Chapter 1

Limits,
Alternatives, and
Choices

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 Economics

Economics
A social science concerned with
making optimal choices under
conditions of scarcity
Economic wants exceed societys
productive capacity

LO 1-2
 The Economic Perspective

Economic perspective
Scarcity and choice
Opportunity cost
Purposeful behavior (rational) to
increase utility
Marginal analysis

LO 1-3
 Scarcity and Choice

Resources are scarce

Choices must be made
Opportunity cost
Theres no free lunch

LO 1-4
 Purposeful Behavior

Rational self-interest
Individuals and utility (what goods
and services to buy)
Firms and profit (what to produce and
how to produce them)

LO 1-5
 Marginal Analysis

Marginal benefit
Marginal cost
Marginal means extra, additional,
or change in.
Every option involve comparison
between marginal benefit and
marginal cost (because of scarce
resources-forgoing something else)

LO 1-6
 Micro and Macro

Microeconomics
The study of the individual consumer,
firm, or market decision-making.
Macroeconomics
The study of the entire economy or a
major aggregate of the economy
Examples: level and growth rate of
national output, interest rates,
unemployment, and inflation.
LO 1-7
 Positive and Normative
Economics
Positive economics
Economic statements that are factual.
Analysis describing relationships of cause and
effect.
Concern with what is
Normative economics
Economic statements that involve value
judgments.
Analysis examining questions of what ought
to be.

LO 1-8
 Societys Economizing
Problem
4 categories of economic
resources
Land (all natural resources)
Labor (physical actions and mental
activities)
Capital (all manufactured aids e.g
factory, tools)
Entrepreneurial ability (special
human resources)

LO 1-9
 Societys Economizing
Problem
Entrepreneurs
Employs the other factors of
production
Takes initiative
Makes strategic business decisions
Innovates
Takes risk

LO 1-10
 Production Possibilities Model

Economic model that shows different

combinations of two goods that an
economy can produce
Full employment
Fixed resources
Fixed technology
2-good economy
Consumer goods and capital goods

LO 1-11
 Production Possibilities Model

Production Alternatives
Type of Product A B C D E

Pizzas 0 1 2 3 4
(in hundred thousands)

Industrial Robots 10 9 7 4 0
(in thousands)

Plot the points to create the graph

LO 1-12
 Production Possibilities Graph
Q
14
13
12
11
A
10 Unattainable
Industrial robots

9 B
W
8
7 C
6
5
4 D
3
2 Attainable
1 E
0 1 2 3 4 5 6 7 8 9 Q

LO
Pizzas 1-13
 Increasing Opportunity Costs

Law of increasing opportunity costs

As more of a particular good is produced,
its marginal opportunity costs increase
Production possibilities curve
Concave shape
Economic rationale
Econ resources not adaptable to alternative use.
Better at producing 1 type of goods than others.

LO 1-14
 Production Possibilities and
Opportunity Cost

Production
Possibilities
Frontier
Any point on the
frontier such as E
and any point
inside the PPF such
as Z are attainable.
Points outside the
PPF are
unattainable.
Pearson Education 2012
1-15
 Production Possibilities and
Opportunity Cost
Production Efficiency
Production
efficiency -
achieved when one
good cannot be
produce without
producing less of
some other good.
Points on the
frontier are efficient.

Pearson Education 2012

1-16
 Production Possibilities and
Opportunity Cost
Any point inside the
frontier, such as Z, is
inefficient.
At such a point, it is
possible to produce
more of one good
without producing
less of the other
good.
At Z, resources are
either unemployed
or misallocated.

Pearson Education 2012

1-17
 Production Possibilities and
Opportunity Cost
Trade-off Along the
PPF
Every choice along
the PPF involves a
trade-of.
On this PPF, we
must give up some
CDs to get more
pizzas or give up
some pizzas to get
more CDs.

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1-18
 Production Possibilities and
Opportunity Cost
Opportunity Cost
The PPF makes the
concept of opportunity
cost precise.
From Point A to F, one
will produce more
pizzas but the
quantity of CDs can
produce decreases.
The opportunity cost
of a pizza is the CDs
forgone.

Pearson Education 2012

1-19
 Production Possibilities and
Opportunity Cost

In moving from E to
F, the quantity of
pizzas produced
increases by 1
million.
The quantity of CDs
produced decreases
by 5 million.
The opportunity cost
of producing the
fifth 1 million pizzas
is 5 million CDs.
One of these pizzas
costs 5 CDs.

Pearson Education 2012

1-20
 Production Possibilities and
Opportunity Cost

In moving from F to E,
the quantity of CDs
produced increases
by 5 million.
The quantity of pizzas
produced decreases
by
1 million.
The opportunity cost
of the first 5 million
CDs is
1 million pizzas.
One of these CDs
costs 1/5 of a pizza.
Pearson Education 2012
1-21
 Production Possibilities and
Opportunity Cost

Note that the

opportunity cost
of a CD is the
inverse of the
opportunity cost
of a pizza.
One pizza costs 5
CDs.
One CD costs 1/5
of a pizza.

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1-22
 Production Possibilities and
Opportunity Cost
Because resources are
not all equally
productive in all
activities, the PPF
bows outward is
concave.
The outward bow of
the PPF means that as
the quantity produced
of each good
increases, so does its
opportunity cost.

Pearson Education 2012

1-23
 A Growing Economy

Production Alternatives
Type of Product A' B' C' D' E'

Pizzas 0 2 4 6 8
(in hundred thousands)

Industrial Robots 14 12 9 5 0
(in thousands)

LO 1-24
 Unemployment, Growth, & the
Future
Economic growth
14 A
13
12 B
11
Industrial robots

A Unattainable
10
B C
9
8
C
7
6
D
5
D
4
3 Now attainable
2 Attainable
1
E E
0 1 2 3 4 5 6 7 8 9
LO Pizzas 1-25
 Economic Growth

The expansion of production possibilities and

increase in the standard of living is called
economic growth.
Two key factors influence economic growth:
1 Advances in technology
2 Increase in resource supplies
Advances in technology is the development of new
goods and of better ways of producing goods and
services. Eg computerized system to manage inventory.
Increase in resource supplies increase the ability to
produce more of both consumer goods and capital
goods.

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1-26
 Economic Systems

Economic systems
Set of institutionalized arrangements
& coordinating mechanism to
respond to the economizing problems
Differences in systems as to
Who owns factor of production
Method used to motivate, coordinate
and direct economic activity.

LO 1-27
 Laissez-Faire (Pure Capitalism)

Ideal economy
Keep the government from interfering (will
disturb the efficient working of the market)
with the economy.
Role of government (limited) just needed to
Protect private property
Established environment appropriate to
the operation of market system
People interact in markets to buy and sell

LO 1-28
 The Command System

The command system is known as

socialism or communism
Government ownership of most
property resources
Decisions made by a central planning
board (eg. The use of resources,
composition and distribution of output,
org of production)
North Korea, Cuba, Myanmar
LO 1-29
 The Market System or
Capitalism
Private ownership of resources and used markets
and prices to coordinate and direct econ. activity.
Participants act in their own self interest.
Goods and services are produced and resources
are supplied by whoever is willing and able to do
so.
Result in competition among independently acting
buyers and sellers of each product and resources.
Economic decision making is dispersed (vs
centralized)
Monetary reward- create incentive to innovate

LO 1-30
 Active, but Limited
Government
Government may be needed to
alleviate market failures
Government can increase
effectiveness of a market system
Possible government failure

LO 1-31
 The Five Fundamental
Questions
What goods and services will be
produced?
How will the goods and services be
produced?
Who will get the goods and services?
How will the system accommodate
change?
How will the system promote progress?

LO 1-32
 What Will Be Produced?

Goods and services that create a profit,

product that create loss will be
discontinue
Consumer sovereignty
Money votes
Method for consumers to determine
which goods will be produced
Determines which products and
industries survive or fail

LO 1-33
 How Will the Goods Be
Produced?
What combination of resources and tech.
will be used? How production organized?
Combination that minimize the cost per
unit
Firm take great effort to minimize
production cost.
Effort intensified when competition exist
Competition eliminate high-cost producer

LO 1-34
 Who Will Get the Output?

Consumers with the ability and

willingness to pay will get the product
Ability to pay depends on income
Amount of income depends on
Quantity and of the properties and
human resource they supply
Price of the resources in the resource
market

LO 1-35
 How Will the System Change?

Changes in consumer tastes

Changes in technology
Changes in resource prices

LO 1-36
 How Will the System Progress?

Technological advance
Creative destruction Creation of new
product and production methods
completely destroys the market position
of firms that weeded to existing products
and older way of doing business.
Capital accumulation who votes for
capital goods? Entrepreneurs and business
owners.

LO 1-37
 The Invisible Hand

The invisible hand

1776 Wealth of Nations by Adam
Smith
Unity of private and social interest
Virtues of the market system
Efficiency
Incentives
Freedom
LO 1-38
 The Demise of Command
Systems
Command system was a failure
Soviet Union, Eastern Europe, and
China
The coordination problem
Set output targets for all goods
The incentive problem
No adjustments for surplus or
shortage
LO 1-39
 The Circular Flow Model

The circular flow diagram

Households
Businesses
Sole proprietorship
Partnership
Corporation
Product market and the resource
market
The real flow and the money flow

LO 1-40
 The Circular Flow Model

RESOURCE
MARKET
Households
sell
Businesses buy

BUSINESSES HOUSEHOLDS
buy sell
resources resources
sell products buy products

PRODUCT
MARKET
Businesses sell
Households
buy
LO 1-41