Chapter 1

Chapter 1
Limits, Alternatives, and Choices

The Economic Perspective
• Critical features of economic perspective:
• Scarcity and choice
• Purposeful behavior
• Marginal analysis
Theories, Principles, and Models
• Economics relies on the scientific method (procedure as follows):
1. observing real-world behavior and outcomes
2. formulating hypothesis explaining cause-and-effect relationship
3. testing
4. accepting, rejecting, modifying the hypothesis
5. accumulating favorable results into “purposeful simplifications”: a theory,
an economic principle, a model
Theories, Principles, and Models
• Features of economic principles:
• Generalizations
• Economic principles are expressed as the tendencies of typical or average consumers,
workers, or business firms.
• Other-things-equal assumption (ceteris paribus)
• the assumption that factors other than those being considered do not change
• Graphical expression
Microeconomics and
Macroeconomics
Microeconomics is the part of economics concerned with individual
units such as a person, a household, a firm, or an industry
Macroeconomics measures total output/ employment/ income,
general level of prices etc.; seeks to obtain general outline of the
structure of the economy in using aggregates.
Positive and Normative Economics
Positive economics deals with factual statements (“what is”)
Normative economics involves value judgments (“what ought to be”)
Individual's Economizing Problem
Microeconomic model of the economizing problem faced by an
individual:
1. Limited income. An amount of income coming to us in the form of wages,
interest, rent, profit, and money from government programs or family
members is finite.
2. Unlimited wants. The desire for various goods and services providing utility
is virtually unlimited. Range of wants extends from necessities (i.e. food,
shelter, and clothing) to luxuries (i.e. perfumes, yachts, and sports cars). It is
in one's self-interest to pick and choose goods and services that maximize
satisfaction given the limitations she faces.
Individual's Economizing Problem
3. A budget line (constraint). It illustrates several ideas:
• the budget line shows all combinations that cost exactly the full money income;
• the attainable combinations are on and within the budget line; the unattainable
combinations are beyond the budget line;
• all combinations on the budget line maximize utility;
• trade-offs arise from limited income - to obtain more of good X, one have to give up
some of good Y;
• the straight-line budget constraint, with its constant slope, indicates constant
opportunity cost;
• the location of the budget line varies with money income - an increase in money income
shifts the budget line to the right; a decrease in money income shifts it to the left.
Society's Economizing Problem
• Society has scarce economic resources. These resources are called
factors of production:
• Land. Includes all natural resources used in the production process, i.e.
forests, mineral and oil deposits, water resources etc.
• Labor. Consists of the physical actions and mental activities that people
contribute to the production of goods and services.
• Capital. Includes all manufactured aids used in producing consumer goods
and services, i.e. machinery, factory, storage etc. Spending that pays for
production and accumulation of capital goods is called investment.
• Entrepreneurial ability. Includes making the strategic business decisions,
innovating, bearing risk, commercializing new products etc.
Production Possibilities Model
• The alternatives and choices faced by society can be best understood
through a macroeconomic model of production possibilities i.e:
• Full employment
• Fixed resources
• Fixed technology
• Two goods
Production Possibilities Table
Production Possibilities Curve
Law of increasing opportunity costs
As the production of a particular good increases, the opportunity cost
of producing an additional unit rises.
Optimal Allocation
The optimal amount of the activity (of all the attainable combinations)
occurs where MB = MC. No resources beyond that point should be
allocated to the product.
Unemployment, Growth, and the
Future
• Economic growth is the result of
1. increases in supplies of resources,
2. improvements in resource quality, and
3. technological advances.
• Static, no-growth economies must sacrifice some of one good to
obtain more of another, dynamic, growing economies can have larger
quantities of both goods
• Expansion of domestic production possibilities and international trade
are two separate routes for obtaining greater output
Unemployment and the production possibilities curve
Economic growth and the production possibilities curve
Present choices and future locations of production possibilities
curves

Chapter 1

Uploaded by

Copyright:

Available Formats

Chapter 1

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 1

Uploaded by

Copyright:

Available Formats

Chapter 1

Limits, Alternatives, and Choices

You might also like