Limits, Alternatives, and Choices

1. Chapter 1 Limits, Alternatives, and Choices

2. Introduction We begin the first chapter by defining the economic perspective or economic way of thinking The economic way of thinking involves several critical and closely related features� 2

3. Scarcity and Choice We live in a world of scarce resources and unlimited wants and desires This is a concept economists define as scarcity Scarcity restricts options and demands choices be made At the core of economics is the idea that �There ain�t no such thing as a free lunch!� 3

4. Opportunity Cost There is a difference between �cost� and �price� The cost of a lunch may be free to you in terms of the price you pay for it�for instance, if I pick up the tab But, the lunch still has a cost�an opportunity cost�meaning that the resources that went to producing that lunch were no longer available to produce something else 4

5. Opportunity Cost Thus�the sacrifice of whatever other product could have been made using those resources is called the opportunity cost of the lunch To obtain more of one thing, society sacrifices the opportunity to have the next best thing 5

6. Purposeful Behavior Economics assumes that human behavior reflects �rational self-interest� Humans seek to maximize the utility (satisfaction, happiness, pleasure, etc.) received from decisions they make and opportunities they pursue Because we consider costs and benefits when we make economic decisions, we call them �purposeful� or �rational� Self-interested behavior is designed to increase personal satisfaction 6

7. Marginal Analysis The essence of marginal analysis is comparing marginal costs and marginal benefits when making decisions This is not restricted to only economic decisions but can be applied to many different types of decisions Economists define �marginal� as meaning �extra� or �additional� or �a change in� Most decisions we make involve small changes in the status quo 7

8. Marginal Analysis For some examples of the use of marginal analysis in some economic and non-economic ways, see Dwight Lee� It�s the Margin that Counts More on Marginalism Markets and Marginalism Marriages, Mistresses, and Marginalism Take This Job and Shove It, at the Margin 8

9. Theories, Principles, and Models Like the physical and life sciences, economics relies on the scientific method Observing real-world behavior and outcomes Formulating possible explanations of cause and effect based on the observations (hypotheses) Testing the hypotheses Accepting or rejecting the hypotheses and continuing to test them against the facts If the hypotheses hold up, they evolve into theories and, ultimately, principles and laws 9

10. Theories, Principles, and Models Principles , theories, and laws eventually become incorporated into models, which are abstract or simplified representations of how something works Economic models are useful in analyzing and understanding economic behavior and how an economy operates They are tools for ascertaining cause and effect and are useful in making predictions 10

11. Macroeconomics & Microeconomics We develop economic models at two levels: Microeconomics � which is concerned with decision making at the individual unit level of consumers and organizations Macroeconomics � which examines the entire economy or its major subdivisions 11

12. Positive and Normative Analysis Positive economics focuses on facts and cause and effect relationships and is objective It includes description, theory development, and theory testing It avoids value judgments Normative economics incorporates value judgments about what the economy should be like or ought to be like � it is subjective in nature 12

13. The Economizing Problem for an Individual Assumptions: Limited income Unlimited wants and desires The necessity to make choices 13

14. The Economizing Problem for an Individual 14

15. Global Perspective 15

16. Society�s Economizing Problem Society must also make choices under conditions of scarcity If we want a larger military, can we have more hospitals and schools, also? Perhaps�but there is something that we will have to make do with less of if we decide we want both 16

17. Resource Categories Economists classify economic resources into four general categories Land � natural resources like forests, minerals, air, water, oil, solar power, wind, etc. Labor � the physical and mental activities that people contribute to the production of goods and services Capital � all goods that are produced for the purpose of producing other (final) goods and services (factories, machinery, tools, etc.) 17

18. Resource Categories Entrepreneurship � the special human resource that combines land, labor, and capital to actually produce something Makes strategic business decisions Innovates Bears the risk of failure but reaps the rewards for success 18

19. Production Possibilities Model Let�s now take a look at a model that will help us understand the choices and tradeoffs that must be made due to scarcity � the Production Possibilities Model 19

20. Production Possibilities Model Assumptions: Full employment � the economy is employing all of its resources Fixed resources � the quantity and quality of resources are fixed Fixed technology � the state of technology is fixed Only two goods are produced: pizzas and industrial robots 20

21. Production Possibilities Model 21

22. Production Possibilities Model 22

23. Optimal Allocation 23

24. Unemployment, Growth, and the Future Suppose we relax our assumptions from the PP model and there is an increase in resources? 24

25. A Growing Economy 25

26. Present Choices, Future Possibilities 26

27. A Qualification: International Trade Our current Production Possibilities Model assumes no trade takes place between countries In our model, the consumption possibilities equal the production possibilities in this economy Later, when we introduce international trade and specialization and division of labor to the model we will see that consumption can be enhanced even though production is not increased! 27