Limits, Alternatives, and Choices

1. 1 Limits, Alternatives, and Choices

2. Chapter Objectives • Economics Defined • Economic Perspective • Role of Economic Theory • Microeconomics and Macroeconomics • Scarce Resources • The Economizing Problem • Production Possibilities

3. The Economic Perspective • Scarcity and Choice • Opportunity Cost • Purposeful Behavior • Utility • Marginal Analysis • Marginal Benefits • Marginal Costs

4. Theories Principles and Models • The Scientific Method • Economic Principle • Generalizations • Other-Things-Equal Assumption (ceteris paribus) • Graphical Expression

5. Macro and Microeconomics • Macroeconomics • Aggregate • Microeconomics • Individual Units • Positive Economics • Normative Economics

6. Individual’s Economizing Problem • Limited • Income • Time • Resources • Unlimited Wants • A Budget Line

7. Suppose that Russ has budgeted $20 a month to buy candy bars, music downloads, or some combination of each. If Russ buys only candy bars he can obtain 40 bars a month; if he buys only downloads, he can buy 20 a month. •  What is the price of a candy bar? • The price of a candy bar is 50 cents. • $20/40 • What is the price of a music download? • The price of a music download is $1 • $20/20

8. What is the opportunity cost of a music download? • The opportunity cost of 1 more music download is the number of candy bars given up to get it • That number is 2 • $1/$.50 • What is the opportunity cost of a candy bar? • The opportunity cost of 1 more candy bar is ½ • $.50/$1 • Would the opportunity cost of each good change if Russ decided to increase his monthly budget to $30 for the two items? • No, the opportunity cost would not change because the prices of the two goods have not changed • Russ simply can either buy more candy bars and/or music downloads than before

9. Individual’s Economizing Problem • Attainable and Unattainable Combinations • Tradeoffs & Opportunity Costs • Choice • Income Change

10. GLOBAL PERSPECTIVE Individual’s Economizing Problem Average Income, Selected Nations Country Per Capita Income 2010 $67,463 47,198 42,831 39,459 20,756 10,710 9,123 4,428 1,222 1,108 529 197 Switzerland United States Japan France South Korea Brazil Mexico China Nigeria Pakistan Rwanda Liberia Source: World Bank

11. Income = $120 Income = $120 = 12 = 6 Pb= $10 Pdvd= $20 Individual’s Economizing Problem $120 Budget 12 10 8 6 4 2 0 DVDs $20 Books $10 6 5 4 3 2 1 0 0 2 4 6 8 10 12 Unattainable Quantity of DVDs Attainable 2 4 6 8 10 12 14 Quantity of Books

12. Society’s Economizing Problem • Scarce Resources • Resource Categories • Land • Labor • Capital • Investment • Entrepreneurial Ability • Factors of Production

13. Production Possibilities Model • Full Employment • Fixed Resources • Fixed Technology • Two Goods • Consumer Goods (Pizzas) • Capital Goods (Industrial Robots)

14. Production Possibilities Model Production Possibilities Table Production Alternatives A B C D E Type of Product Pizzas (in hundred thousands) 0 1 2 3 4 Industrial Robots (in thousands) 10 9 7 4 0 Plot Points to Create Graph…

15. Production Possibilities Model Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable A Economic Growth B C’ C Industrial Robots D’ D Now Attainable Attainable E’ E 0 1 2 3 4 5 6 7 8 9 Pizzas

16. Production Possibilities Model Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable A Law of Increasing Opportunity Cost B C’ C Industrial Robots D’ Shape of the Curve D Attainable E’ E 0 1 2 3 4 5 6 7 8 9 Pizzas

17. Problem: • Suppose that a nation's production possibilities can be represented by the table below: • What is the maximum amount of food this economy can produce? How much clothing can it produce at this point? • The greatest amount of food is 16 units. • Clothing production is zero.

18. Problem: • Suppose that a nation's production possibilities can be represented by the table below: • If the economy is producing at alternative C, what is the cost of one more unit of food? • D, 4 additional units of food are produced at the cost of 6 units of clothing • 6/4 = 1.5 units of clothing.

19. Problem: • Suppose that a nation's production possibilities can be represented by the table below: • If the economy is producing at alternative C, what is the cost of one more unit of clothing? • B, 4 units of clothing at a cost of 4 units of food • 4/4 = 1 unit of food.

20. Is this economy subject to the law of increasing opportunity costs? How can you tell? • Yes—Starting at alternative A, each successive increase in food production requires a larger and larger reduction in clothing. • Specifically, the opportunity cost of each successive four units of food cost 2 (=20–18), 4 (=18–14), 6 (=14–8), and 8 (=8–0) units of clothing.

21. Suppose the economy is currently producing 4 units of food and 16 units of clothing. Is this economy producing efficiently? • No—By producing efficiently, the table suggests that the economy can produce 4 units of clothing and 18 units of food (alternative B). • This is 2 more clothing than is currently being produced, suggesting the economy is inefficient.

22. Production Possibilities Model Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable C’ Industrial Robots U D’ Under or Unemployment E’ 0 1 2 3 4 5 6 7 8 9 Pizzas

23. Production Possibilities Model Optimal Allocation of Resources MC a c 15 10 5 0 MB = MC e Marginal Benefit & Marginal Cost b d MB 1 2 3 Quantity of Pizza

24. Unemployment Growth and the Future • A Growing Economy • Economic Growth • Increasing Resource Supplies • Increasing Resource Quality • Technological Advances

25. Present Choices & Future Possibilities Compare Two Hypothetical Economies Future Curve Future Curve F Goods for the Future Goods for the Future P Current Curve Current Curve Goods for the Present Goods for the Present Presentville Futureville Implications of International Trade

26. 2 The Market System and the Circular Flow

27. Chapter Objectives • Command Systems vs. Market Systems • Characteristics of a Market System • How Markets Determine What to Produce, How to Produce, and Who Receives the Output • How Market System Adjusts to Change and Promotes Progress • The Mechanics of the Circular Flow

28. Economic Systems • Economic System Defined • Ownership of Factors of Production • Method Used to Motivate, Coordinate, and Direct Economic Activity • Command System • Socialism, Fascist or Communism • Market System • Capitalism • Pure Capitalism – Laissez-Faire

29. The Market System Characteristics • Private Property • Freedom of Enterprise • Freedom of Choice 0-49.9 50-59.9 70-79.9 60-69.9 80-100 Moderately Free Repressed Mostly Unfree Mostly Free Free 158- Argentina 171- Iran 179- North Korea 1- Hong Kong 2- Singapore 5- Switzerland 9- Ireland 10- US 28- Austria 92- Italy 119- Greece 138- China 54- Mexico 64- Poland 90- Lebanon Source: Heritage Foundation (www.heritage.org/index/ranking) and he Wall Street Journal

30. The Market System Characteristics • Self-Interest • Competition • Markets and Prices • Technology and Capital Goods • Specialization • Division of Labor

31. The Market System Characteristics • Geographic Specialization • Use of Money • Medium of Exchange • Barter • Active but Limited Government

32. The Market System Five Fundamental Questions • What Goods Will Be Produced? • Consumer Sovereignty • Dollar Votes • How Will the Goods Be Produced? • Available Technology • Prices of Needed Resources

33. The Market System Five Fundamental Questions • Who gets the output? • willingness to pay • How is change accommodated? • self-interest • How is progress promoted? • technological advance • capital accumulation • Creative destruction

34. The Market System The “Invisible Hand” • 1776 Wealth of Nations byAdam Smith • Unity of private and social interest • Virtues of the market system • Efficiency • Incentives • Freedom

35. The Market System Demise of Command Systems • Insurmountable Problems • The Coordination Problem • Set output targets for all goods • The Incentive Problem • No adjustments for shortage or surplus • No Profits • The Calculation Problem • No Prices East Germany Yugoslavia China

36. Circular Flow Resource Market Businesses Households Product Market

37. Circular Flow Resource Market Money Income Costs Input Factors Resources Businesses Households Goods & Services Goods & Services Product Market Consumption Revenue

38. Circular Flow Both Flows Are Equal Resource Market Money Income Costs Input Factors Resources Both Flows Are Equal Businesses Households Goods & Services Goods & Services Product Market Consumption Revenue

39. 3 Demand, Supply, and Market Equilibrium

40. Chapter Objectives • Demand Defined and What Affects It • Supply Defined and What Affects It • How Supply & Demand Together Determine Market Equilibrium • How Changes in Supply and Demand Affect Equilibrium Prices and Quantities • Government-Set Prices and their Implications for Surpluses & Shortages

41. Demand • Demand Defined • Demand Schedule • Law of Demand • Diminishing Marginal Utility • Income Effect • Substitution Effect • Demand Curve • Market Demand

42. 6 5 4 3 2 1 0 Price (per bushel) 10 20 30 40 50 60 70 80 Quantity Demanded (bushels per week) Individual Demand P Individual Demand P Qd $5 4 3 2 1 10 20 35 55 80 D Q

43. Individual Demand Determinants of Demand • Tastes • Number of Buyers • Income • Normal Goods • Inferior Goods • Price of Related Goods • Substitute Good • Complementary Good • Unrelated Goods • Consumer Expectations

44. Individual Demand Demand Can Increase or Decrease P 6 5 4 3 2 1 0 Individual Demand Increase in Demand P Qd $5 4 3 2 1 10 20 35 55 80 Price (per bushel) D2 D1 Decrease in Demand D3 Q 2 4 6 8 10 12 14 16 18 Quantity Demanded (bushels per week)

45. Individual Demand Demand Can Increase or Decrease An Increase in Demand Means a Movement of the Line P 6 5 4 3 2 1 0 Individual Demand A Movement Between Any Two Points on a Demand Curve is Called a Change in Quantity Demanded P Qd $5 4 3 2 1 10 20 35 55 80 Price (per bushel) D2 D1 Decrease in Demand D3 Q 2 4 6 8 10 12 14 16 18 Quantity Demanded (bushels per week)

46. Supply • Supply Defined • Supply Schedule • Law of Supply • Revenue Implications • Marginal Cost • Supply Curve • Market Supply

47. Individual Supply P 6 5 4 3 2 1 0 Individual Supply S1 P Qs $5 4 3 2 1 60 50 35 20 5 Price (per bushel) Q 10 20 30 40 50 60 70 Quantity Supplied (bushels per week)

48. Individual Supply Determinants of Supply • Resource Prices • Technology • Taxes and Subsidies • Prices of Other Goods • Producer Expectations • Number of Sellers

49. Individual Supply Supply Can Increase or Decrease P 6 5 4 3 2 1 0 S3 Individual Supply S1 S2 P Qs $5 4 3 2 1 60 50 35 20 5 Price (per bushel) Q 2 4 6 8 10 12 14 Quantity Supplied (bushels per week)

50. Individual Supply Supply Can Increase or Decrease A Movement Between Any Two Points on a Supply Curve is Called a Change in Quantity Supplied P 6 5 4 3 2 1 0 S3 Individual Supply S1 S2 P Qs $5 4 3 2 1 60 50 35 20 5 Price (per bushel) An Increase in Supply Means a Movement of the Line Q 2 4 6 8 10 12 14 Quantity Supplied (bushels per week)