CHAPTER 1 LIMITS, ALTERNATIVES, AND CHOICES
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Transcript of CHAPTER 1 LIMITS, ALTERNATIVES, AND CHOICES
Slides prepared by Dr. Amy Peng, Ryerson University
CHAPTER 1CHAPTER 1LIMITS, LIMITS,
ALTERNATIVES,ALTERNATIVES, AND CHOICES AND CHOICES
Part One: An Introduction Part One: An Introduction to Economics and the to Economics and the
EconomyEconomy
©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
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.1 3
Ten Key ConceptsTen Key Concepts
The Individual1. Facing Tradeoffs2. Opportunity Costs3. Choosing a Little More or Less4. The Influence of Incentives
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.1 4
Ten Key ConceptsTen Key Concepts
Interaction Among Individuals5. Specialization and Trade6. The Effectiveness of Markets7. The Role of Governments
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.1 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
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.2 6
The Economic Way of ThinkingThe Economic Way of Thinking
• Scarcity and Choice• Purposeful Behaviour• Marginal Analysis: Benefits and
Costs
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.3 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, or modify hypotheses
as indicated• continue testing against the facts theory or model law or principle
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.3 8
Theories, Principles, and ModelsTheories, Principles, and Models
Deriving Theories:• Terminology• Generalizations• Other-Things-Equal Assumption• Abstractions• Graphical Expression
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.4 9
Macroeconomics and Macroeconomics and MicroeconomicsMicroeconomics
• Macroeconomics examines:– the whole economy– the subdivisions or aggregates
• Microeconomics examines:– individual units ( a household,
firm, or industry) and their decision-making process
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.4 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
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.5 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
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.5 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
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.6 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
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 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
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 15
Pizzas (00,000s)
0 1 2 3 4
Robots (000s) 10 9 7 4 0Production Possibilities
0
2
4
6
8
10
12
0 1 2 3 4 5
Pizzas (hundred thousands)
Ro
bo
ts (
tho
usa
nd
s)
The Production Possibilities CurveThe Production Possibilities Curve
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 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 CurveThe Production Possibilities Curve
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 17
Production Possibilities Curve
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 CurveThe Production Possibilities Curve
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 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...Illustrated...
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 19
Pizza (00,000s) 0 1 2 3 4
Robots (000s) 10 9 7 4 0
The Law of Increasing The Law of Increasing Opportunity CostOpportunity Cost
• opportunity cost of 1st 100,000 pizzas = 1,000 robots
• opportunity cost of 2nd 100,000 pizzas = 2,000 robots
• opportunity cost of 3rd 100,000 pizzas = 3,000 robots
• opportunity cost of 4th 100,000 pizzas = 4,000 robots
The more pizzas we make,The more pizzas we make, the more each one coststhe 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 coststhe more each one costs
in terms of machines foregonein terms of machines foregone
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 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
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 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
The Law of Increasing The Law of Increasing Opportunity CostOpportunity Cost
Additional pizza unit costs 1, 2, 3, 4 robot unitThe more pizza we make,the more machines we give up,the steeper the curve
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 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
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 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 AllocationOptimal Allocation
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 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
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.8 25
Unemployment, Growth, and the Unemployment, Growth, and the FutureFuture
• A Growing Economy– increases in factor supplies– advances in technology
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.8 26
Figure 1-5 Economic Growth and Figure 1-5 Economic Growth and the Production Possibilities Curve the Production 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’
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.8 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
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.8 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
©2007 McGraw-Hill Ryerson Ltd. Chapter 1 29
Chapter SummaryChapter 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