CHAPTERS 1 & 2

LIMITS, ALTERNATIVES,
CHOICES, THE MARKET
SYSTEM, AND THE
CIRCULAR FLOW

1
The Scope of Economics
MICRO

VS.

MACRO
2
 The Scope of Economics
MICRO
Examines the
Examines the economic behavior
economic behavior of aggregates
of individual
VS.
decision-
making units
MACRO
3
 Ceteris Paribus
All else equal

Economists often wish to observe

the behavior of two variables
while the values of other
variables in the model are held
fixed. 4
The Fallacy of Composition

The often mistaken belief that

what is true for a part is
necessarily true for the whole

5
 APPLICATION: The
Fallacy of Composition

When I stand up at a ballgame, I can see

better.
Therefore, if everyone stands up, everyone
will be able to see better?

If Farmer Jones produces more corn, her

revenues will rise.
If all farmers produce more corn, their
revenues will all rise? 6
 How to Read and
Understand Graphs

7
 SUMMARY
Graphs can be used to illustrate relationships between
variables.
Each point in a Cartesian coordinate system represents a
pair of values for two variables.
The slope of straight lines is constant.
The slope of curved lines changes at each point.

8
A graph is a two-dimensional representation of a set
of numbers or data.

X Y 14
Y 12
0 2
10
1 4 8
6
2 6
4
3 8 2

4 10 0 X
0 1 2 3 4 5
5 12 9
Many graphs in economics are shown on a
Cartesian coordinate system.
Y-axis
X negative X positive
y positive y positive

X-axis
ORIGIN
X negative X positive
y negative y negative
10
Any combination of values of X and Y can be
plotted in this space.

Y
For example, point A represents
3 Y = -5 when X = 3.
X
-5 A

11
The slope of a line measures how much the
variable on the y-axis changes when the
variable on the x-axis changes by one unit.

Slope = Y1-Y2 = rise

X1-X2 run 12
The slope of an upward-sloping line is
positive.
X Y Y 14
12
0 2
10

1 4 8
6
2 6 4

3 8 2
0
4 10 0 1 2 3 4 5
X
5 12 13
 For example...
Suppose x represents hours
spent studying and y represents
your grade on your next
economics quiz.

Suppose there is a maximum of

12 points available on the quiz.
14
 This means that each hour spent
studying earns you 2 points on the quiz.
study quiz
14
hours score 12

0 2 10
quiz score
8
1 4
6
2 6 4

3 2
8
0
4 10 0 1 2 3 4 5

5 12 study hours 15
 The slope of the line is the change in
the quiz score for an additional hour of
study time, which is 2 points.
study quiz 14
hours score 12
10
0 2 quiz score 8
1 4
6 2 points
2 6 4
1 hour
3 8 2
0
4 10 0 1 2 3 4 5
5 12 study hours
16
The slope of a downward-
sloping line is negative.
X Y 25
Y
0 20 20

1 16 15

2 12 10

3 8 5

4 4 0 X
0 1 2 3 4 5
5 0 17
If a line is not straight, its slope will
change as you move along it.

X
18
The same change in x results in a greater
change in y as you move down the curve.

9
8 Slope is
increasing.
6

X
2 3 5 6
19
 EXAM TYPE QUESTION
Macroeconomics is the branch of economics that examines the
economic behavior
a. on a national scale
b. on an international scale
c. of a consumer
d. of a producer
e. all of the above
The correct answer is
C

20
 EXAM TYPE QUESTION
The graph shows a curve which has
a slope that is:
A) first positive and then negative.
Y B) first negative and then positive.
C) infinite throughout.
D) zero throughout.

The correct answer is

C

X
21
 EXAM TYPE QUESTION
If two variables are independent of each other, this will graph as

a. an upward sloping line.

b. a downward sloping line.
c. a circle.
d. a horizontal or vertical line.

The correct answer is

d

22
 Some precautions...when you
read a graph
Make sure you know what variables are on the axes.
Pay attention to the scale used to measure the variables
on the axes.

23
THERE ARE TWO FACTS IN OUR
LIVES THAT CREATE A PROBLEM,
OF WHICH HUMAN BEINGS
SUFFER.
THE SCIENCE OF ECONOMICS HAS
BEEN INTRODUCED IN HUMAN
CIVILIZATION TO HELP IN THE
SOLUTION OF THE ABOVE
PROBLEM. 24
 UNLIMITED WANTS

SCARCITY OF
RESOURCES

25
IT IS A FACT THAT HUMAN MATERIAL
WANTS ARE UNLIMITED.
DIFFERENTLY SPEAKING, PEOPLE
WANT TO HAVE UNLIMITED
AMOUNTS OF ALL TYPES OF
GOODS_AND_SERVICES.

25
GOODS AND SERVICES CAN BE GROUPED
IN TWO DIFFERENT CATEGORIES:
NECESSITIES
LUXURIES
NECESSITIES: ARE THOSE GOODS THAT
PEOPLE NEED TO SURVIVE. EXAMPLES:
FOOD AND SHELTER.
LUXURIES: ARE THOSE GOODS THAT
PEOPLE WANT FOR AN ENJOYABLE LIFE.
EXAMPLES: CIGARS AND CAVIAR.

26
T F Human material wants are
unlimited.
TRUE

27
RESOURCES ARE ALSO KNOWN AS
INPUTS OR AS FACTORS OF
PRODUCTION.
THERE ARE TWO CATEGORIES OF
RESOURCES:
PROPERTY RESOURCES
HUMAN RESOURCES

28
THERE ARE TWO TYPES OF
PROPERTY RESOURCES:
LAND
CAPITAL
LAND: IS THE ECONOMIC NAME
OF ALL NATURAL RESOURCES.
EXAMPLE: ALL MINERALS.

29
 Capital
Anything that is produced that will
be used to produce other valuable
goods or services over time.
Capital goods or real goods are also
known as investment goods or as
industrial goods
30
How does the Economist define Capital?
Man-made products used to produce other
products

32
Capital goods differ from primary
factors (such as labor and land) in
that:
a. Capital goods tend to be outputs,
the others dont.
b. Capital goods increase labor
productivity.
c. Capital goods play a less important
role in the production process.
d. Capital goods are outputs of the
economy but are not inputs.
e. None of the above.
THE CORRECT ANSWER IS
a
33
 GOODS AND SERVICES ARE OF TWO
TYPES:
- CAPITAL GOODS
- CONSUMER GOODS

Consumer Goods
Goods produced for present
consumption.
These are not considered resources.

34
In economics, which of the following is
NOT considered capital?
a. offices and warehouses
b. stocks and bonds
c. machinery
d. factories
e. equipment

THE CORRECT ANSWER IS

b
35
Indicate whether the following goods are capital or
consumer goods:
a. a casio cash register in a supermarket
Capital Good
b. a screw driver used by a carpenter
. CAPITAL GOOD
c. The Litani dam in the Bekaa Valley

d. A public bus used

CONSUMER GOODbetween Dora and Byblos

CONSUMER
e. Your telephone GOOD
at home 36
THERE ARE TWO TYPES OF HUMAN
RESOURCES:
LABOR
ENTREPRENEURIAL ABILITY
LABOR: IS ALSO KNOWN AS BLUE COLAR
WORKERS.
EXAMPLES: MINING WORKERS AND
CONSTRUCTION WORKERS.
37
ENTREPRENEURIAL ABILITY: IS A SPECIAL HUMAN
RESOURCE. THE BUSINESS NAMING FOR THE
ENTREPRENEUR IS THE MANAGER AND/OR THE
OWNER.
FUNCTIONS OF AN ENTREPRENEUR:
COORDINATING THE THREE OTHER TYPES OF
RESOURCES IN ORGANIZING PRODUCTION.
TAKING THE BASIC BUSINESS POLICY
DECISIONS.
INNOVATING:
INTRODUCING NEW PRODUCTS
INTRODUCING NEW PRODUCTION
TECHNIQUES
INTRODUCING NEW FORMS OF BUSINESS
ORGANIZATION
RISK TAKING
38
 PAYMENTS
TO PROPERT
RESOURCES AR Y
E KNOWN A
RENTAL OR S
INTEREST IN
PAYMENTS COME.
TO LABOR A
KNOWN AS RE
WAGES, SALA
COMMISSION RIES, OR
S.
PAYMENTS
TO ENTREPR
ARE KNOWN ENEURS
AS PROFITS
LOSSES. OR

39
SCARCITY IS THE ECONOMIC NAME FOR
BEING LIMITED.
LAW OF SCARCITY: IT IS A FACT THAT ALL
RESOURCES OF THE WORLD ARE MORE
OR LESS SCARCE.
LAW OF RELATIVE SCARCITY: SINCE
RESOURCES THAT ARE USED AS INPUTS
ARE SCARCE, THEN GOODS AND SERVICES
AS OUTPUTS ARE SUPPOSED TO BE
RELATIVELY LIMITED.
40
Economic scarcity applies in:
a. All societies
b. Capitalist countries only, because of
exploitation
c. Socialist countries only, because of lack of
incentive
d. Developing countries only, because of
lack of capital
The correct answer is
a 41
Using resources to produce capital implies
a. not using them to produce consumer goods in the
present time
b.lack of efficiency
c. scarcity of resources
d.all of the above
e. none of the above
The correct answer is
a
42
ECONOMICS IS A
SOCIAL SCIENCE
THAT DEALS
WITH THE
EFFICIENT
UTILIZATION OF
SCARCE
RESOURCES, TO
GENERATE
MAXIMUM
POSSIBLE
OUTPUT, AND
MINIMIZE THE
PROBLEM OF
UNSATISFIED
WANTS. 43
Economics is best defined as the study of
a. How people attempt to maximize their satisfaction, given
their limited incomes.
b. How to make money.
c. How people allocate scarce resources among unlimited wants.
d. How firms attempt to maximize their profits, given some
production target.
e. How prices are determined.

The correct answer is c

T F Economics is a physical science.
FALSE

45
Production Possibility Frontier PPF

The PPF is a graphical device that

shows all the combinations of
goods and services that can be
produced if all of societys
resources are used efficiently.
46
International Trade

Comparative Advantage
 Benefits of Trade
Free trade benefits all trading partners
Comparative advantage: having a lower
opportunity cost of producing a good
 With 8 hours of labor, I
can catch 20 shrimp or
harvest 60 bananas...

Bob
 Production Possibilities
for Bob
20

10

20 40 60
 With 8 hours of labor, I
can catch 30 shrimp or
harvest 40 bananas...
Frank
 Production Possibilities
30
for Frank
20

10

20 40 60
30 Frank
20
10
20 40 60

Bob
20
10

20 40 60
 Bob and Frank Cooperate
Frank fishes for shrimp and gets 30.
Bob picks bananas and gets 60.
(30)

(60)
 Suppose They Trade
Lets say they trade half for half...
Bob gives up 30 bananas.
Frank gives up 15 shrimp.
Rate of exchange: 2 B = 1 S
 (15)

(15) (30)

(30)
Each has 30 bananas and 15 shrimp --
much better than individual production!
30 Frank
20
10
20 40 60

Consumption
points

Bob
20
10

20 40 60
59
 Comparative Advantage
You have a comparative advantage in a
good if you can produce it at a lower
opportunity cost than other people can.

59
 Opportunity Costs

Frank Bob
1 Banana 3/4
= shrimp 1/3 shrimp

1 Shrimp 4/3
= banana 3 bananas

61
 Opportunity Costs

Frank Bob
>
1 Banana3/4 shrimp 1/3 shrimp

<
1 Shrimp4/3 bananas 3 bananas
Frank
Frank has
has a
a
comparative
comparative advantage
advantage
in
in shrimp;
shrimp; Bob
Bob has
has a
a
comparative
comparative advantage
advantage
in
in bananas.
bananas. 61
 Opportunity Costs

Frank Bob
>
1 Banana3/4 shrimp 1/3 shrimp

<
1 Shrimp4/3 bananas 3 bananas

Frank
Frank should
should produce
produce
shrimp;
shrimp;
Bob
Bob should
should produce
produce
bananas.
bananas. 62
 Opportunity Costs

Frank Bob
>
1 Banana3/4 shrimp 1/3 shrimp

<
1 Shrimp4/3 bananas 3 bananas

Frank
Frank requires
requires at
at least
least 4/3
4/3 bananas
bananas per
per
shrimp
shrimp
Bob
Bob requires
requires at
at least
least 1/3
1/3 shrimp
shrimp per
per
banana
banana
63
 Terms of Trade
One banana will trade for at least 1/3
shrimp.
One shrimp will trade for at least 4/3
banana.
One-third shrimp < 1 banana < 3/4
shrimp

64
 Summary
Comparative advantage means there are
gains to trade.
Specialization will mean more efficient
resource allocation.
Individuals (and countries) can consume
more than they can produce individually.

65
ASSUMPTIONS:
1. FULL-EMPLOYMENT AND FULL-
PRODUCTION
2. SHIFTABILITY OF RESOURCES
3. RESOURCE SUPPLY AND TECHNOLOGY
FIXED
4. ONLY TWO PRODUCTS

66
 TOTAL CORN TOTAL
WHEAT
POINT PRODUCTION
PRODUCTION
ON PPF (millions of bushels) (millions of
bushels)
per year per year
A 700 100
B 650 200
67
C 510 300
A typical PPF has the following
shape:
The curve has a
negative slope.
The curve is concave to
the origin.

68
LAW OF DIMINISHING RETURNS:
ALSO KNOWN AS THE LAW OF DIMINISHING
MARGINAL PHYSICAL PRODUCTIVITY.
ASSUMING ALL RESOURCES TO BE HELD
CONSTANT, EXCEPT ONE VARIABLE INPUT. IF
EQUAL UNITS OF THE VARIABLE INPUT ARE
ADDED CONSECUTIVELY IN A PRODUCTIVE
SYSTEM, THE RESULTING ADDITIONAL
OUTPUTS TURN TO BE LESS AND LESS.

69
 EXAMPLE:
Inputs Output
6 10
12 18 THE REASONING
BEHIND THE LAW IS
18 24 THE LIMITED
24 28 COMBINATION
CAPACITY OF THE
30 30 ASSUMED FIXED
RESOURCES.

70
 The correct answer is

The law of diminishing returns states that

a. As successive units of a variable resource are added to a fixed resource,
additional output of each variable resource added will diminish.
b. As successive units of a fixed resource are added to a variable resource,
costs begin to rise.
c. More output can be produced only with more resources.
d. Fewer resources are required to produce lesser output.
e. As successive units of a variable resource are added to a fixed resource,
additional output of each variable resource added will increase.

72
Law of Increasing Opportunity Costs

The opportunity cost of producing

a good increases as more resources
are shifted into its production.
How does this relate to the concave
shape of the PPF?

73
 Can you explain the law of increasing opportunity costs
using this data?

POINT ON TOTAL TOTAL

Bushels of corn per year

PPF CORN WHEAT

PRODUCTI PRODUCTI
ON ON
(millions of (millions of
800 bushels) bushels)
700 per year per year
600
500
A 700 100
(millions)

400
300
B 650 200
200
100 C 510 300
0
D 300 400
0 200 400 600
Bushels of wheat per year E 0 500
(millions)

74
Given the following production possibilities schedule,
Good A Good B
-10 Choice 1: 100 0
-20 Choice 2: 90 20
Choice 3: 70 40
-30
Choice 4: 40 60
-40
Choice 5: 0
80 of the following statements is true?
Which
a. Moving from choice 3 to choice 4, the opportunity cost of more B is 30
units of A.
b. Moving from choice 2 to choice 3, the opportunity cost of more B is 20
units of A.
c. Moving from choice 1 to choice 2, the opportunity cost of more B is 10
units of A.
d. There are increasing opportunity costs associated with getting more of B.
The correct answer is
e. All of the above statements are true
e

75
Reference: the production possibility frontier. Assume that the
actual production of both outputs is less than that possible. This
would indicate:
a. Unemployment.
b. Inefficient production methods.
c. Both (a) and (b).
d. None of the above.

The correct answer is

76
ECONOMIES OF MASS
PRODUCTION:
ASSUMING ALL RESOURCES
TO BE HELD CONSTANT,
EXCEPT ONE VARIABLE
INPUT.
IF EQUAL UNITS OF THE
VARIABLE INPUT ARE
ADDED CONSECUTIVELY IN
THE EARLY STAGE OF A
PRODUCTIVE SYSTEM,
THE RESULTING
ADDITIONAL OUTPUTS
TURN TO BE MORE AND
MORE. 77
EXAMPLE:
THE REASONING
Inputs Output BEHIND THE LAW IS
THE SPECIALIZATION
6 10
CHANCES OPEN TO
12 24 THE VARIABLE INPUTS.
18 42
24 56 78
30 66
 Periods of unemployment or inefficiency in
production correspond to points under the
Capital goods PPF.

.A
79

Consumer
Economic growth indicates an increase in
the total output capacity of an economy.
Capital goods

The PPF shifts to

the right !

80

Consumer
goods
Given the following incomplete production possibilities
schedule for commodities T and A:
T A
11 0 The opportunity cost of 2 additional units of A is
9 2 2 units of T given up.
The opportunity cost of 5 additional units of A
5 3 7 must be greater than 5/2 x 2 = 5 units of T to be
0 given up. Let it be 6.

a. In the above table, there is an error. Correct

the wrong number by any acceptable number.

b. Complete the table by putting in the empty space any

acceptable number. Next slide.
81
b. Complete the table by putting in the empty space any
acceptable number.
T A
11 0
9 2 The opportunity cost of 5 additional units of A is
3 7 6 unit of T given up.
0 9
That is, at this stage, the opportunity cost of each
additional unit of A is 6/5 = 1.2 units of T
given up.
So, the opportunity cost of each additional unit of
A after that must be greater than 1.2 units of T
to be given up.
Let the opportunity cost of each additional unit of
A now be 1.5 units of T given up.
Then 3 units of T will be given up,
to let A rise by 3/1.5 = 2 units.

82
c. Draw the PPF.
T A
11 0
9 2
3 7
0 9
d. Plot on your diagram
A
any point i in the
10x space inside the PPF,
8 a x and specify the waste
PPF
6 in both commodities
4 ix b A and T.
2 x
0 2 4 6 8 10x12 T
ai is the waste in A.
bi is the waste in T. 83
e. Assume technology, which is helpful only in
producing T improves, raising the potential of the
nation in producing T by 3 units. Demonstrate the
effect of the above on your diagram of the previous
questions.
f. Assume the nation
raises its productivity
A from point i up
horizontally to a point
10x on the old PPF, to
8 x PPFc point b. Specify the
6 waste after the
PPF d
4 ix improvement in
b x
2 technology.
0 2 4 6 8 10x12 14 x
T
bc is the waste in A.
bd is the waste in T. 84
A production function:
a. is useful for long-run, but not short-
run, decision making.
b. refers to the relationship between inputs
and outputs.
c. measures the opportunity cost of
producing a unit of output.
d. measures the relative cost of
alternative ways of producing a good.
The correct answer is
b

85
 COUNTRY A COUNTRY B
I I
d
x

f x

C C
86
 Three Basic Economic Questions

What will be produced?

How will it be produced?
Who will get what is
produced?

87
 Markets
The institutions through
which buyers and sellers
interact and engage in
exchange

Prices are determined in

markets; prices reflect what
society is willing to pay for 88
 Laissez-faire
Economy
Individual
Individual people
people and
and firms
firms pursue
pursue
their
their own
own self-interests
self-interests without
without any
any
central
central direction
direction or
or regulation.
regulation.
The
The central
central institution
institution in
in these
these
economies:
economies: markets!
markets!

89
Command Economy

A central authority or
agency draws up a plan
that establishes what
will be produced and
when, sets production
goals, and makes rules
for distribution. 90
 Coordinating Mechanism

Market System Central Planning

Ownership Private JAPAN Nazi Germany

of
Resources Public Yugoslavia USSR

Authoritarian
Market Capitalism
Socialism
91
THE TRADITIONAL ECONOMY

TECHNOLOGY IS RESTRAINED
BECAUSE OF TRADITIONS
AND RELIGIOUS BELIEFS.

92 74
THE THOMAS MALTHUSIAN THEORY
OF POPULATION
POPULATION GROWTH:
GEOMETRIC PROGRESSION 1, 2, 4,
8
FOOD GROWTH: ARITHMETIC
PROGRESSION 1, 2, 3, 4
93
 NEO - MALTHUSIANISM

AVERAGE PRODUCT (standard of living)

Labor Output MP AP AP Subsitance Income

0 0 15
1 10 10 10 14
13
2 22 12 11
12
3 36 14 12
11
4 44 8 11 10
5 50 6 10 9
6 54 4 9 8
7
0 1 2 3 4 5 6
FAMINES & WARS QUANTITY OF LABOR

BIRTH CONTROL
94
NET REPRODUCTION RATE
1,000 FEMALES 50 YEARS
1,600 FEMALES
NRR: 1,600/1,000 - 1 = 60%
60% EVERY 25 YEARS
(generation)
ZERO POPULATION GROWTH
(ZPG)
95
 COSTS
RESOURCE
MONEY INCOME
MARKET
RESOURCES RESOURCES

BUSINESSES HOUSEHOLDS

GOODS &
SERVICES GOODS &
PRODUCT SERVICES
CONSUMPTION EXP.
RECEIPTS MARKET
96
A resource market is a market in which:
a. households buy goods and services
b. households sell the services of the factors of
production they control
c. firms sell the services of factors of production
d. firms sell goods and services

b
97
The money businesses pay for resources constitutes
a. part of the real flow.
b. income to resource owners.
c. the supply of resources.
d. the product market.
e. the resource market.

b
98
Capital Full employment is shown with
Products point
Ax a. A.
Dx
Bx b. B.
c. C.
Ex d. All of the above.
Cx
e. None of the above.
0
ConsumerProducts
Thecorrectansweris:
d

99
A product market is a market in which:
a. Houselhold sell the services of the factors of production
they control
b. Firms sell their final output of goods and services
c. Firms and government buy their needed goods and services
d. The government, households, and firms decide what will be
produced in the coming year

The correct answer is b

100
The resource market incorporates the markets for
a. Money.
b. Land.
c. Labor.
d. all of the above.
e. b. and c. e

101