Slides prepared by Dr. Amy Peng, Ryerson University
CHAPTER 1CHAPTER 1LIMITS, LIMITS,
ALTERNATIVES,ALTERNATIVES, AND CHOICES AND CHOICES
Part One: An Introduction to Economics and the Economy
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 2
In this chapter you will learn:In this chapter you will learn:
1.1 The Ten Key Concepts to retain for a lifetime
1.2 The features of the economic way of thinking
1.3 The role of economic theory in economics
1.4 The distinction between microeconomics and macroeconomics
1.5 The nature of the economic problem and the categories of scarce resources
1.6 About production possibilities analysis, increasing opportunity costs, and economic growth
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 3
Ten Key ConceptsTen Key Concepts
The Individual1. Facing Tradeoffs2. Opportunity Costs3. Choosing a Little More or Less4. The Influence of Incentives
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 4
Ten Key ConceptsTen Key Concepts
Interaction Among Individuals5. Specialization and Trade6. The Effectiveness of Markets7. The Role of Governments
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 5
Ten Key ConceptsTen Key Concepts
The Economy as a Whole and the Standard of Living
8. Production and the Standard of Living
9. Money and Inflation10.Inflation-Unemployment
Tradeoff
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Chapter 1 6
The Economic Way of ThinkingThe Economic Way of Thinking
• Scarcity and Choice• Rational Behaviour• Marginal Analysis: Benefits and
Costs
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Chapter 1 7
Theories, Principles, and ModelsTheories, Principles, and Models
The Scientific Method:• Observe the world• Formulate hypotheses• Test by comparing actual outcomes
to the hypothesized predictions• Accept, reject, modify hypotheses as
indicated• Continue testing against the factsTheory or ModelLaw or Principle
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 8
Theories, Principles, and ModelsTheories, Principles, and Models
Deriving Theories:• Terminology• Generalizations• Other-Things-Equal Assumption• Abstractions• Graphical Expression
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 9
Macroeconomics and Macroeconomics and MicroeconomicsMicroeconomics
• Macroeconomics examines:– the whole economy– the subdivisions or aggregates
• Microeconomics examines:– individual units (household, firm or
industry) and their decision making process
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 10
Positive and Normative Positive and Normative EconomicsEconomics
POSITIVE STATEMENTS…• based upon facts and cause-
and-effect relationships• what is• without value judgmentsNORMATIVE STATEMENTS…• based upon subjective beliefs• what ought to be
Predictions are positivePredictions are positiveif they are based on if they are based on what what future facts will befuture facts will be
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 11
The Individual’s Economic The Individual’s Economic ProblemProblem
• We all have a finite amount of income• Most people have unlimited wants• A consumer’s budget line
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 12
Figure 1-1Figure 1-1A Consumer’s Budget LineA Consumer’s Budget Line
DVD ($20)
Book ($10)
Total Expenditure
6 0 120 = 120 + 0
5 2 120 =100 +20
4 3 120 = 80 + 40
3 6 120 = 60 + 60
2 8 120 = 40 + 80
1 10 120 = 20+100
0 12 120 = 0 + 120
0
2
4
6
8
0 2 4 6 8 10 12 14
Books
DV
Ds
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 13
Property Resources:• Land• CapitalHuman Resources:• Labour• Entrepreneurial Ability:
– takes initiative– makes policy decisions– innovates– bears risk
Society’s Economic Problem:Society’s Economic Problem:Scarce ResourcesScarce Resources
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 14
The Production Possibilities The Production Possibilities ModelModel
Assumptions:• full employment and productive
efficiency• fixed resources• fixed technology• two goods
– pizzas symbolize consumer goods– industrial robots symbolize capital
goods
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 15
Pizzas (00,000s)
0 1 2 3 4
Robots (000s) 10 9 7 4 0
The Production Possibilities The Production Possibilities CurveCurve
Production Possibilities
0
2
4
6
8
10
12
0 1 2 3 4 5
Pizzas (hundred thousands)
Ro
bo
ts (
tho
usa
nd
s)
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 16
Pizzas (00,000s)
0 1 2 3 4
Robots (000s) 10 9 7 4 0
Production Possibilities
0
2
4
6
8
10
12
0 1 2 3 4 5
Pizzas (hundred thousands)
Ro
bo
ts (
tho
usa
nd
s)
ProductionProductionPossibilitiesPossibilities
CurveCurve
ProductionProductionPossibilitiesPossibilities
CurveCurve
The Production Possibilities The Production Possibilities CurveCurve
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 17
Production Possibilities
0
2
4
6
8
10
12
0 1 2 3 4 5
Pizzas (hundred thousands)
Ro
bo
ts (
tho
usa
nd
s)
AABB
CC
DD
EE
WW
attainableattainable
unattainableunattainableattainable butattainable but
inefficientinefficient
Figure 1-2
The Production Possibilities The Production Possibilities CurveCurve
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 18
The Production Possibilities CurveThe Production Possibilities Curve
Law of Increasing Opportunity Cost
• Opportunity cost increases with amount produced
• As we make more pizzas, the number of robots we have to give up (per pizza) increases
Illustrated...
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 19
Pizza (00,000s) 0 1 2 3 4
Robots (000s) 10 9 7 4 0
• opportunity cost of 1st 100,000 pizzas = 1,000 robots
• opportunity cost of 2st 100,000 pizzas = 2,000 robots
• opportunity cost of 3st 100,000 pizzas = 3,000 robots
• opportunity cost of 4st 100,000 pizzas = 4,000 robots
The Law of Increasing The Law of Increasing Opportunity CostOpportunity Cost
The more pizzas we make,The more pizzas we make, the more each one costs,the more each one costs,
in terms of machines foregonein terms of machines foregone
The more pizzas we make,The more pizzas we make, the more each one costs,the more each one costs,
in terms of machines foregonein terms of machines foregone
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 20
The Law of Increasing The Law of Increasing Opportunity CostOpportunity Cost
Shape of the Curve• As we make more pizzas, the
number of robots we have to give up (per pizza) increases
• Slope of the production possibilities curve gets steeper and steeper
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 21
Production Possibilities
0
2
4
6
8
10
12
0 1 2 3 4 5
Pizzas (hundred thousands)
Ro
bo
ts (
tho
usa
nd
s)AA
BB
CC
DD
EE
Additional pizza unit costs 1, 2, 3, 4 robot units
The Law of Increasing The Law of Increasing Opportunity CostOpportunity Cost
The more pizza we make,the more machines we give up,the steeper the curve
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 22
Shape of the Curve• concave to the originEconomic Rationale• resources are not completely
adaptable to alternative uses
The Law of Increasing The Law of Increasing Opportunity CostOpportunity Cost
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Chapter 1 23
• Decide on optimal allocation by comparing Marginal (extra) Cost (MC) to Marginal Benefit (MB)
• Marginal Benefit is the extra benefit associated with consuming one more unit
• Marginal Cost is the extra opportunity cost of that extra unit
Optimal Allocation
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Chapter 1 24
Figure 1-3Figure 1-3Optimal Allocation MB = MCOptimal Allocation MB = MC
0
5
10
15
1 2 3Quantity of Pizzas
MB
/MC MC
MBMB=MC
a b
e
b c
Optimal allocation requires the expansion of a good’s output until its MC and MB are equal
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 25
Unemployment, Growth, and the Future
• A Growing Economy– increases in factor supplies– advances in technology
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Chapter 1 26
Figure 1-5 Economic Growth and the Figure 1-5 Economic Growth and the Production Possibilities CurveProduction Possibilities Curve
Production Possibilities
0
2
4
6
8
10
12
14
0 2 4 6 8 10
Pizzas (hundred thousands)
Robo
ts (t
hous
ands
)
A’ B’ C’ D’ E’
Pizza 0 2 4 6 8
Robot
14 12 9 5 0A’
B’
C’
D’
E’
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 27
Figure 1-6Figure 1-6Present Choices and Future Present Choices and Future
PossibilitiesPossibilities
Goods for the PresentGoods for the Present
Go
od
s fo
r th
e F
utu
reG
oo
ds
for
the
Fu
ture
FAVOURINGFAVOURINGFUTURE GOODSFUTURE GOODS
FutureFutureCurveCurve
Goods for the PresentGoods for the Present
Go
od
s fo
r th
e F
utu
reG
oo
ds
for
the
Fu
ture
FAVOURINGFAVOURINGPRESENT GOODSPRESENT GOODS
FutureFutureCurveCurve
Copyright © 2007 McGraw-Hill Ryerson Ltd.
Chapter 1 28
A Qualification: International A Qualification: International TradeTrade
• An individual nation is limited by the production possibilities curve
• But NOT when there is international specialization and trade!– possible to consume ABOVE the
production possibilities curve
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Chapter 1 29
Chapter Summary
1.1 Ten Key Concepts to Retain for a Lifetime
1.2 The Economic Way of Thinking1.3 Theories, Principles, and Models1.4 Macroeconomics and
Microeconomics1.5 The Individual’s Economic Problem1.6 Society’s Economic Problem1.7 The Production Possibilities Model1.8 Unemployment, Growth, and the
Future