Limits, Alternatives and Choices Economics is about wants and means. Society has the resources to make goods and services that satisfy our many desires. However, our economic wants far exceed the productive capacity of our limited resources. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Limits, Alternatives and Choices Unfortunately, our resources are scarce. Scarcity means that society has limited resources and therefore cannot produce all the goods and services people want. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Theory, Principles, and Models Used to develop theories, laws and principles, the scientific method consists of: the observation of behavior and outcomes, the formulation of a possible explanation of cause and effect (hypothesis) based on the observation, the testing of this explanation by comparing actual and predicted outcomes, and the acceptance, rejection or modification of the hypothesis. the continual testing of the hypothesis. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Theory, Principles, and Models An economic theory evolves from a hypothesis that accumulates favorable results after continued testing against the facts. Economic laws and principles are widely accepted theories that have been well tested and widely accepted. An economic model is a simplified representation of how something works using a combination of laws or principles. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Theory, Principles, and Models Economic principles are statements about economic behavior or the economy that enable prediction of the probable effects of certain actions. Economic models are highly useful in analyzing economic behavior and understanding how the economy operates. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Theory, Principles, and Models Economic principles: are generalizations, use the ceteris paribus, or other-things-equal assumption, and can be expressed graphically. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Microeconomics and Macroeconomics Microeconomics focuses on a specific economic unit. An individual household, firm, or industry Macroeconomics looks at the economy as a whole or its major components of the economy. All consumers, a federal government, or the U.S. economy Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Economic Problem Both individuals and society face an economic problem: They need to make choices because wants exceed means. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Individual’s Economic Problem A limited income (from wages, rents, interest. And profit) constrains individuals to make decisions on how to spend their money. Unlimited wants include both necessities and luxuries. Each type yields some level of utility. Every individual must economize: choose goods and services that will maximize utility. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Individual’s Economic Problem The economic problem individuals face can be depicted as a budget line (or budget constraint), which is a line that illustrates various combinations of two products a consumer can afford with a specific income, given the products’ prices. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Society’s Economic Problem Society must also make choices under conditions of scarcity. It must decide how and where to allot its limited resources. Scare economic resources include land, labor, capital and entrepreneurial ability. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Resource Categories 1.Land include natural resources used in the production process, such as rivers, minerals, and forests. 2.Labor includes physical and mental talents of individuals used to produce goods and services. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Resource Categories 3.Capital includes human-made resources used in producing consumer goods and services such as machinery, tools, and warehouse facilities. 4.Entrepreneurial Ability is human talent that combines the other resources to produce products, make strategic decisions and bear risks. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Production Possibilities Model A production possibilities function shows the different combinations of two products that can be produced given a specific set of resources. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Law of Increasing Opportunity Cost The law of increasing opportunity cost states that the more of a product society produces, the greater is the opportunity costs of obtaining an extra unit. For example, to produce more food, society must give up larger amounts of manufacturing equipment. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Optimal Allocation The optimal allocation depends on marginalism. Ideally, the optimal amount of activity occurs where MB = MC. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.