01 Limits, Alternatives, and Choices Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

Economic wants exceed productive capacity Introduction Economic wants exceed productive capacity Economics: A social science concerned with making optimal choices under conditions of scarcity LO1 1-2

The Economic Perspective Scarcity and Choice Purposeful Behavior Marginal Analysis Resources are scarce Rational self-interest Marginal benefit Choices must be made Individuals and utility Marginal cost Opportunity cost Firms and profit Marginal means extra There’s no free lunch Desired outcomes MB and MC Humans and property resources are scarce (limited) so goods and services have to be limited. “We can’t have it all”. The core of economics says “There’s no free lunch”. It means that there was land use involved, farm labor, the labor of cooks and waiters, and management. LO1 1-3

Opportunity Cost The goods and services that could have been produced but are sacrificed is called opportunity cost. That “free lunch” is at the expense of other crops, other farm laborers, etc. To get more of one thing, you forgo the opportunity of getting something else. That “something else” you could have gotten may or may not have been more valuable economically than the “free lunch” you’re getting right now.

Marginalism Marginal analysis: comparisons of marginal benefits and marginal costs Marginal means “extra” or “additional” Every option involves marginal benefits and marginal costs (because of scarce resources) Should you attend school for another year or not? Should the government increase its funding for a missile defense system? Should a business expand or reduce its output?

Microeconomics and Macroeconomics Microeconomics: Decision making by individual units Macroeconomics: Examines either the economy as a whole or its basic subdivisions or aggregates (collection of specific economic units being treated as one unit The government Household sectors Business sectors Millions of consumers get lumped together and just called “consumers” LO3 1-6

Macro vs. Micro

Positive and Normative Economics Positive economics: Deals with economic facts and cause-and-effect relationships Theoretical economics Normative economics: A subjective perspective of the economy Value judgments about what the economy should be like or what policies should be enacted to achieve a desirable goal Theoretical economics – descriptions, theory development and theory testing. Avoids value judgments, establishes scientific statements about economics behavior. LO3 1-8

Examples Positive economics statement: “The unemployment rate in several European nations is higher than that in the US” Normative economics statement: “European nations ought to undertake policies to reduce their unemployment rates” Most economists disagree with each other when speaking in normative economics terms (“we could do this” or “they should do this”)

Pitfalls to Sound Economic Reasoning Biases Some people think corporate profits are excessive Some people think that more government regulation is better than less regulation Loaded terminology Tabloid journalism Fallacy of composition “What is true for one individual is true for the whole” Post hoc fallacy “A comes before B so A must have caused B” Correlation not causation People are biased. End of story. Think about tabloid journalism and how they use phrases like “high profits are obscene” or “low wages are exploitive”. The fallacy of composition is an assumption that is NOT CORRECT. It is NOT necessarily true for one individual’s truth to be the whole group’s truth. DO NOT FALL FOR THE POST HOC FALLACY! IT IS NOT ALWAYS TRUE!! 1-10

Individual’s Economizing Problem Limited income Unlimited wants A budget line Attainable and unattainable options Trade-offs and opportunity costs Make the best choice possible Change in income Introduction to Chapter 2 ^^ (don’t freak out, I just need to show you this to get you started) Attainable and unattainable options are things like “I can buy this apple” versus “I cannot possibly pay for a Lamborghini”. Opportunity costs are those sacrifices where “to get more of one thing you have to forgo the opportunity to get something else” LO4 1-11

Individual’s Economizing Problem 12 10 8 6 4 2 2 4 6 8 10 12 14 Quantity of Paperback Books Quantity of DVDs 6 5 4 3 2 1 8 10 12 DVDs $20 Books $10 $120 Budget Income = $120 Pdvd = $20 = 6 Pb = $10 = 12 Attainable Unattainable This graph shows the difference in opportunity costs of DVD’s vs. paperback books. This is just a random example of an individual’s economizing problem (think microeconomics). LO4 1-12

Society’s Economizing Problem Scarce resources Land Labor Capital Entrepreneurial Ability (takes initiatives, makes decisions, innovates, and takes risks) This is a much more broad example of macroeconomics and scarcity working together. LO4 1-13

Production Possibilities Model Illustrates production choices Assumptions Full employment Fixed resources Fixed technology Two goods LO5 1-14

Production Possibilities Model Production Alternatives Type of Product A B C D E Pizzas (in hundred thousands) 1 2 3 4 Industrial Robots (in thousands) 10 9 7 4 Plot the Points to Create the Graph… LO5 1-15

Production Possibilities Model 14 13 12 11 10 9 8 7 6 5 4 3 2 1 The law of increasing opportunity costs makes the PPC concave. A B Unattainable C Industrial Robots U D Attainable E 0 1 2 3 4 5 6 7 8 9 Pizzas LO5 1-16

A Growing Economy Economic Growth Now Attainable Unattainable 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable A Economic Growth B C’ C Industrial Robots D’ D Now Attainable Attainable E E’ 0 1 2 3 4 5 6 7 8 9 Pizzas LO6 1-17

Present Choices, Future Possibilities Compare Two Hypothetical Economies Future Curve Future Curve F Goods for the Future Goods for the Future P Current Curve Current Curve Goods for the Present Goods for the Present Presentville Futureville LO6 1-18