Choice in a World of Scarcity

1. Choice in a World of Scarcity Microeconomics What is Marketing? Principles of Marketing

2. Budget Constraint A budget constraint refers to all possible combinations of goods that someone can afford, given the prices of goods, when all income (or time) is spent

3. Sunk Costs Sunk costs—costs incurred in the past that can’t be recovered—should not affect the current decision

4. Calculating Opportunity Cost • The equation for any budget constraint is the following: Budget =P1×Q1+P2×Q2+⋯+Pn×Qn • Apply the budget constraint equation to the scenario. • Simplify the equation. • Use the equation • Graph the results

5. Graphs of Budget Constraints • The slope of the line is negative. The only way to get more of one good is to give up some of the other • The slope of a budget constraint always shows the opportunity cost of the good that is on the horizontal axis

6. The Production Possibilities Frontier The production possibilities frontier (PPF)is an economic model that shows the possible combinations of two products or services that could potentially be produced by a society Because society has limited resources (e.g., labor, land, capital, and raw materials) at any given moment, there’s a limit to the quantities of goods and services it can produce

7. PPF vs. Budget Constraint Model A budget constraint model shows the purchase choices that an individual or society can make given a specific budget and specific purchase prices. The production possibilities frontier shows the possible combinations of two products or services that could potentially be produced by a society. Budgets and prices are more precise. If you think about it, a society’s “possibilities of production” are vastly more complicated and have a great degree of variability. For this reason, a PPF is not as precise

8. Why does the PPF have a different shape? The curve of the production possibilities frontier shows that as additional resources are added to education, moving from left to right along the horizontal axis, the initial gains are fairly large, but those gains gradually diminish The law of diminishing returns asserts that as additional increments of resources are devoted to a certain purpose, the marginal benefit from those additional increments will decline

9. Productive Efficiency • Productive efficiency means that, given the available inputs and technology, it’s impossible to produce more of one good without decreasing the quantity of another good that’s produced • If a society is producing a combination of goods that falls along the PPF, it is achieving productive efficiency

10. Allocative Efficiency Allocative efficiency means that producers supply the quantity of each product that consumers demand. Only one of the productively efficient choices will be the allocative efficient choice for society as a whole. 

11. Comparative Advantage When a country can produce a good at a lower opportunity cost than another country, we say that this country has a comparative advantage in that good

12. Trade Allows Countries to Benefit from Comparative Advantage When countries engage in trade, they specialize in the production of the goods in which they have comparative advantage and trade part of that production for goods in which they don’t have comparative advantage in. With trade, goods are produced where the opportunity cost is lowest, so total production increases, benefiting both trading parties.

13. Assumption of Rationality Economists assume that people will make choices in their own self-interest. They will choose those things that provide the greatest personal benefit, and they’ll avoid or forego those that aren’t as personally valuable and compelling

14. Consumer and Business Behavior • Consumers maximize benefit (happiness) and minimize costs • Businesses maximize profits

15. How do you decide on a choice? The answer is that you compare, to the best of your ability, the marginal benefits with the marginal costs. This is called marginal analysis. An economically rational decision is one in which the marginal benefits of a choice are greater than the marginal costs of the choice.

16. Marginal Benefit Marginal benefit is the difference (or change) in what you receive from a different choice. From a consumer’s point of view, marginal benefit is the additional satisfaction of one more item purchased. From a business’ point of view, marginal benefit is the additional revenues received from selling one more item

17. Marginal Benefit Marginal benefit is the difference (or change) in what you receive from a different choice. From a consumer’s point of view, marginal benefit is the additional satisfaction of one more item purchased. From a business’ point of view, marginal benefit is the additional revenues received from selling one more item

18. Positive vs. Normative Statements • Positive statements are objective and testable • hypothesis • statement of fact • Normative statements are subjective and make a value judgement • Good economists are careful to differentiate between the two

19. Practice Question Is each statement positive or normative? • We should do more to help the environment. • Carbon is released into the atmosphere when fossil fuels are burned. • We predict that an increase of 5% gasoline price will cause a 10% reduction in fuel use.

20. Quick Review • What are the cost of choices and trade-offs? • How do economists use the production possibilities frontier to illustrate society’s trade-offs? • What is the assumption of economic rationality by individuals and firms? • What is marginal analysis? • What is the difference between positive and normative statements?