Chapter 1

Limits, Alternatives, and Choices

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

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

Individuals 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
DVDs Books $20 $10

12 10
Income = $120 Quantity of DVDs

6 5 4 3 2 1 0

0 2 4 6 8 10 12

8 6 4 2 0

Pdvd = $20

=6

Unattainable

Income = $120 Pb = $10

= 12

Attainable

Quantity of Paperback Books

10

12

14
1-11

Societys 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 0

B 1

C 2

D 3

E 4

Pizzas
(in hundred thousands)

Industrial Robots
(in thousands)

10

Plot Points to Create Graph

1-14

Production Possibilities Curve

14 13 12 11 10 9 8 7 6 5 4 3 2 1
0 A

B
A B C C

Unattainable

Industrial Robots

Economic Growth
D

Attainable
E 1 2 3 4 5 6 7

Now Attainable
E 8 9

Pizzas
1-15

Production Possibilities Curve

14 13 12 11 10 9 8 7 6 5 4 3 2 1
0 A

B
A B C C

Unattainable

Industrial Robots

Law of Increasing Opportunity Cost

D

Shape of the Curve

E

Attainable
E 1 2 3 4 5 6 7 8 9

Pizzas
1-16

Production Possibilities Curve

14 13 12 11 10 9 8 7 6 5 4 3 2 1
0 A

Unattainable
C

Industrial Robots

U Under or Unemployment

E 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

Future Curve

Goods for the Future

Future Curve
F

Current Curve

Current 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 15

a
MB = MC

MC

10

d
MB

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 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 economic growth 1-23

The Market System and the Circular Flow

1-24