Chapter 1: Limits, Alternatives, and Choice
Introduction
- Every choice made has an impact on the economy.
- Economics:
o The study of how individuals and groups make decisions with limited resources as to best satisfy
their wants and needs.
o Economic wants exceed productive capacity.
▪ Limited resources but unlimited human wants.
o A social science concerned with making “optimal choices” under conditions of “scarcity”.
▪ Making the best choice to fully use of our limited resources.
The Economic Perspective ( = economic way of thinking )
- Thinking like an economist.
- Scarcity and Choice:
o Scarcity limited our options and demands choices.
o Resources are scarce
▪ Limited goods and services
o Choices must be made
▪ Need to give up something
o Opportunity costs
▪ To obtain more of one thing, society forgoes the opportunity of getting the next best thing.
▪ The value of the best alternative forgone (or the value of the next-highest-valued alternative
use of that resource).
▪ It is always present whenever a choice is made.
▪ The sacrifice is the opportunity cost of the choice.
• For example: if you pay a pizza, you need to give up MCD. (MCD is the opportunity
cost)
- Purposeful Behavior:
o People make decisions with some desired outcome in mind.
o Human behavior reflects “rational self-interest”.
▪ Self-interested behavior is simply behavior designed to increase personal satisfaction.
• People always looking for a way to maximize their personal utility / satisfaction.
o Individuals and utility
▪ Individuals want to maximize their satisfaction from their spending.
▪ They weigh costs & benefits, so the decisions are “rational” not “random”.
o Firms and profit
▪ Firms always looking for maximum profit by deciding what and how to produce.
o Desired (preferred) outcomes in mind
▪ Not must be a prefect decision, sometime can also make a mistake
- Marginal Analysis:
o Comparisons of marginal benefits and marginal costs to make decisions.
▪ Marginal benefits
• Perceived pleasure (utility)
▪ Marginal cost
• Expenses
o People will think something is worth when they think the benefit is greater than the cost for
themselves.
o We choose to do something if the marginal benefit is greater than the marginal cost because that is
rational and will help to maximize utility.
Theories, Principles, and Models ( = “purposeful simplifications” )
- Economics relies on the scientific method. Elements of procedure:
, o Observe
o Formulate a hypothesis
o Test the hypothesis
o Accept, reject, or modify the hypothesis
o Continue to test the hypothesis
- A very well-tested and widely accepted theory is referred to as an economic law or an economic principle.
o A statement about economic behavior or the economy that enables prediction of the probable
effects of certain actions.
- Economic principles:
o Generalizations
▪ Relating to economic behavior or to the economy itself.
▪ The tendencies of typical or average consumers, workers, or business firms.
o Other-Things-Equal Assumption ( = ceteris paribus assumption )
▪ The assumption that factors other than those being considered do not change.
o Graphical Expression
▪ To illustrate the relationship between variables.
Microeconomics and Macroeconomics
- Microeconomics:
o Decision making by individual units.
▪ Exp: customers, workers, households, business firms…
o Specific types of individuals are examined.
o Concerned with individual units.
- Macroeconomics:
o Aggregate component
▪ Collection of specific economic unites treated as if they were one unit.
o Examines economy as a whole.
o Look at the basic subdivisions of economy
▪ Exp: government, businesses, international trade…
Positive and Normative Economics
- Positive economics:
o Deal with economic facts.
▪ Cause and effect relationships
o Includes description, theory development, and theory testing.
o Avoids value judgement.
o Describes the world the way it is.
o Concerned with what is and what will happen if a course of action is taken or not taken.
o Exp: the unemployment rate in France is higher than that in the United States.
- Normative economics:
o A subjective perspective of the economy.
o Incorporates value judgements about what the economy should be like or what particular policy
actions should be recommended to achieve a desirable goal.
o What should do?
o Exp: France should undertake policies to make its labor market more flexible to reduce
unemployment rates.
Individuals’ Economizing Problem
- Limited income
o All people have limited amount of income.
- Unlimited wants
o Most people have virtually unlimited wants.
, o Limited income + unlimited wants caused individual’s economizing problem.
▪ We need to use self-interest to economize by picking and choosing goods and services that
can maximize our satisfaction.
- A budget line
o To illustrate the greatest combinations of two goods that can be purchased with a certain amount of
income.
▪ Shows how much of one good must sacrificed to get more of another good. (opportunity
costs)
o Attainable and unattainable options.
▪ Above the line is unattainable, under the line is attainable.
o Tradeoffs and opportunity costs.
𝑦 −𝑦
▪ The slope, 𝑥2 −𝑥1 , is the opportunity costs.
2 1
o Make the best choice possible.
▪ Choose what to buy and what to forgo to fulfil wants.
o Change in income.
▪ Location of the budget line varies with money income.
▪ Income increase, budget line moves to right.
▪ Income decrease, budget line moves to left.
Society’ Economizing Problem
- Scare resources = factors of production = inputs
o Land
▪ Includes all natural resources. Also refer to buildings, production equipment…
o Labor
▪ Physical and mental talents of individuals used in producing goods and services.
o Capital
▪ All manufactured aids used in producing consumer goods and services.
▪ The purchase of capital goods is an investment.
o Entrepreneurial ability
▪ Takes initiative
• To combine resources of land, labor, and capital to produce a good/service.
▪ Make decisions
▪ Innovates
• Commercializes new products/production technique or new form of business
organization.
▪ Takes risk
• No guarantee of profit.
Production Possibilities Model
- Shows maximum combination of two goods that can be produced with the resources available today.
- Assumptions:
o Full employment
▪ All available labor are working, and they are being used to their potential.
o Fixed resources
, ▪ At the level, we only have those resources (fixed quantity and quality of production’s
factors).
o Fixed technology
▪ State of technology is constant.
o Two goods
▪ Only two goods in the model: 1 capital goods, 1 consumer goods.
- Production Possibilities Table
o Lists the different combinations of two products that can be produced with a specific set of
resources.
- Production Possibilities Curve (PPC)
o Display the different combinations of goods and services that society can produce.
o Law of increasing opportunity costs:
▪ The production of a particular good increases, the opportunity cost of producing an
additional unit rises.
▪ Shape of the curve
• The curve is bowed out from the origin of the graph.
▪ Economic rationale
• Economic resources are not completely adaptable to alternative use.
o Producing anywhere along the line means the economy is producing the maximum amount of both
goods. (efficiency economy)
Optimal Allocation
- Marginal cost (MC) always increases.
- Marginal benefit (MB) always decreases.
- Economic decisions center on comparisons of marginal benefit (MB) and marginal cost (MC).
- Optimal amount of a product/service is where MB = MC.
Introduction
- Every choice made has an impact on the economy.
- Economics:
o The study of how individuals and groups make decisions with limited resources as to best satisfy
their wants and needs.
o Economic wants exceed productive capacity.
▪ Limited resources but unlimited human wants.
o A social science concerned with making “optimal choices” under conditions of “scarcity”.
▪ Making the best choice to fully use of our limited resources.
The Economic Perspective ( = economic way of thinking )
- Thinking like an economist.
- Scarcity and Choice:
o Scarcity limited our options and demands choices.
o Resources are scarce
▪ Limited goods and services
o Choices must be made
▪ Need to give up something
o Opportunity costs
▪ To obtain more of one thing, society forgoes the opportunity of getting the next best thing.
▪ The value of the best alternative forgone (or the value of the next-highest-valued alternative
use of that resource).
▪ It is always present whenever a choice is made.
▪ The sacrifice is the opportunity cost of the choice.
• For example: if you pay a pizza, you need to give up MCD. (MCD is the opportunity
cost)
- Purposeful Behavior:
o People make decisions with some desired outcome in mind.
o Human behavior reflects “rational self-interest”.
▪ Self-interested behavior is simply behavior designed to increase personal satisfaction.
• People always looking for a way to maximize their personal utility / satisfaction.
o Individuals and utility
▪ Individuals want to maximize their satisfaction from their spending.
▪ They weigh costs & benefits, so the decisions are “rational” not “random”.
o Firms and profit
▪ Firms always looking for maximum profit by deciding what and how to produce.
o Desired (preferred) outcomes in mind
▪ Not must be a prefect decision, sometime can also make a mistake
- Marginal Analysis:
o Comparisons of marginal benefits and marginal costs to make decisions.
▪ Marginal benefits
• Perceived pleasure (utility)
▪ Marginal cost
• Expenses
o People will think something is worth when they think the benefit is greater than the cost for
themselves.
o We choose to do something if the marginal benefit is greater than the marginal cost because that is
rational and will help to maximize utility.
Theories, Principles, and Models ( = “purposeful simplifications” )
- Economics relies on the scientific method. Elements of procedure:
, o Observe
o Formulate a hypothesis
o Test the hypothesis
o Accept, reject, or modify the hypothesis
o Continue to test the hypothesis
- A very well-tested and widely accepted theory is referred to as an economic law or an economic principle.
o A statement about economic behavior or the economy that enables prediction of the probable
effects of certain actions.
- Economic principles:
o Generalizations
▪ Relating to economic behavior or to the economy itself.
▪ The tendencies of typical or average consumers, workers, or business firms.
o Other-Things-Equal Assumption ( = ceteris paribus assumption )
▪ The assumption that factors other than those being considered do not change.
o Graphical Expression
▪ To illustrate the relationship between variables.
Microeconomics and Macroeconomics
- Microeconomics:
o Decision making by individual units.
▪ Exp: customers, workers, households, business firms…
o Specific types of individuals are examined.
o Concerned with individual units.
- Macroeconomics:
o Aggregate component
▪ Collection of specific economic unites treated as if they were one unit.
o Examines economy as a whole.
o Look at the basic subdivisions of economy
▪ Exp: government, businesses, international trade…
Positive and Normative Economics
- Positive economics:
o Deal with economic facts.
▪ Cause and effect relationships
o Includes description, theory development, and theory testing.
o Avoids value judgement.
o Describes the world the way it is.
o Concerned with what is and what will happen if a course of action is taken or not taken.
o Exp: the unemployment rate in France is higher than that in the United States.
- Normative economics:
o A subjective perspective of the economy.
o Incorporates value judgements about what the economy should be like or what particular policy
actions should be recommended to achieve a desirable goal.
o What should do?
o Exp: France should undertake policies to make its labor market more flexible to reduce
unemployment rates.
Individuals’ Economizing Problem
- Limited income
o All people have limited amount of income.
- Unlimited wants
o Most people have virtually unlimited wants.
, o Limited income + unlimited wants caused individual’s economizing problem.
▪ We need to use self-interest to economize by picking and choosing goods and services that
can maximize our satisfaction.
- A budget line
o To illustrate the greatest combinations of two goods that can be purchased with a certain amount of
income.
▪ Shows how much of one good must sacrificed to get more of another good. (opportunity
costs)
o Attainable and unattainable options.
▪ Above the line is unattainable, under the line is attainable.
o Tradeoffs and opportunity costs.
𝑦 −𝑦
▪ The slope, 𝑥2 −𝑥1 , is the opportunity costs.
2 1
o Make the best choice possible.
▪ Choose what to buy and what to forgo to fulfil wants.
o Change in income.
▪ Location of the budget line varies with money income.
▪ Income increase, budget line moves to right.
▪ Income decrease, budget line moves to left.
Society’ Economizing Problem
- Scare resources = factors of production = inputs
o Land
▪ Includes all natural resources. Also refer to buildings, production equipment…
o Labor
▪ Physical and mental talents of individuals used in producing goods and services.
o Capital
▪ All manufactured aids used in producing consumer goods and services.
▪ The purchase of capital goods is an investment.
o Entrepreneurial ability
▪ Takes initiative
• To combine resources of land, labor, and capital to produce a good/service.
▪ Make decisions
▪ Innovates
• Commercializes new products/production technique or new form of business
organization.
▪ Takes risk
• No guarantee of profit.
Production Possibilities Model
- Shows maximum combination of two goods that can be produced with the resources available today.
- Assumptions:
o Full employment
▪ All available labor are working, and they are being used to their potential.
o Fixed resources
, ▪ At the level, we only have those resources (fixed quantity and quality of production’s
factors).
o Fixed technology
▪ State of technology is constant.
o Two goods
▪ Only two goods in the model: 1 capital goods, 1 consumer goods.
- Production Possibilities Table
o Lists the different combinations of two products that can be produced with a specific set of
resources.
- Production Possibilities Curve (PPC)
o Display the different combinations of goods and services that society can produce.
o Law of increasing opportunity costs:
▪ The production of a particular good increases, the opportunity cost of producing an
additional unit rises.
▪ Shape of the curve
• The curve is bowed out from the origin of the graph.
▪ Economic rationale
• Economic resources are not completely adaptable to alternative use.
o Producing anywhere along the line means the economy is producing the maximum amount of both
goods. (efficiency economy)
Optimal Allocation
- Marginal cost (MC) always increases.
- Marginal benefit (MB) always decreases.
- Economic decisions center on comparisons of marginal benefit (MB) and marginal cost (MC).
- Optimal amount of a product/service is where MB = MC.
