Chapter 1 Limits Alternatives and Choices Chapter Objectives

Chapter 1 Limits, Alternatives, and Choices

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

Economics Defined § Economic Reality § Human wants exceed productive capacity § We don’t have the resources needed to produce what we want § This is also known as scarcity of resource 1 -3

Economics Defined § Definition of Economics § A discipline in social science concerned with making optimal choices under conditions of scarcity 1 -4

The Economic Perspective § Three features of economic perspective: I. Scarcity and choice II. Purposeful behavior III. Marginal analysis 1 -5

I. Scarcity and Choice § Resources are scarce § This means we cannot have all we want § We must make choices about: § What we want § What we are willing to give up. § Scarcity forces us to make this choice 1 -6

Opportunity Cost § Because of scarcity, every choice involves a trade off § This means: § When we choose to get something § We must give up something else § What we must give up is also known as opportunity cost of the choice to get something 1 -7

Example: Opportunity Cost § What is the opportunity cost of coming to class today § If you were to work for $10 an hour, the O. C. is $10 x 1. 42 hour = $14. 20 § For Kobe Bryant, Drew Berrymore, Jennifer Lopez and Bill gates, O. C. must have been much higher. 1 -8

II. Purposeful Behavior § Rational self-interest § Human are rational and they behave to maximize self interest § For example; § Individuals tend to maximize their utility (satisfaction). § Firms tend to maximize their profits § This simply means for every action there is a desired outcome in the mind of the actor. § No action is completely random 1 -9

III. Marginal Analysis § Marginal benefit § Benefit associated with one extra unit of output § Marginal cost § Cost associated with one extra unit of output § Optimal decision compares marginal benefit with marginal cost § Specifically, when MB=MC, output is optimal 1 -10

Macro and Microeconomics § Concerned with how an individual or a single firm makes decision. § Individual analysis § Macroeconomics § Concerned with how an economy operates. § Aggregate analysis

Macro and Microeconomics § Positive Economics § Described economic reality. § Can be proved or disproved using economic data. § Normative Economics § Offers subjective judgments. § Can not be disproved.

Individual’s Economizing Problem § Assumptions: § Limited income § Fixed price § Two goods § A budget line § Combination of two goods that can be purchased exhausting a fixed income.

Individual’s Economizing Problem § A budget line § Tradeoffs & opportunity costs § Make best choice possible § Change in income

§A Budget Line DVDs Books $20 $10 6 5 4 3 2 1 0 0 2 4 6 8 10 12 12 10 Income = $120 Quantity of DVDs $120 Budget 8 Unattainable 6 Income = $120 4 2 0 =6 Pdvd = $20 Pb = $10 = 12 Attainable 2 4 6 8 10 12 Quantity of Paperback Books 14 1 -15

§Society’s Economizing Problem § Scarce resources § Land § Labor § Capital § Entrepreneurial Ability § Factors of production 1 -16

§Production Possibilities Model § Illustrate production choices § Assumptions: § Full employment § Fixed resources § Fixed technology § Two goods 1 -17

Production Possibilities Table Production Alternatives Type of Product Pizzas A B C D E 0 1 2 3 4 10 9 7 4 0 (in hundred thousands) Industrial Robots (in thousands) Plot Points to Create Graph… 1 -18

Industrial Robots §Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable A B Economic Growth C’ C D’ D Now Attainable E’ E 0 1 2 3 4 5 6 7 8 9 Pizzas 1 -19

Industrial Robots §Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable A B Law of Increasing Opportunity Cost C’ C D’ Shape of the Curve D Attainable E’ E 0 1 2 3 4 5 6 7 8 9 Pizzas 1 -20

Industrial Robots §Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable C’ U D’ Under or Unemployment E’ 0 1 2 3 4 5 6 7 8 9 Pizzas 1 -21

§The Future Economy § Consequences of unemployment § Economic growth § More resources § Better quality resources § Technological advances 1 -22

§Future Possibilities Future Curve Current Curve P Goods for the Presentville Goods for the Future Compare Two Hypothetical Economies Future Curve F Current Curve Goods for the Present Futureville 1 -23

§International Trade § Production point § Consumption point § Specialization § Preview 1 -24

Marginal Benefit & Marginal Cost §Optimal Allocation of Resources 15 a c MC MB = MC e 10 5 0 b 1 d MB 2 3 Quantity of Pizza 1 -25

LAST Word: Pitfalls to Sound Economic Reasoning § Biases § Loaded terminology § Fallacy of composition § Post hoc fallacy § Correlation but not causation 1 -26

§Key Terms § § § § economics 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 1 -27 § economic growth