Chapter 1

Limits, Alternatives,
and Choices

Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
 Economics

• Economics
• A social science concerned with making
optimal choices under conditions of scarcity
• Economic wants exceed society’s productive
capacity

LO1 1-2
 The Economic Perspective

• Economic perspective
• Scarcity and choice
• Opportunity cost
• Purposeful behavior (rational) to increase
utility
• Marginal analysis

LO1 1-3
 Scarcity and Choice

• Resources are scarce

• Choices must be made
• Opportunity cost
• There’s no free lunch

LO1 1-4
 Purposeful Behavior

• Rational self-interest
• Individuals and utility (what goods and
services to buy)
• Firms and profit (what to produce and how to
produce them)

LO1 1-5
 Marginal Analysis

• Marginal benefit
• Marginal cost
• Marginal means “extra”, “additional”, or
“change in”.
• Every option involve comparison between
marginal benefit and marginal cost (because
of scarce resources-forgoing something else)

LO1 1-6
 Micro and Macro

• Microeconomics
• The study of the individual consumer, firm,
or market decision-making.
• Macroeconomics
• The study of the entire economy or a major
aggregate of the economy
• Examples: level and growth rate of national
output, interest rates, unemployment, and
inflation.
LO3 1-7
 Positive and Normative Economics

• Positive economics
• Economic statements that are factual.
• Analysis describing relationships of cause and effect.
• Concern with ‘what is’
• Normative economics
• Economic statements that involve value judgments.
• Analysis examining questions of ‘what ought to be’.

LO3 1-8
 Society’s Economizing Problem

• 4 categories of economic resources

• Land (all natural resources)
• Labor (physical actions and mental activities)
• Capital (all manufactured aids e.g factory, tools)
• Entrepreneurial ability (special human resources)

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 Society’s Economizing Problem

• Entrepreneurs
• Employs the other factors of production
• Takes initiative
• Makes strategic business decisions
• Innovates
• Takes risk

LO5 1-10
 Production Possibilities Model

• Economic model that shows different

combinations of two goods that an economy
can produce
• Full employment
• Fixed resources
• Fixed technology
• 2-good economy
• Consumer goods and capital goods
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 Production Possibilities Model

Production Alternatives
Type of Product A B C D E

Pizzas 0 1 2 3 4
(in hundred thousands)

Industrial Robots 10 9 7 4 0
(in thousands)

Plot the points to create the graph…

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 Production Possibilities Graph
Q
14
13
12
11
A
10 Unattainable
B
9 W
8
Industrial robots

C
7
6
5
D
4
3
2 Attainable
1 E
0 1 2 3 4 5 6 7 8 9 Q

LO6
Pizzas 1-13
 Increasing Opportunity Costs

• Law of increasing opportunity costs

• As more of a particular good is produced,
its marginal opportunity costs increase
• Production possibilities curve
• Concave shape
• Economic rationale
• Econ resources not adaptable to alternative use.
• Better at producing 1 type of goods than others.

LO6 1-14
 A Growing Economy

Production Alternatives
Type of Product A' B' C' D' E'

Pizzas 0 2 4 6 8
(in hundred thousands)

Industrial Robots 14 12 9 5 0
(in thousands)

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 Unemployment, Growth, & the
Future
• Economic growth
A’
14
13
B’
12
11
A Unattainable
10
B C’
Industrial robots

9
8
C
7
6
D’
5
D
4
3 Now attainable
2 Attainable
1 E E’
0 1 2 3 4 5 6 7 8 9
LO7 Pizzas 1-16
 Economic Growth

• The expansion of production possibilities  and increase

in the standard of living  is called economic growth.
• Two key factors influence economic growth:
1 Advances in technology
2 Increase in resource supplies
•Advances in technology is the development of new goods and of
better ways of producing goods and services. Eg computerized
system to manage inventory.
•Increase in resource supplies increase the ability to produce more
of both consumer goods and capital goods.

© Pearson Education 2012 1-17

 Economic Systems

• Economic systems
• Set of institutionalized arrangements &
coordinating mechanism to respond to the
economizing problems
• Differences in systems as to
• Who owns factor of production
• Method used to motivate, coordinate and
direct economic activity.

LO1 1-18
 Laissez-Faire (Pure Capitalism)

• Ideal economy
• “Keep the government from interfering (will disturb
the efficient working of the market) with the
economy”.
• Role of government (limited) just needed to
• Protect private property
• Established legal environment which contracts
would be enforced
• People interact in markets to buy and sell

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 The Command System

• The command system is known as socialism or

communism
• Government owns most of the business firms.
• Decisions made by a central planning board
(e.g. The use of resources, composition and
distribution of output, org of production)
• North Korea, Cuba, Myanmar (in North Korea,
gov. owns all country’s home)

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 The Market System or Capitalism

• Also know as mixed economy

• Mix of centralized gov. econ. initiatives and decentralized
actions by individuals and firms.
• Individual and business try to achieve economic goal
through their own decision regarding work, consumption
and production.
• Allow for private ownership of capital
• Participants act in their own self-interest.
• Goods and services are produced and resources are
supplied by whoever willing and able to do so.

LO1 1-21
 The Market System or Capitalism

• Result in competition among independently

acting buyers and sellers.
• Market also offer high potential monetary
rewards. Thus create powerful incentives.

LO2 1-22
 The Five Fundamental Questions

• What goods and services will be produced?

• How will the goods and services be produced?
• Who will get the goods and services?
• How will the system accommodate change?
• How will the system promote progress?

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 What Will Be Produced?

• Goods and services that create a profit,

product that create loss will be discontinue
• Consumer sovereignty
• “Dollar votes”
• Method for consumers to determine which
goods will be produced
• Determines which products and industries
survive or fail

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 How Will the Goods Be Produced?

• What combination of resources and tech. will

be used? How production organized?
• Combination that minimize the cost per unit
• Firm take great effort to minimize production
cost.
• Effort intensified when competition exist
• Competition eliminate high-cost producer

LO3 1-25
 Who Will Get the Output?

• Consumers with the ability and willingness to

pay will get the product
• Ability to pay depends on income
• Amount of income depends on
• Quantity and of the properties and human
resource they supply
• Price of the resources in the resource market

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 How Will the System Change?

• Changes in consumer tastes

• Changes in technology
• Changes in resource prices

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 How Will the System Progress?

• Technological advance
• Creative destruction – Creation of new
product and production methods
completely destroys the market position of
firms that weeded to existing products and
older way of doing business.
• Capital accumulation – who votes for capital
goods? Entrepreneurs and business owners.

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 The Invisible Hand

• The “invisible hand”

• 1776 Wealth of Nations by Adam Smith
• Unity of private and social interest
• Virtues of the market system
• Efficiency
• Incentives
• Freedom

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 The Demise of Command Systems

• Command system was a failure

• Soviet Union, Eastern Europe, and China
• The coordination problem
• Set output targets for all goods
• The incentive problem
• No adjustments for surplus or shortage

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 The Circular Flow Model

• The circular flow diagram

• Households
• Businesses
• Sole proprietorship
• Partnership
• Corporation
• Product market and the resource market
• The real flow and the money flow
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 The Circular Flow Model

RESOURCE
MARKET
•Households sell
•Businesses buy

BUSINESSES HOUSEHOLDS
• buy resources • sell resources
• sell products • buy products

PRODUCT
MARKET
•Businesses sell
•Households buy
LO5 1-32