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Limits, Alternatives, and Choices

1. Limits, Alternatives, and Choices. Chapter Objectives. Economics Defined Economic Perspective Role of Economic Theory Microeconomics and Macroeconomics Scarce Resources The Economizing Problem Production Possibilities. The Economic Perspective. Scarcity and Choice Opportunity Cost

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Limits, Alternatives, and Choices

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  1. 1 Limits, Alternatives, and Choices

  2. Chapter Objectives • Economics Defined • Economic Perspective • Role of Economic Theory • Microeconomics and Macroeconomics • Scarce Resources • The Economizing Problem • Production Possibilities

  3. The Economic Perspective • Scarcity and Choice • Opportunity Cost • Purposeful Behavior • Utility • Marginal Analysis • Marginal Benefits • Marginal Costs

  4. Theories Principles and Models • The Scientific Method • Economic Principle • Generalizations • Other-Things-Equal Assumption (ceteris paribus) • Graphical Expression

  5. Macro and Microeconomics • Macroeconomics • Aggregate • Microeconomics • Individual Units • Positive Economics • Normative Economics

  6. Individual’s Economizing Problem • Limited • Income • Time • Resources • Unlimited Wants • A Budget Line

  7. Suppose that Russ has budgeted $20 a month to buy candy bars, music downloads, or some combination of each. If Russ buys only candy bars he can obtain 40 bars a month; if he buys only downloads, he can buy 20 a month. •  What is the price of a candy bar? • The price of a candy bar is 50 cents. • $20/40 • What is the price of a music download? • The price of a music download is $1 • $20/20

  8. What is the opportunity cost of a music download? • The opportunity cost of 1 more music download is the number of candy bars given up to get it • That number is 2 • $1/$.50 • What is the opportunity cost of a candy bar? • The opportunity cost of 1 more candy bar is ½ • $.50/$1 • Would the opportunity cost of each good change if Russ decided to increase his monthly budget to $30 for the two items? • No, the opportunity cost would not change because the prices of the two goods have not changed • Russ simply can either buy more candy bars and/or music downloads than before

  9. Individual’s Economizing Problem • Attainable and Unattainable Combinations • Tradeoffs & Opportunity Costs • Choice • Income Change

  10. GLOBAL PERSPECTIVE Individual’s Economizing Problem Average Income, Selected Nations Country Per Capita Income 2010 $67,463 47,198 42,831 39,459 20,756 10,710 9,123 4,428 1,222 1,108 529 197 Switzerland United States Japan France South Korea Brazil Mexico China Nigeria Pakistan Rwanda Liberia Source: World Bank

  11. Income = $120 Income = $120 = 12 = 6 Pb= $10 Pdvd= $20 Individual’s Economizing Problem $120 Budget 12 10 8 6 4 2 0 DVDs $20 Books $10 6 5 4 3 2 1 0 0 2 4 6 8 10 12 Unattainable Quantity of DVDs Attainable 2 4 6 8 10 12 14 Quantity of Books

  12. Society’s Economizing Problem • Scarce Resources • Resource Categories • Land • Labor • Capital • Investment • Entrepreneurial Ability • Factors of Production

  13. Production Possibilities Model • Full Employment • Fixed Resources • Fixed Technology • Two Goods • Consumer Goods (Pizzas) • Capital Goods (Industrial Robots)

  14. Production Possibilities Model Production Possibilities Table Production Alternatives A B C D E Type of Product Pizzas (in hundred thousands) 0 1 2 3 4 Industrial Robots (in thousands) 10 9 7 4 0 Plot Points to Create Graph…

  15. Production Possibilities Model Production Possibilities Curve A’ 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

  16. Production Possibilities Model Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable A Law of Increasing Opportunity Cost B C’ C Industrial Robots D’ Shape of the Curve D Attainable E’ E 0 1 2 3 4 5 6 7 8 9 Pizzas

  17. Problem: • Suppose that a nation's production possibilities can be represented by the table below: • What is the maximum amount of food this economy can produce? How much clothing can it produce at this point? • The greatest amount of food is 16 units. • Clothing production is zero.

  18. Problem: • Suppose that a nation's production possibilities can be represented by the table below: • If the economy is producing at alternative C, what is the cost of one more unit of food? • D, 4 additional units of food are produced at the cost of 6 units of clothing • 6/4 = 1.5 units of clothing.

  19. Problem: • Suppose that a nation's production possibilities can be represented by the table below: • If the economy is producing at alternative C, what is the cost of one more unit of clothing? • B, 4 units of clothing at a cost of 4 units of food • 4/4 = 1 unit of food.

  20. Is this economy subject to the law of increasing opportunity costs? How can you tell? • Yes—Starting at alternative A, each successive increase in food production requires a larger and larger reduction in clothing. • Specifically, the opportunity cost of each successive four units of food cost 2 (=20–18), 4 (=18–14), 6 (=14–8), and 8 (=8–0) units of clothing.

  21. Suppose the economy is currently producing 4 units of food and 16 units of clothing. Is this economy producing efficiently? • No—By producing efficiently, the table suggests that the economy can produce 4 units of clothing and 18 units of food (alternative B). • This is 2 more clothing than is currently being produced, suggesting the economy is inefficient.

  22. Production Possibilities Model Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable C’ Industrial Robots U D’ Under or Unemployment E’ 0 1 2 3 4 5 6 7 8 9 Pizzas

  23. Production Possibilities Model Optimal Allocation of Resources MC a c 15 10 5 0 MB = MC e Marginal Benefit & Marginal Cost b d MB 1 2 3 Quantity of Pizza

  24. Unemployment Growth and the Future • A Growing Economy • Economic Growth • Increasing Resource Supplies • Increasing Resource Quality • Technological Advances

  25. 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 Implications of International Trade

  26. 2 The Market System and the Circular Flow

  27. Chapter Objectives • Command Systems vs. Market Systems • Characteristics of a Market System • How Markets Determine What to Produce, How to Produce, and Who Receives the Output • How Market System Adjusts to Change and Promotes Progress • The Mechanics of the Circular Flow

  28. Economic Systems • Economic System Defined • Ownership of Factors of Production • Method Used to Motivate, Coordinate, and Direct Economic Activity • Command System • Socialism, Fascist or Communism • Market System • Capitalism • Pure Capitalism – Laissez-Faire

  29. The Market System Characteristics • Private Property • Freedom of Enterprise • Freedom of Choice 0-49.9 50-59.9 70-79.9 60-69.9 80-100 Moderately Free Repressed Mostly Unfree Mostly Free Free 158- Argentina 171- Iran 179- North Korea 1- Hong Kong 2- Singapore 5- Switzerland 9- Ireland 10- US 28- Austria 92- Italy 119- Greece 138- China 54- Mexico 64- Poland 90- Lebanon Source: Heritage Foundation (www.heritage.org/index/ranking) and he Wall Street Journal

  30. The Market System Characteristics • Self-Interest • Competition • Markets and Prices • Technology and Capital Goods • Specialization • Division of Labor

  31. The Market System Characteristics • Geographic Specialization • Use of Money • Medium of Exchange • Barter • Active but Limited Government

  32. The Market System Five Fundamental Questions • What Goods Will Be Produced? • Consumer Sovereignty • Dollar Votes • How Will the Goods Be Produced? • Available Technology • Prices of Needed Resources

  33. The Market System Five Fundamental Questions • Who gets the output? • willingness to pay • How is change accommodated? • self-interest • How is progress promoted? • technological advance • capital accumulation • Creative destruction

  34. The Market System The “Invisible Hand” • 1776 Wealth of Nations byAdam Smith • Unity of private and social interest • Virtues of the market system • Efficiency • Incentives • Freedom

  35. The Market System Demise of Command Systems • Insurmountable Problems • The Coordination Problem • Set output targets for all goods • The Incentive Problem • No adjustments for shortage or surplus • No Profits • The Calculation Problem • No Prices East Germany Yugoslavia China

  36. Circular Flow Resource Market Businesses Households Product Market

  37. Circular Flow Resource Market Money Income Costs Input Factors Resources Businesses Households Goods & Services Goods & Services Product Market Consumption Revenue

  38. Circular Flow Both Flows Are Equal Resource Market Money Income Costs Input Factors Resources Both Flows Are Equal Businesses Households Goods & Services Goods & Services Product Market Consumption Revenue

  39. 3 Demand, Supply, and Market Equilibrium

  40. Chapter Objectives • Demand Defined and What Affects It • Supply Defined and What Affects It • How Supply & Demand Together Determine Market Equilibrium • How Changes in Supply and Demand Affect Equilibrium Prices and Quantities • Government-Set Prices and their Implications for Surpluses & Shortages

  41. Demand • Demand Defined • Demand Schedule • Law of Demand • Diminishing Marginal Utility • Income Effect • Substitution Effect • Demand Curve • Market Demand

  42. 6 5 4 3 2 1 0 Price (per bushel) 10 20 30 40 50 60 70 80 Quantity Demanded (bushels per week) Individual Demand P Individual Demand P Qd $5 4 3 2 1 10 20 35 55 80 D Q

  43. Individual Demand Determinants of Demand • Tastes • Number of Buyers • Income • Normal Goods • Inferior Goods • Price of Related Goods • Substitute Good • Complementary Good • Unrelated Goods • Consumer Expectations

  44. Individual Demand Demand Can Increase or Decrease P 6 5 4 3 2 1 0 Individual Demand Increase in Demand P Qd $5 4 3 2 1 10 20 35 55 80 Price (per bushel) D2 D1 Decrease in Demand D3 Q 2 4 6 8 10 12 14 16 18 Quantity Demanded (bushels per week)

  45. Individual Demand Demand Can Increase or Decrease An Increase in Demand Means a Movement of the Line P 6 5 4 3 2 1 0 Individual Demand A Movement Between Any Two Points on a Demand Curve is Called a Change in Quantity Demanded P Qd $5 4 3 2 1 10 20 35 55 80 Price (per bushel) D2 D1 Decrease in Demand D3 Q 2 4 6 8 10 12 14 16 18 Quantity Demanded (bushels per week)

  46. Supply • Supply Defined • Supply Schedule • Law of Supply • Revenue Implications • Marginal Cost • Supply Curve • Market Supply

  47. Individual Supply P 6 5 4 3 2 1 0 Individual Supply S1 P Qs $5 4 3 2 1 60 50 35 20 5 Price (per bushel) Q 10 20 30 40 50 60 70 Quantity Supplied (bushels per week)

  48. Individual Supply Determinants of Supply • Resource Prices • Technology • Taxes and Subsidies • Prices of Other Goods • Producer Expectations • Number of Sellers

  49. Individual Supply Supply Can Increase or Decrease P 6 5 4 3 2 1 0 S3 Individual Supply S1 S2 P Qs $5 4 3 2 1 60 50 35 20 5 Price (per bushel) Q 2 4 6 8 10 12 14 Quantity Supplied (bushels per week)

  50. Individual Supply Supply Can Increase or Decrease A Movement Between Any Two Points on a Supply Curve is Called a Change in Quantity Supplied P 6 5 4 3 2 1 0 S3 Individual Supply S1 S2 P Qs $5 4 3 2 1 60 50 35 20 5 Price (per bushel) An Increase in Supply Means a Movement of the Line Q 2 4 6 8 10 12 14 Quantity Supplied (bushels per week)

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