deciding what products to
produce and how.
• Governmental entities are purposeful in deciding what services
to provide and how to finance them.

Utility is the pleasure, happiness, or satisfaction

obtained from consuming a good or service.
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1-13
Marginalism:
Benefits and Costs
• Individuals make rational decisions such that the
marginal benefit exceeds (or equals) the marginal
cost.
• In a world of scarcity, the decision to obtain the
marginal benefit associated with some specific option
always includes the marginal cost of forgoing
something else.

Marginal analysis is the comparison of marginal

(“extra” or “additional”) benefits and marginal
costs, usually for decision making.
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1-14
An Example: Marginalism
• Shopping for a new car
• You find a standard model that you like but
you are considering additional features (a
sunroof, leather interior, heated seats and
alloy wheels). As long as the marginal
benefit (greater satisfaction) exceeds the
marginal cost (extra expenses) of the
additional features, you will add them.

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 Economics Relies on the
Scientific Method
• Observing real-world behavior and outcomes.
• Formulating possible explanations of cause and effect
(hypothesis).
• Testing hypothesis by comparing predicted and actual
outcomes.
• Accepting, rejecting, or modifying hypothesis.
• Continuing the process.

Hypotheses → Theories → Laws and principles → Models

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1-16
Economic Principles
• Economic principles are statements about
economic behavior or the economy that enable
prediction of the probable effects of certain actions.
• They serve as tools for ascertaining cause and
effect (or action and outcome) within the economic
system:
• “Purposeful simplifications” – simplify complex reality
• Generalizations – make statements about typical or
average consumers, workers, or business firms
• Ceteris paribus (Other things equal) – all variables except those
under consideration are held constant
• Graphical expression – many models are expressed graphically
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1-17
Microeconomics and
Macroeconomics
• Microeconomics studies individual
decision-making units, such as a consumer,
a worker, or a business firm.
• Macroeconomics studies economy as a
whole or its aggregates.

Aggregate is a collection of specific economic

units treated as if there were one unit.

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 An Economic Problem
• Both individuals and society face an
economic problem.

An economic problem is the need to make

choices because wants exceed means.

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1-21
An Individual’s
Economic Problem
• Limited income (from
wages, interest, rent,
profit) forces people to
choose what to buy and
what to forgo.
• Can be represented
by a budget line
A Budget line shows
various combinations of
two products a consumer
can purchase with a
specific money income,
given the products’ prices.
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• Unlimited wants
means individuals have
to evaluate their
marginal benefits and
marginal costs to make
choices that maximize
their satisfaction
• Two types of wants:
• Necessities (food,
shelter, clothing, health
care)
• Luxuries (jewelry,
electronics, private art
collections)
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A Budget Line
$120 Budget 12
DVDs Books
$20 $10 10 Income = $120
=6
6 0
Quantity of DVDs
Pdvd = $20
8
5 2 Unattainable

4 4 6

3 6 4
Income = $120
Pb = $10
= 12

2 8 Attainable
1 10 2

0 12 0 2 4 6 8 10 12 14
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1-25
 Society’s
Economic Problem
• Scarce economic • Many ways to use
resources (also called limited resources:
factors of production, • Goods
or inputs): • Services
• Land • Private services
• Labor • Government services

• Capital
• Entrepreneurial
ability
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 A Production
Possibilities Model
• Assumptions
• Full employment – economy is employing all
of its available resources (simplification)
• Fixed resources - the quantity and quality of
production are fixed (ceteris paribus)
• Fixed technology – the methods used to
produce output are fixed (ceteris paribus)
• Two goods (simplification)

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 A 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…

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1-29
A Production
Possibilities Curve
12
11
10 A
Industrial Robots
B
9
8 Unattainable
C
7
6
5
4 D
3
2 Attainable
1
E

0 1 2 3 4 5 6 7 8 9
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• Microeconomics studies individual
decision-making units, such as a
consumer, a worker, or a business firm.
• Consumer Theory
• Firm Theory
• Imperfect Markets
 QUIZ
• QUIZZES\Quiz1.doc
 assignment
• Differentiate between a command system
and a market system.
• Explain the main characteristics of the
market system.
• Discuss how the market system answers
four fundamental questions.
• Explain the mechanics of the circular flow
model.