01 Limits, Alternatives, and Choices McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved Introduction • LO1 Economics defined: • Economic wants exceed productive capacity • A social science concerned with making optimal choices under conditions of scarcity 1-2 The Economic Perspective • • Thinking like an economist Key features: • • • LO1 Scarcity and choice Purposeful behavior Marginal analysis 1-3 Scarcity and Choice • • • Resources are scarce Choices must be made Opportunity cost • LO1 There’s no free lunch 1-4 Purposeful Behavior • • • • LO1 Rational self-interest Individuals and utility Firms and profit Desired outcomes 1-5 Marginal Analysis LO1 • • • Marginal benefit • Comparison between marginal benefit and marginal cost Marginal cost Marginal means change or “extra” 1-6 Theories, Principles, and Models • The scientific method: Observe Formulate a hypothesis Test the hypothesis Accept, reject, or modify the hypothesis Continue to test the hypothesis, if necessary • Economic principles • • • LO2 Generalizations Other-things-equal assumption Graphical expression 1-7 • Microeconomics and Macroeconomics Microeconomics • • Macroeconomics • LO3 Decision making by individual units Aggregate 1-8 Positive and Normative Economics • Positive economics • • Normative economics • LO3 Deals with economic facts A subjective perspective of the economy 1-9 Individual’s Economizing Problem • • • Limited income Unlimited wants A budget line • • • • LO4 Attainable and unattainable options Tradeoffs and opportunity costs Make the best choice possible Change in income 1-10 The Market System Five Fundamental Questions Chapter Objectives Economic Perspect ive Theories Principl es and Models Macro and Microec onomics Individual’s Econo mizing Problem Society’s Economiz ing Problem Production Possibil ities Model Unemployment, Grow th, and the Future Last Word • Who Will Get the Output? • How Will the System Accommodate Change? • How Will the System Promote Progress? –Technological Advance –Creative Destruction –Capital Accumulation Key Terms End Show 1-16 Copyright 2008 The McGraw-Hill Companies The Market System The “Invisible Hand” Chapter Objectives Economic Perspect ive Theories Principl es and Models Macro and Microec onomics Individual’s Econo mizing Problem Society’s Economiz ing Problem Production Possibil ities Model Unemployment, Grow th, and the Future Last Word • 1776 Wealth of Nations by Adam Smith –Efficiency –Incentives –Freedom Key Terms End Show 1-17 Copyright 2008 The McGraw-Hill Companies The Market System Demise of Command Systems Chapter Objectives Economic Perspect ive Theories Principl es and Models Macro and Microec onomics Individual’s Econo mizing Problem Society’s Economiz ing Problem Production Possibil ities Model Unemployment, Grow th, and the Future Last Word USSR East Germany Yugoslavia • Two Insurmountable Problems –The Coordination Problem –The Incentive Problem Key Terms End Show 1-18 Copyright 2008 The McGraw-Hill Companies Economic Efficiency • Allocative Chapter Objectives Economic Perspect ive Theories Principl es and Models Macro and Microec onomics Individual’s Econo mizing Problem Society’s Economiz ing Problem Production Possibil ities Model Unemployment, Grow th, and the Future Last Word Efficiency – Producing what society wants Marginal Benefit = Marginal Cost •Productive Efficiency – Producing at lowest cost Lowest Average Total Cost Key Terms End Show 1-19 Copyright 2008 The McGraw-Hill Companies Production Possibilities Model • • Illustrates production choices Assumptions: • • • • LO5 Full employment Fixed resources Fixed technology Two goods 1-20 Production Possibilities Table Production Alternatives Type of Product Pizzas A B C D E 10 (in hundred thousands) Industrial Robots (in thousands) Plot the Points to Create the Graph… LO5 1-21 Industrial Robots Production Possibilities Curve 14 13 12 11 10 The law of increasing opportunity costs makes the PPC concave A B Unattainable C D U Attainable E Pizzas LO5 1-22 Marginal Benefit & Marginal Cost Optimal Allocation MC 15 c MB = MC e 10 LO5 a b d MB Quantity of Pizza 1-23 A Growing Economy • Economic Growth • • • LO6 More resources Improved resource quality Technological advances 1-24 A Growing Economy Production Alternatives Type of Product Pizzas A' B' C' D' E' 14 12 (in hundred thousands) Industrial Robots (in thousands) LO6 1-25 Industrial Robots A Growing Economy 14 13 12 11 10 A’ B’ Unattainable A B Economic Growth C’ C D’ D Now Attainable Attainable E’ E Pizzas LO6 1-26 Future Curve Current Curve P Goods for the Present Presentville LO6 Goods for the Future Goods for the Future Present Choices, Future Possibilities Future Curve F Current Curve Goods for the Present Futureville 1-27 International Trade • • LO6 Specialization Increased production possibilities 1-28 Pitfalls to Sound Economic Reasoning • Biases • • • • Loaded terminology Fallacy of composition Post hoc fallacy Correlation not causation 1-29 Key Terms Chapter Objectives Economic Perspect ive Theories Principl es and Models Macro and Microec onomics Individual’s Econo mizing Problem Society’s Economiz ing Problem Production Possibil ities Model Unemployment, Grow th, and the Future Last Word Key Terms End Show 1-30 • • • • • • • • • • • • • • • 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 Copyright 2008 The McGraw-Hill Companies • • • • • • • • • • 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 ... possible Change in income 1- 10 Individual’s Economizing Problem $12 0 Budget 12 DVDs Books $20 $10 10 Income = $12 0 Quantity of DVDs 60 52 44 36 28 11 0 012 Pdvd = $20 Unattainable Income = $12 0 = 12 ... 012 Pdvd = $20 Unattainable Income = $12 0 = 12 Pb = $10 =6 Attainable 10 12 Quantity of Paperback Books LO4 14 1- 11 Global Perspective LO4 1- 12 Almost half the world — over three billion people... Graph… LO5 1- 21 Industrial Robots Production Possibilities Curve 14 13 12 11 10 The law of increasing opportunity costs makes the PPC concave A B Unattainable C D U Attainable E Pizzas LO5 1- 22 Marginal