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

Copyright 2008 The McGraw-Hill Companies1-1

1Limits, Alternatives, and Choices


Chapter Objectives• Economics Defined

–Economic Perspective

• Role of Economic Theory• Microeconomics and

Macroeconomics• Scarce Resources

–The Economizing Problem

• Production Possibilities

O 1.1


What is Economics??

• A social science that deals with how people use scarce resources to produce and distribute goods and services


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


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


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


Costs include the opportunity costs

• Opportunity costs, the highest valued option given up when a choice is made


The Economic Perspective

• Marginal Analysis–Marginal Benefits

–Marginal Costs

O 1.3


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!!!!


Costs of taking economics?

• Its Difficult!!!

• Less precision in the social sciences

• Can be mathematical


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.


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.


Theories Principles and Models

• The Scientific Method• Economic Principle

–Generalizations–Other-Things-Equal Assumption (ceteris paribus)

–Graphical Expression

O 1.4


Economics as a “Science”

• Social sciences, difficult to perform lab experiments of theories

• Important to understand the difference between positive and normative economics


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


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


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



Average Income, Selected NationsPer Capita Income 2004

SwitzerlandUnited StatesJapanFranceSouth KoreaMexicoBrazilChinaPakistanNigeriaRwandaLiberia

Source: World Bank

$48,23041,40037,18030,09013,980

6,7703,0901,290

600390220110

Country

GLOBAL PERSPECTIVE



6543210

02468

1012

DVDs$20

Books$10

12

10

8

6

4

2

02 4 6 8 10 12 14

$120 Budget

Income = $120

Pdvd = $20= 6

Income = $120

Pb = $10= 12

Attainable

Unattainable

Quantity of Books

Qu

anti

ty o

f D

VD

s


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


For simplicity, lets take a world with only 2 products

Lets use beer and pizza (a typical college campus?)


A typical PPF has the following shape:.

Pizza

Bee

r

The curve has a negative slope.The curve is concave to the origin.


All points on the curve correspond to full use of resources.

Pizza

Bee

r

A

B


Points outside the the PPF are not feasible with existing resources.

Pizza

Bee

r

.A


Periods of unemployment or inefficiency in production correspond to points under the PPF.

Pizza

Bee

r

.A


Shape of the PPF? Why Concave?

• If PPF a straight line, we have constant opportunity costs

• If PPF concave, we have increasing opportunity costs


Consider a straight line PPF

Beer

Pizza

Beer given up, the opportunity cost, remains constant


Concave shape, increasing opportunity costs.

Pizza

Bee

rBeer given up, the opportunity cost, is increasing


What is the Law of Increasing Opportunity Costs?

• The opportunity cost of producing a good increases as more of the good is produced


Why does the Law of Increasing Opportunity costs hold?

• Because resources are not perfectly adaptable to all products


Causes of rightward shifts in PPF’s?

• Increase in resources

• Increased productivity

• Improved technology


Can a PPF shift inward (to the left)?

• YES!! For just the opposite reasons as an outward shift such as a loss of resources


Economic growth and the Capital Consumer goods

tradeoff:

Consumer goods

Cap

ital

go

od

s A

B

From which point would an economy grow faster, A or B?? Answer is A, with more capital goods


Production Possibilities Model(using the books example)

• Full Employment• Fixed Resources• Fixed Technology• Two Goods

–Consumer Goods (Pizzas)–Capital Goods (Industrial

Robots)


Production Possibilities Model

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 Points to Create Graph…



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’

Production Possibilities Curve

G 1.1



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

Law of IncreasingOpportunity Cost

A’

B’

C’

D’

E’


Shape of the Curve

W 1.2



Pizzas

Ind

ust

rial

Ro

bo

ts

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’


U


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 PresentPresentville Futureville

P

F

CurrentCurve

CurrentCurve

FutureCurve

FutureCurve

Compare Two Hypothetical Economies

Implications of International Trade

G 1.2


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.



15

10

5

0 1 2 3

a

b

c

d

e

MB = MC

MC

MB

Optimal Allocation of Resources

Quantity of Pizza

Mar

gin

al B

enef

it &

Mar

gin

al C

ost


Pitfalls to Sound Economic Reasoning

• Biases

• Loaded Terminology

• Fallacy of Composition

• Post Hoc Fallacy

• Correlation but not Causation

Last

Word


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?


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.


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?


Key Terms• economics• economic perspective• opportunity cost• utility• marginal analysis• scientific method• economic principle• other-things-equal as

sumption• 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 possibilitie

s curve• law of increasing oppo

rtunity costs• economic growth


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