Chapter_01 (Introduction to Microeconomics)

7/30/2019 Chapter_01 (Introduction to Microeconomics)

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PART ONE

Introduction


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Chapter 1: Limits,Alternatives, and Choices

Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.


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Limits, Alternativesand Choices

Economics is about wantsand means.

Society has the resources to make goods

and services that satisfy our many desires.

However, our economic wants far exceed

the productive capacity of our limited

resources.



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Limits, Alternativesand Choices

Unfortunately, our resources are scarce.

Scarcitymeans that society has limited

resources and therefore cannot produceall the goods and services people want.



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Limits, Alternatives andChoices

Economics is the study of how people,institutions, and society make choices

under conditions of scarcity.



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The Economic Perspective

An economic perspective is a viewpointthat envisions individuals and institutions

making rational decisions by comparingmarginal benefits and marginal costs of

their actions.



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The Economic Perspective

The economic way of thinking takes the

following into consideration:

Scarcity and Choice Purposeful Behavior

Marginalism: Benefits and Costs



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Scarcity and Choice

Scarce economic resources mean limited

goods and services. When a good is produced, the resources employed

can no longer be used to make another good.

When a choice is made, another opportunity is passed

up

Opportunity cost represents the value ofthe good, service, or time forgone to

obtain something else.



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Purposeful Behavior

Economics assumes that individuals act

rationally and in their own self-interest.

Individual decisions are purposeful and

seek to maximize utility.

Utility is the pleasure, happiness, orsatisfaction obtained from consuming a goodor service.



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Purposeful Behavior

Consumers are purposeful in deciding

what goods and services to buy.

Business firms are purposeful in decidingwhat products to produce and how.

Governmental entities are purposeful in

deciding what services to provide and how

to finance them.



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Marginalism:Benefits and Costs

Marginal analysis is the comparison ofmarginal (extra or additional) benefits

and marginal costs, usually for decision

making.

Individuals make rational decisions such

that the marginal benefit exceeds (orequals) the marginal cost.



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Marginalism:Benefits and Costs

Example: Shopping for a new car

You find a standard model that you like but

you are considering additional features (a

sunroof, leather interior, heated seats and

alloy wheels). As long as the marginal benefit

(greater satisfaction) exceeds the marginal

cost (extra expenses) of the additionalfeatures, you will add them.



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Theory, Principles, and Models

Used to develop theories, laws and

principles, the scientific method consists of: the observationof behavior and outcomes,

the formulationof a possible explanation of cause andeffect (hypothesis) based on the observation,

the testingof this explanation by comparing actual andpredicted outcomes, and

the acceptance, rejection or modificationof thehypothesis.

the continual testingof the hypothesis.



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An economic theory evolves from ahypothesis that accumulates favorable results

after continued testing against the facts.

Economic laws and principles are widelyaccepted theories that have been well tested

and widely accepted.

An economic model is a simplifiedrepresentation of how something works using

a combination of laws or principles.



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Economic principles are statements abouteconomic behavior or the economy that

enable prediction of the probable effects of

certain actions.

Economic models are highly useful inanalyzing economic behavior and

understanding how the economy operates.



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Economic principles:

are generalizations,

use the ceteris paribus, or other-things-equalassumption, and

can be expressed graphically.



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Microeconomics andMacroeconomics

Microeconomics focuses on a specific

economic unit.

An individual household, firm, or industry

Macroeconomicslooks at the economy asa whole or its major components of the

economy. All consumers, a federal government, or the

U.S. economy



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Economic Problem

Both individuals and society face an

economic problem:

They need to make choices becausewants exceed means.



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Individuals

Economic Problem

A limited income (from wages, rents,interest. And profit) constrains individualsto make decisions on how to spend their

money.Unlimited wants include both necessitiesand luxuries. Each type yields some levelof utility.

Every individual must economize: choosegoods and services that will maximizeutility.



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Individuals

Economic Problem

The economic problem individuals face can

be depicted as a budget line (or budgetconstraint), which is a line that illustrates

various combinations of two products aconsumer can afford with a specific income,

given the products prices.



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The Budget Line

Points on or inside the line

are attainable and can be

purchased. (A, B, C, and D)

However, points on the line

(A, C, and D) exhaust theallotted budget and maximize

utility whereas points inside

the line do not. (B)

Points beyond the line are

unattainable. (E)


Qu

antityOfDVDs

Quantity

of books

6

12

Attainable

Unattainable

3

6

A

B C

0 2

D

E


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The Budget Line

Along the budget line, tradeoffs arise fromlimited income. The straight-line budgetconstraint indicates constant opportunity

cost. Moving from point A to point C means giving up 3

DVDs to get 6 books, or 1 DVD for 2 books.

Moving from point C to point D means giving up 3

more DVDs to get 6 more books. Constant tradeoff is 1 extra DVD = 2 books (or DVD = 1 book)



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The Budget Line

Limited income forces people to select the

combination that is considered the best.

this combination maximizes overall satisfaction

As income changes, the budget line shifts.

If income increases, the budget line shifts to the

right. A decrease in income will shift the budget line to

the left.



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Societys Economic Problem

Society must also make choices under

conditions of scarcity.

It must decide how and where to allot itslimited resources.

Scare economic resources include land,labor, capital and entrepreneurial ability.



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Resource Categories

1. Land includenatural resources used inthe production process, such as rivers,

minerals, and forests.

2. Labor includesphysical and mentaltalents of individuals used to produce

goods and services.



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Resource Categories

3. Capital includes human-made resourcesused in producing consumer goods and

services such as machinery, tools, and

warehouse facilities.

4. Entrepreneurial Ability ishuman talent

that combines the other resources toproduce products, make strategic

decisions and bear risks.



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Resource Categories

Because land, labor, capital, and

entrepreneurial ability are combined to

produce goods and services, they are

also known as factors of production orsimply inputs.



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Production Possibilities Model

The production possibilities model

illustrates the alternatives and choices

society faces when using its scarce

resources to produce products.

The model assumes: Full employment

Fixed resources

Fixed technology

Two goods: consumer goods and capital goods



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A production possibilities table lists thedifferent combinations of two products that

can be produced given a specific set of

resources.

Each combination of two products (i.e.

consumer goods and capital goods) canbe plotted in a graph to create a

production possibilities curve (PPC).



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Production Possibilities Curve

The PPC is a constraint because it

shows the limit of attainable outputs.

Points on the PPC are considered attainable.

They employ all available resources andtechnology and operate at full employment.

Points lying inside the PPC are attainable but

represent less total output.

Points lying beyond the PPC are unattainable

given the current technology and resources.



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Law of IncreasingOpportunity Cost

The law of increasing opportunity cost

states that the more of a product society

produces, the greater is the opportunity

costs of obtaining an extra unit.

For example, to produce more food, society

must give up larger amounts of manufacturing

equipment.



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Law of IncreasingOpportunity Cost

The law of increasing opportunity costs is

reflected in the bowed out from the origin

shape of the PPC.

Economic resources are not completely

adaptable to alternative uses; therefore,

with each one unit increase in foodproduction, successively larger amounts of

manufacturing production are given up.



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Optimal Allocation

The optimal allocation depends on

marginalism; any economic activity should

be expanded as long as marginal benefits

exceeds the marginal costs (MB > MC)

and should be reduced if marginal benefit

is less than marginal costs (MB < MC).

Ideally, the optimal amount of activity

occurs where MB = MC.



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Optimal Allocation


U l G h


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Unemployment, Growthand The Future

Societies experience

episodes of unemployment

and unused production

capacity from time to time.In the production

possibilities model, this is

represented by a pointinside the PPC.


U l G h


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Over time, a growing economy may cause

a shift of the PPC outward if there are:

There is an increase in resource supplies

Advances in technology arise


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The PPC may also shift outward over timedepending on an economys present choicesand future possibilities.

The rate of economic growth depends on thechoices society makes today.

A focus on future goods production, such asthe capital stock, that incorporatetechnological advances and increases thequality and quantity of resources results ingreater economic growth.


U l t G th


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C i h 2005 b Th M G Hill C i I All i h d

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Chapter_01 (Introduction to Microeconomics)