LIMITS, ALTERNATIVES,

AND CHOICES

PROF. LANI D. DEADA, LPT, PhD

LECTURER

©2007 McGraw-Hill Ryerson Ltd. Chapter 1 1

 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 2

 Ten Key Concepts

The Individual
1. Facing Tradeoffs
2. Opportunity Costs
3. Choosing a Little More or Less
4. The Influence of Incentives

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.1 3

 Ten Key Concepts

Interaction Among Individuals

5. Specialization and Trade
6. The Effectiveness of Markets
7. The Role of Governments

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.1 4

 Ten Key Concepts

The Economy as a Whole and the

Standard of Living
8. Production and the Standard of Living
9. Money and Inflation
10. Inflation-Unemployment Tradeoff

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.1 5

 The Economic Way of Thinking

• Scarcity and Choice

• Purposeful Behaviour
• Marginal Analysis: Benefits and Costs

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.2 6

 Theories, 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

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.3 7

 Theories, Principles, and Models

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

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.3 8

 Macroeconomics and Microeconomics

• Macroeconomics examines:
– the whole economy
– the subdivisions or aggregates
• Microeconomics examines:
– individual units ( a household, firm, or
industry) and their decision-making process

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.4 9

 Positive and Normative Economics

POSITIVE STATEMENTS…
• based upon facts and cause-and-effect
relationships Predictions are positive
• what is if they are based on what
future facts will be
• without value judgments
NORMATIVE STATEMENTS…
• based upon subjective beliefs
• what ought to be

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.4 10

 The Individual’s Economic Problem

• We all have a finite amount of income

• Most people have unlimited wants
• A consumer’s budget line

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.5 11

 Figure 1-1
A Consumer’s Budget Line
DVD Book Total
($20) ($10) Expenditure 8

6 0 120 = 120 + 0 6

5 2 120 = 100 + 20

DV Ds
4
4 3 120 = 80 + 40
3 6 120 = 60 + 60 2

2 8 120 = 40 + 80 0
0 2 4 6 8 10 12 14
1 10 120 = 20 + 100
Books
0 12 120 = 0 + 120

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.5 12

 Society’s Economic Problem:
Scarce Resources
Property Resources:
• Land
• Capital
Human Resources:
• Labour
• Entrepreneurial Ability:
– takes initiative
– makes policy decisions
– innovates
– bears risk
©2007 McGraw-Hill Ryerson Ltd. Chapter 1.6 13
 The Production Possibilities Model
Assumptions:
• full employment and productive efficiency
• fixed resources
• fixed technology
• two goods
– pizzas symbolize consumer goods
– industrial robots symbolize capital goods

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 14

 The Production Possibilities Curve
Pizzas (00,000s) 0 1 2 3 4
Robots (000s) 10 9 7 4 0

Production Possibilities

12

10
Robots (thousands)

0
0 1 2 3 4 5
Pizzas (hundred thousands)

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 15

 The Production Possibilities Curve
Pizzas (00,000s) 0 1 2 3 4
Robots (000s) 10 9 7 4 0

Production Possibilities

12

10

Robots (thousands)
Production
Production 8

Possibilities
Possibilities 4

Curve
Curve
2

0
0 1 2 3 4 5
Pizzas (hundred thousands)

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 16

 The Production Possibilities Curve

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...

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 17

 The Law of Increasing Opportunity Cost

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

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 18

 The Law of Increasing Opportunity Cost

Additional Production Possibilities

pizza unit 12

costs 1, 2, 3, 4 Robots (thousands) 10

A
B
robot unit 8 C
6
The more pizza we make,
D
the more machines we 4
give up,
the steeper the curve2
E
0
0 1 2 3 4 5
Pizzas (hundred thousands)

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 19

 The Law of Increasing Opportunity Cost

Shape of the Curve

• concave to the origin
Economic Rationale
• resources are not completely adaptable to
alternative uses

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 20

 Optimal Allocation

• 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

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 21

 Figure 1-3
Optimal Allocation: MB = MC

15
b c
MC
MB/MC

e
Optimal allocation requires
10
the expansion of a good’s
output until its MC and MB
MB=MC
are equal
5
MB
a b

0
1 2 3
Quantity of Pizzas

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.7 22

 Unemployment, Growth, and the Future

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

©2007 McGraw-Hill Ryerson Ltd. Chapter 1.8 23

 A Qualification: International Trade

• 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 1.8 24

 Chapter Summary
 1.1 Ten Key Concepts to Retain for a Lifetime
 1.2 The Economic Way of Thinking
 1.3 Theories, Principles, and Models
 1.4 Macroeconomics and Microeconomics
 1.5 The Individual’s Economic Problem
 1.6 Society’s Economic Problem
 1.7 The Production Possibilities Model
 1.8 Unemployment, Growth, and the Future

©2007 McGraw-Hill Ryerson Ltd. Chapter 1 25

 THANK YOU!

©2007 McGraw-Hill Ryerson Ltd. Chapter 1 26