CHAPTER 1 LIMITS, ALTERNATIVES, AND CHOICES

Slides prepared by Dr. Amy Peng, Ryerson University

CHAPTER 1CHAPTER 1LIMITS, LIMITS,

ALTERNATIVES,ALTERNATIVES, AND CHOICES AND CHOICES

Part One: An Introduction Part One: An Introduction to Economics and the to Economics and the

EconomyEconomy

©2007 McGraw-Hill Ryerson Ltd. Chapter 1 2

In this chapter you will learn:In this chapter you will learn:

1.1 The Ten Key Concepts to retain for a lifetime

1.2 The features of the economic way of thinking

1.3 The role of economic theory in economics

1.4 The distinction between microeconomics and macroeconomics

1.5 The nature of the economic problem and the categories of scarce resources

1.6 About production possibilities analysis, increasing opportunity costs, and economic growth

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.1 3

Ten Key ConceptsTen Key Concepts

The Individual1. Facing Tradeoffs2. Opportunity Costs3. Choosing a Little More or Less4. The Influence of Incentives



Interaction Among Individuals5. Specialization and Trade6. The Effectiveness of Markets7. The Role of Governments



The Economy as a Whole and the Standard of Living

8. Production and the Standard of Living

9. Money and Inflation10.Inflation-Unemployment

Tradeoff


The Economic Way of ThinkingThe Economic Way of Thinking

• Scarcity and Choice• Purposeful Behaviour• Marginal Analysis: Benefits and

Costs


Theories, Principles, and ModelsTheories, Principles, and Models

The scientific method:• observe the world• formulate hypotheses• test by comparing actual outcomes

to the hypothesized predictions• accept, reject, or modify hypotheses

as indicated• continue testing against the facts theory or model law or principle


Theories, Principles, and ModelsTheories, Principles, and Models

Deriving Theories:• Terminology• Generalizations• Other-Things-Equal Assumption• Abstractions• Graphical Expression


Macroeconomics and Macroeconomics and MicroeconomicsMicroeconomics

• Macroeconomics examines:– the whole economy– the subdivisions or aggregates

• Microeconomics examines:– individual units ( a household,

firm, or industry) and their decision-making process


Positive and Normative Positive and Normative EconomicsEconomics

POSITIVE STATEMENTS…• based upon facts and cause-

and-effect relationships• what is• without value judgmentsNORMATIVE STATEMENTS…• based upon subjective beliefs• what ought to be

Predictions are positivePredictions are positiveif they are based on if they are based on what what future facts will befuture facts will be


The Individual’s Economic The Individual’s Economic ProblemProblem

• We all have a finite amount of income• Most people have unlimited wants• A consumer’s budget line


Figure 1-1Figure 1-1A Consumer’s Budget LineA Consumer’s Budget Line

DVD ($20)

Book ($10)

Total Expenditure

6 0 120 = 120 + 0

5 2 120 = 100 + 20

4 3 120 = 80 + 40

3 6 120 = 60 + 60

2 8 120 = 40 + 80

1 10 120 = 20 + 100

0 12 120 = 0 + 120

0

2

4

6

8

0 2 4 6 8 10 12 14

Books

DV

Ds


Property Resources:• Land• CapitalHuman Resources:• Labour• Entrepreneurial Ability:

– takes initiative– makes policy decisions– innovates– bears risk

Society’s Economic Problem:Society’s Economic Problem:Scarce ResourcesScarce Resources


The Production Possibilities The Production Possibilities ModelModel

Assumptions:• full employment and productive

efficiency• fixed resources• fixed technology• two goods

– pizzas symbolize consumer goods– industrial robots symbolize capital

goods


Pizzas (00,000s)

0 1 2 3 4

Robots (000s) 10 9 7 4 0Production Possibilities

0

2

4

6

8

10

12

0 1 2 3 4 5

Pizzas (hundred thousands)

Ro

bo

ts (

tho

usa

nd

s)

The Production Possibilities CurveThe Production Possibilities Curve


Pizzas (00,000s)

0 1 2 3 4

Robots (000s) 10 9 7 4 0

Production Possibilities

0

2

4

6

8

10

12

0 1 2 3 4 5


Ro

bo

ts (

tho

usa

nd

s)

ProductionProductionPossibilitiesPossibilities

CurveCurve

ProductionProductionPossibilitiesPossibilities

CurveCurve



Production Possibilities Curve

0

2

4

6

8

10

12

0 1 2 3 4 5


Ro

bo

ts (

tho

usa

nd

s)

AABB

CC

DD

EE

WW

attainableattainable

unattainableunattainableattainable butattainable but

inefficientinefficient

Figure 1-2




Law of Increasing Opportunity Cost

• Opportunity cost increases with amount produced

• As we make more pizzas, the number of robots we have to give up (per pizza) increases

Illustrated...Illustrated...


Pizza (00,000s) 0 1 2 3 4

Robots (000s) 10 9 7 4 0

The Law of Increasing The Law of Increasing Opportunity CostOpportunity Cost

• opportunity cost of 1st 100,000 pizzas = 1,000 robots

• opportunity cost of 2nd 100,000 pizzas = 2,000 robots

• opportunity cost of 3rd 100,000 pizzas = 3,000 robots

• opportunity cost of 4th 100,000 pizzas = 4,000 robots

The more pizzas we make,The more pizzas we make, the more each one coststhe more each one costs

in terms of machines foregonein terms of machines foregone

The more pizzas we make,The more pizzas we make, the more each one coststhe more each one costs

in terms of machines foregonein terms of machines foregone



Shape of the Curve• As we make more pizzas, the

number of robots we have to give up (per pizza) increases

• Slope of the production possibilities curve gets steeper and steeper



0

2

4

6

8

10

12

0 1 2 3 4 5


Ro

bo

ts (

tho

usa

nd

s)AA

BB

CC

DD

EE


Additional pizza unit costs 1, 2, 3, 4 robot unitThe more pizza we make,the more machines we give up,the steeper the curve


Shape of the Curve• concave to the originEconomic Rationale• resources are not completely

adaptable to alternative uses



• Decide on optimal allocation by comparing Marginal (extra) Cost (MC) to Marginal Benefit (MB)

• Marginal Benefit is the extra benefit associated with consuming one more unit

• Marginal Cost is the extra opportunity cost of that extra unit

Optimal AllocationOptimal Allocation


Figure 1-3Figure 1-3Optimal Allocation: MB = MCOptimal Allocation: MB = MC

0

5

10

15

1 2 3Quantity of Pizzas

MB

/MC MC

MBMB=MC

a b

e

b c

Optimal allocation requires the expansion of a good’s output until its MC and MB are equal


Unemployment, Growth, and the Unemployment, Growth, and the FutureFuture

• A Growing Economy– increases in factor supplies– advances in technology


Figure 1-5 Economic Growth and Figure 1-5 Economic Growth and the Production Possibilities Curve the Production Possibilities Curve


0

2

4

6

8

10

12

14

0 2 4 6 8 10


Robo

ts (t

hous

ands

)

A’ B’ C’ D’ E’

Pizza 0 2 4 6 8

Robot

14 12 9 5 0A’

B’

C’

D’

E’


Figure 1-6Figure 1-6Present Choices and Future Present Choices and Future

PossibilitiesPossibilities

Goods for the PresentGoods for the Present

Go

od

s fo

r th

e F

utu

reG

oo

ds

for

the

Fu

ture

FAVOURINGFAVOURINGFUTURE GOODSFUTURE GOODS

FutureFutureCurveCurve

Goods for the PresentGoods for the Present

Go

od

s fo

r th

e F

utu

reG

oo

ds

for

the

Fu

ture

FAVOURINGFAVOURINGPRESENT GOODSPRESENT GOODS

FutureFutureCurveCurve


A Qualification: International A Qualification: International TradeTrade

• An individual nation is limited by the production possibilities curve

• But NOT when there is international specialization and trade!– possible to consume ABOVE the

production possibilities curve

©2007 McGraw-Hill Ryerson Ltd. Chapter 1 29

Chapter SummaryChapter Summary

1.1 Ten Key Concepts to Retain for a Lifetime

1.2 The Economic Way of Thinking1.3 Theories, Principles, and Models1.4 Macroeconomics and

Microeconomics1.5 The Individual’s Economic Problem1.6 Society’s Economic Problem1.7 The Production Possibilities Model1.8 Unemployment, Growth, and the

Future

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CHAPTER 1 LIMITS, ALTERNATIVES, AND CHOICES