1. CHAPTER 1 LIMITS, ALTERNATIVES, AND CHOICES
Part One: An Introduction to Economics and the Economy
CHAPTER 1 LIMITS, ALTERNATIVES, AND CHOICES

2. 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

3. Ten Key Concepts The Individual Facing Tradeoffs Opportunity Costs
Choosing a Little More or Less
The Influence of Incentives
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Chapter 1.1

4. Ten Key Concepts Interaction Among Individuals
Specialization and Trade
The Effectiveness of Markets
The Role of Governments
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Chapter 1.1

5. Ten Key Concepts The Economy as a Whole and the Standard of Living
Production and the Standard of Living
Money and Inflation
Inflation-Unemployment Tradeoff
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Chapter 1.1

6. The Economic Way of Thinking
Scarcity and Choice
Purposeful Behaviour
Marginal Analysis: Benefits and Costs
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Chapter 1.2

7. Theories, 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 Models
Deriving Theories:
Terminology
Generalizations
Other-Things-Equal Assumption
Abstractions
Graphical Expression
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Chapter 1.3

9. Macroeconomics and Microeconomics
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 Economics
POSITIVE STATEMENTS…
based upon facts and cause-and-effect relationships
what is
without value judgments
NORMATIVE STATEMENTS…
based upon subjective beliefs
what ought to be
Predictions are positive
if they are based on what
future facts will be
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Chapter 1.4

11. The Individual’s Economic Problem
We all have a finite amount of income
Most people have unlimited wants
A consumer’s budget line
Illustrated...
©2007 McGraw-Hill Ryerson Ltd.
Chapter 1.5

12. Figure 1-1 A Consumer’s Budget Line
DVD ($20)
Book ($10)
Total
Expenditure 6
120 = 5 2
120 = 4 3
120 =
120 = 8
120 = 1 10
120 = 12
120 =
Unattainable
Attainable
©2007 McGraw-Hill Ryerson Ltd.
Chapter 1.5

13. Society’s Economic Problem: Scarce Resources
Property Resources:
Land
Capital
Human Resources:
Labour
Entrepreneurial Ability:
takes initiative
makes policy decisions
innovates
bears risk
©2007 McGraw-Hill Ryerson Ltd.
Chapter 1.6

14. The Production Possibilities Model
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. The Production Possibilities Curve
Pizzas (00,000s) 1 2 3 4
Robots (000s) 10 9 7
©2007 McGraw-Hill Ryerson Ltd.
Chapter 1.7

16. The Production Possibilities Curve
Pizzas (00,000s) 1 2 3 4
Robots (000s) 10 9 7
Production
Possibilities
Curve
©2007 McGraw-Hill Ryerson Ltd.
Chapter 1.7

17. The Production Possibilities Curve
Figure 1-2 A B
attainable C W
attainable but
inefficient
unattainable D E
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Chapter 1.7

18. The 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...
©2007 McGraw-Hill Ryerson Ltd.
Chapter 1.7

19. The Law of Increasing Opportunity Cost
Pizza (00,000s) 1 2 3 4
Robots (000s) 10 9 7
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 each one costs
in terms of machines foregone
©2007 McGraw-Hill Ryerson Ltd.
Chapter 1.7

20. The Law of Increasing Opportunity 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. The Law of Increasing Opportunity Cost
Additional pizza unit costs 1, 2, 3, 4 robot unit A B C
The more pizza we make,
the more machines we give up,
the steeper the curve D E
©2007 McGraw-Hill Ryerson Ltd.
Chapter 1.7

22. The Law of Increasing Opportunity Cost
Shape of the Curve
concave to the origin
Economic Rationale
resources are not completely adaptable to alternative uses
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Chapter 1.7

23. Optimal Allocation
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
©2007 McGraw-Hill Ryerson Ltd.
Chapter 1.7

24. Figure 1-3 Optimal Allocation: MB = MC
Optimal allocation requires the expansion of a good’s output until its MC and MB are equal e
MB=MC MB a b
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Chapter 1.7

25. Unemployment, Growth, and the Future
A Growing Economy
increases in factor supplies
advances in technology
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Chapter 1.8

26. Figure 1-5 Economic Growth and the Production Possibilities Curve
Pizza 2 4 6 8
Robot 14 12 9 5 A’ B’ C’ D’ E’
©2007 McGraw-Hill Ryerson Ltd.
Chapter 1.8

27. Figure 1-6 Present Choices and Future Possibilities
FAVOURING
PRESENT GOODS
FAVOURING
FUTURE GOODS
Future
Curve
Future
Curve
Goods for the Future
Goods for the Future
Goods for the Present
Goods for the Present
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Chapter 1.8

28. A Qualification: International Trade
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 1.8

29. Chapter Summary 1.1 Ten Key Concepts to Retain for a Lifetime
1.2 The Economic Way of Thinking
1.3 Theories, Principles, and Models
1.4 Macroeconomics and Microeconomics
1.5 The Individual’s Economic Problem
1.6 Society’s Economic Problem
1.7 The Production Possibilities Model
1.8 Unemployment, Growth, and the Future
©2007 McGraw-Hill Ryerson Ltd.
Chapter 1