CH: 1 Limits, Alternatives, and Choices

Rational behavior: Weighing costs and

People’s wants are infinite. Our economic benefits and choosing the option which
wants far exceed the productive capacity maximizes utility.
of our scarce (limited) resources.
Purposeful behavior: People make
decisions with some desired outcome in
mind. Purposeful behavior assumes that
people make mistakes and are influenced by
Hence, we are forced to make choices.
emotions.
Economics: The social science concerned Rational self-interest: Behavior designed
with how individuals, institutions, and to increase personal satisfaction, however it
society make optimal (best) choices under may be derived e.g: Charities
conditions of scarcity.
Marginal analysis: Comparisons of
Economic perspective: Stresses (a) marginal benefits and marginal costs,
resource scarcity and the necessity of usually for decision making.
making choices, (b) the assumption of pur-
poseful (or rational) behavior, and (c)
comparisons of marginal benefit and
marginal cost. Marginal = “Additional” or “change in”

Scarcity: Limited goods and services Faced with an array of choices, consumers,
resulting in restricted options and demands workers, and businesses rationally compare
choices. marginal costs and marginal benefits in
making decisions.
WHY CAN’T THINGS BE FREE?
Marginal costs are a result of scarce
 Resources are used to produce each resources.
of these products, and because those
resources have alternative uses, The marginal cost of a larger-size diamond,
society gives up something else to for example, is the added expense beyond
get the “free” good. Where resources the cost of the smaller-size diamond. The
are used to pro- duce goods or marginal benefit is the perceived lifetime
services, there is no free lunch. pleasure (utility) from the larger-size stone.

Free goods are offered for marketing. When there is a choice, there is opportunity
cost.
You may be treated to lunch, making it
“free” from your perspective, but someone If there is a marginal cost, there will be a
bears a cost. Because all resources are marginal benefit, and vice versa.
either privately or collectively owned by
members of society, ultimately society
Theories, Principles, and Models
bears the cost
Economics relies on the scientific method
Opportunity costs: To obtain more of one to formulate economic theories.
thing, society forgoes the opportunity of
getting the next best thing.
a. Observing real-world behavior and
outcomes.
Utility: The pleasure, happiness, or b. Based on those observations,
satisfaction obtained from consuming a formulating a possible explanation of
good or service. cause and effect (hypothesis).
 c. Testing this explanation by comparing consideration are held constant for
the outcomes of specific events to the a particular analysis.
outcome predicted by the hypothesis
d. Accepting, rejecting, and modifying the
Graphical Expression: Many economic
hypothesis, based on these
models are expressed graphically.
comparisons.
e. Continuing to test the hypothesis
against the facts. As favorable results Microeconomics: Part of economics
accumulate, the hypothesis evolves into concerned with individual units such as a
a theory. person, a household, a firm, or an industry.

A very well-tested and widely accepted The details of an economic unit, such as the
theory is referred to as an economic law or price of a specific product, the number of
an economic principle. Combinations of workers employed by a single firm, the
such laws or principles are incorporated reve- nue or income of a particular firm or
into models household, as observed. We look at decision
making by individual customers, workers,
Economic principle: A statement about households, and business firms.
economic behavior or the economy that
enables prediction of the probable effects of In microeconomics, we examine the sand,
certain actions. rock, and shells, not the beach.

Economists develop theories of the Macroeconomics: Examines either the

behavior of individuals (consumers, economy as a whole or its basic
workers) and institutions (businesses, subdivisions or aggregates, such as the
governments) engaged in the production, government, household, and business
exchange, and consumption of goods and sectors
services.
Macroeconomics seeks to obtain an
Theories, principles, and models are overview of the structure of the economy
“purposeful simplifications.” and the relationships of its major
aggregates. Macroeconomics speaks of such
economic measures as total output,
aggregate expenditures, and the general
Simplify the complex economic reality. level of prices.

Uses of Economic principles and models: Macroeconomics looks at the beach, not the
pieces of sand, the rocks, and the shells.
a. Analyze economic behavior
b. Ascertain cause and effect within Aggregate: A collection of specific
economic system economic units treated as if they were one
c. Explain and predict economic unit.
behavior
Many topics and subdivisions of economics
Assumptions made by economic principles: are rooted in both, micro and macro.

a. Generalization: Economic Positive economics:

principles are expressed as the
tendencies of typical or average a. Focuses on facts and cause-and-effect
consumers, workers, or business relationships.
firms. b. Includes description, theory
development, and theory testing
b. Other-Things-Equal Assumption
(theoretical economics).
(Ceteris paribus): All variables
except those under immediate
 c. Avoids value judgments, tries to Every point on the graph represents a
establish scientific statements about possible combination, including fractional
economic behavior. quantities. The slope of the graphed budget
d. Critical to good policy analysis. line measures the opportunity cost of y-axis
e. Includes past facts
quantity for every one additional x-axis
quantity.
Normative economics:

a. Incorporates value judgments about

what the economy should be like.
b. Looks at the desirability of certain
aspects of the economy.
c. It underlies expressions of support for
particular economic policies.
d. Includes “should” in its statements.
e. Breeds arguments among economists

Economizing problem: The need to make

choices because economic wants exceed
economic means.

We all have a finite amount of income.

Wages, interest, money from government In the attainable area (area under the
programs etc are sources of income. graph), combinations are affordable, but
they won’t achieve maximum utility.
Because we have only limited income but
seemingly insatiable wants, it is in our self- Area above the graph are unattainable
interest to economize: to pick and choose combinations.
goods and services that maximize our
satisfaction.
Points on line = Max utility
We desire various goods and services that
provide utility. They may be necessities, like Constant slope = constant opportunity cost
food, for luxuries, like yachts.

As new and improved products are intro-

duced, economic wants tend to change and
multiply. Services, as well as goods, satisfy
our wants. We buy many goods for their
services e.g phones.

Society also faces economizing problem.

Limited income + unlimited wants =

economizing problem

A Budget Line As income increases, budget line moves

right (increasing attainable area). As
Budget line = Budget constraint income decreases, budget line moves left
(decreasing attainable area).
Curve that shows various combinations of
two products a consumer can purchase with Economic resources: All natural, human,
a specific money income. and manufactured resources that go into
the production of goods and services e.g The entrepreneur risks not only his
minerals, factories, labor etc. or her invested funds but those of
associates and stockholders as well.
Factors of production/Inputs/Economic
resources: Production Possibilities Model

Assumptions:
Land: Includes all natural resources used a. Full employment: The economy is
in the production process, such as arable employing all its available
land, forests, mineral. resources.
b. Fixed resources: The quantity and
Labor: Consists of the physical and mental quality of the factors of production
talents of individuals used in producing are fixed.
goods and services e.g. logger, football c. Fixed technology: The state of
player, nuclear physicist. technology (the methods used to
produce output) is constant.
Capital: Includes all manufactured aids d. Two goods: The economy is
used in producing consumer goods and producing only two goods: a
services e.g. factory, storage, transportation, consumer good and a capital good.
tools and machinery. Economists refer to
the purchase of capital goods as investment. Production possibilities table: Lists
the different combinations of two
Capital goods differ from consumer goods products that can be produced with a
because consumer goods satisfy wants specific set of resources, assuming full
directly, whereas satisfy our wants employment.
indirectly by making possible more efficient
production of consumer goods.

Note that the term “capital” as used by

economists refers not to money but to tools,
machinery, and other productive
equipment. Because money produces
nothing, economists do not include it as an A and E unrealistic as an economy typically
economic resource. Money (or money produces both capital goods and consumer
capital or financial capital) is simply a goods i.e. B, C, D.
means for purchasing capital goods.
A to E:
Entrepreneurial Ability:
a. society increases the current
a. Takes the initiative in combining the satisfaction of its wants.
economic resources to produce a b. stock of capital goods does not
good or a service. expand at the current rate,
b. Makes the strategic business c. potential for greater future
decisions that set the course of an production is lost
enterprise. d. society chooses “more now” at the
c. Innovation: Commercializes new expense of “much more later.”
products, new production
techniques, or even new forms of E to A:
business organization.
d. Risk bearer: The reward for the a. current consumption forgone
entrepreneur’s time, efforts, and
abilities may be profits or losses.
 b. resources that can be used to WHY DOES OPPORTUNITY COST
increase the production of capital INCREASE?
goods made available.
c. society will have greater future  As we produce more and more of A,
production and, therefore, greater we use up resources increasingly
future consumption specialized in producing B. Hence, a
d. More later, less now. greater loss of B is incurred with
every unit produced of A as a more
A fully employed economy must sacrifice specialized unit is lost. This is the
some of one good to obtain more of another result of lack of per- fect flexibility,
good due to scarcity. or interchangeability, on the part of
resources.
Production Possibilities Curve: Graphical
representation of data presented in a The production possibilities curve
production possibilities table. illustrates several ideas:

a. Scarcity of resources is implied by

the area of unattain- able
combinations of output lying
outside the production possibilities
curve.
b. Choice among outputs is reflected in
the variety of attainable
combinations of goods lying along
the curve.
c. Opportunity cost is illustrated by the
down- ward slope of the curve.
d. The law of increasing opportunity
costs is implied by the bowed-
outward shape of the curve.
A, B, C, D, E: Maximum combination of two
products that can be produced if resources Optimal Allocation:
are fully employed.
a. Combinations of goods on the curve
W: Unattainable. which maximize satisfaction.
b. The optimal amount of the activity
Points inside curve: Attainable, but full occurs where MB = MC (marginal
employment not being realized. benefit = marginal cost).
c. Each successive unit of a good
The curve is a “constraint” because it shows brings with it both increasing
the limit of attainable outputs. marginal costs (due to increasing
opportunity costs) and decreasing
Law of increasing opportunity costs: As marginal benefits.
the production of a particular good d. The optimal quantity of a good is
increases, the opportunity cost of producing indicated by point of intersection of
an additional unit rises. the MB and MC curves.

Shown by increasing (negative) gradient >

Gradient = Opportunity cost of 1 additional
unit of x-axis good (applicable to y-axis
goods too).
 When an increase in the quantity or quality
of resources occurs, the production
possibilities curve shifts outward and to the
right.

WHY DON’T WE PRODUCE 100,000

PIZZAS?

 Because then, the marginal cost for the

corresponding amount of robots will
exceed its marginal benefit.

Unemployment, Growth, and the Economic growth: A larger total output.

Future
Economic growth is the result of:
Graphically, we represent situations of
a. increases in supplies of
unemployment by points inside the original resources.
production possibilities curve. Point U b. improvements in resource
below is one such point. quality.
c. technological advances

The consequence of growth is that a full-

employment economy can enjoy a greater
output of both consumption goods and
capital goods whereas static, no-growth
economies must sacrifice some of one good
to obtain more of another.

Advancing technology brings both new and

better goods and improved ways of
producing them.

As with increases in resource supplies,

technological advances make possible the
production of more capital and consumer
goods.
Increased supplies of the factors of
production means more of both consumer Pitfalls to Sound Economic
goods and capital goods can be produced. Reasoning

Biases: For example, some might think that

corporate profits are excessive or that
Economic growth lending money is always superior to
borrowing money.
Loaded Terminology: High profits may be
labeled “obscene,” low wages may be called
“exploitive,” or self-interested behavior may
be “greed.”

Fallacy of Composition: Assumption that

what is true for one individual or part of a
whole is necessarily true for a group of
individuals or the whole.

Post Hoc Fallacy (ergo propter hoc, or

“after this, therefore because of this,”
fallacy.): Event A may precede event B, but
A may not necessarily be the cause of B e.g.
The rooster crows before dawn but does
not cause the sunrise.

Correlation but Not Causation: We may

find that when variable X increases, Y also
increases. But this correlation does not
necessarily mean that there is causation—
that increases in X cause increases in Y. The
relationship could be purely coin- cidental
or dependent on some other factor, Z, not
included in the analysis.

Present Choices and Future

Possibilities Production possibilities analysis: An
individual nation is limited to the
Producing goods for future combinations of output indicated by its
production possibilities curve.
Better technology (and hence, better
quantity and quality of resources)
International specialization: Directing
domestic resources to output that a nation
Economic growth
is highly efficient at producing.
Goods for future: Capital goods, research
International trade: Exchange of these
and education, and preventive medicine.
goods for goods produced abroad.
Goods for the present: consumer goods such
Specialization and trade enable a nation to
as food, clothing, and entertainment.
get more of a desired good at less sacrifice
of some other good (less opportunity cost).
If you choose consumer goods over capital
goods (Point P): 1st graph International specialization and trade
enable a nation to obtain more goods than
If you choose consumer goods over capital its production possibilities curve indicates.
goods (Point P): 2nd graph
Specialization and trade have the same
effect as having more and better resources
or discovering improved pro- duction
techniques; both increase the quantities of
capital and consumer goods available to
society.

Outputs gained from trade and

specialisation are not included in the
production possibilities curve.