11 Mic 1 Ch1 Opp Cost

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Chapter 01 - Limits, Alternatives, and Choices

CHAPTER ONE

LIMITS, ALTERNATIVES, AND CHOICES

LECTURE NOTES

I. Learning objectives – After reading this chapter, students should be able to:

A. Define economics and the features of the economic perspective.

B. Describe the role of economic theory in economics.

C. Distinguish microeconomics from macroeconomics and positive economics fromnormative economics.

D. List the categories of scarce resources and nature of the economizing problem.

E. Apply production possibilities analysis, increasing opportunity costs, and economicgrowth.

F. Explain how economic growth and international trade increase consumption possibilities.

G. (Appendix) Understand graphs, curves, and slopes as they relate to economics.

II. Definition of Economics

A. "Economics" comes from the Greek ‘oikos’, meaning "house," and ‘nemein’, meaning "tomanage." "Economics" means "house stewardship"Economics is the social science that studies how people manage their resources

B. The social science that studies how individuals, institutions, and society make optimal choicesunder conditions of scarcity.

C. Human wants are unlimited, but the means to satisfy the wants are limited.

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a) Prefer more to less

b) new wantsunlimited

wants> limited

resourses

scarcity makechoices

opportunitycost

competition

two or more individualswant more of the same

scarce good

discriminationit is needed to

determine who winsand who loses

various economic systems

market / planned / traditional economy

imply

imply

People choose

the option with

the least cost




III. The Economic Perspective

A. Scarcity and choice

1. Resources can only be used for one purpose at a time.

2. Scarcity requires that choices be made.

3. The cost of any good, service, or activity is the value of what must be given up to obtainit. This is known as the opportunity cost.

B. CONSIDER THIS … Free for All?

1. Products provided for “free” to an individual are not free for society because of therequired use of scarce resources to produce them.

2. Companies provide “free” goods as a marketing strategy to promote brand awareness.

3. Products that are promoted as “free” to the individual may actually be bundled withanother good for which the consumer must pay. Because a purchase is required to obtainthem, these products are not really free to the buyer.

4. Therefore, there is “no free lunch,” a common economic expression.

C. Purposeful Behavior

1. Rational self-interest entails making decisions to achieve maximum utility.

a. Utility is the pleasure or satisfaction obtained from consuming a good or service.

b. Utility is measured in a unit called “utils.”

2. Different preferences and circumstances (including errors) lead to different choices.

3. Rational self-interest is not the same as selfishness.

D. Marginal Analysis: Comparing Benefits and Costs

1. Most decisions concern a change in current conditions; therefore the economic

perspective is largely focused on marginal analysis.2. Each option considered weighs the marginal benefit against the marginal cost.

3. Whether the decision is personal or one made by business or government, the principle isthe same.

4. The marginal cost of an action should not exceed its marginal benefits.

5. Opportunity cost is the value of the next best thing forgone.

6. Opportunity costs are always present whenever a decision is made.

E. CONSIDER THIS … Fast Food Lines—An Economic Perspective

1. People choose the shortest line to reduce time cost.

2. Lines tend to have equal lengths as people shift from longer to shorter lines in effort to savetime.

3. Lines are chosen based on length without much other information—cost of obtainingmore information is not worth the benefit.

a. Imperfect information may lead to an unexpected wait.

b. Imperfect information may cause some people to leave when they see a long line.

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4. When a customer reaches the counter, other economic decisions are made about what toorder. From an economic perspective, these choices will be made after the consumer compares the costs and benefits of possible choices.

IV. Theories, Principles, and Models

A. Economists use the scientific method to establish theories, laws, and principles.

1. The scientific method consists of:

a. The observation of facts (real data).

b. The formulations of explanations of cause and effect relationships (hypotheses) based upon the facts.

c. The testing of the hypotheses.

d. The acceptance, rejection, or modification of the hypotheses.

e. The continued testing with an eye toward determination of a theory, law, principle, or model.

2. Theories, principles, and models are “purposeful simplifications.”

3. Principles are used to explain and/or predict the behavior of individuals and institutions.

4. Terminology—Principles, laws, theories, and models are all terms that refer togeneralizations about economic behavior. They are used synonymously in the text, withcustom or convenience governing the choice in each particular case.

B. Generalizations—Economic principles are expressed as the tendencies of the typical or average consumer, worker, or business firm.

C. “Other things equal” or ceteris paribus assumption—In order to judge the effect one variablehas upon another it is necessary to hold other contributing factors constant. Natural scientistscan test with much greater precision than can economists. They have the advantage of controlled laboratory experiment. Economists must test their theories using the realworld as their laboratory.

D. Graphical Expression—Many economic relationships are quantitative, and are demonstratedefficiently with graphs. The “key graphs” are the most important.

V. Microeconomics and Macroeconomics

A. Microeconomics looks at specific economic units.

1. It is concerned with the individual industry, firm or household and the price of specific products and resources.

2. It is an examination of sand, rocks, and shells, and not the beach.

B. Macroeconomics examines the economy as a whole.

1. It includes measures of total output, total employment, total income, aggregateexpenditures, and the general price level.

2. It is a general overview examining the beach, not the sand, rocks, and shells.

C. Positive and Normative Economics.

1. Positive economics describes the economy as it actually is, avoiding value judgmentsand attempting to establish scientific statements about economic behavior.

2. Normative economics involves value judgments about what the economy should be likeand the desirability of the policy options available.

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3. Most disagreements among economists involve normative, value-based questions.

VI. Individual’s Economizing Problem

A. Individuals are confronted with the need to make choices because their wants exceedtheir means to satisfy them.

B. Limited income – everyone, even the most wealthy, has a finite amount of money tospend.

C. Unlimited wants – people’s wants are virtually unlimited.

1. Wants include both necessities and luxuries (although many economists don’t worryabout this distinction).

2. Wants change, especially as new products are introduced.

3. Both goods and services satisfy wants.

4. Even the wealthiest have wants that extend beyond their means (e.g. Bill Gates’charitable efforts).

D. The combination of limited income and unlimited wants force us to choose those goods and

services that will maximize our utility.

Budget line

1. Definition: A schedule or curve that shows the various combinations of two products aconsumer can purchase with a specific money income.

2. The model assumes two goods, but the analysis generalizes to all goods available toconsumers.

3. The location of a budget line depends on a consumer’s money income, and the prices of the two products under analysis.

4. The slope of the graphed budget l ine is the ratio of the price of the goodmeasured on the horizontal axis ( P b in the text) to the price of the good measured on the

vertical axis ( P dvd ). A change in the price of one of the goods will change the slope of the budget line and change the purchasing power of the consumer.

5. The budget line illustrates a number of important ideas:

a. Points on or inside the budget line represent points that are unattainable given therelevant income and prices. Points outside (up and to the right) the budget line areunattainable.

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b. Tradeoffs and opportunity costs – the negative slope of the budget line represents thatconsumers must make tradeoffs in their consumption decisions; the value of the slopemeasures precisely the opportunity cost of one more unit of a good under analysis.

c. Limited income and positive prices force people to choose. Note that the budgetline does not indicate what a consumer will choose, only what they can choose.

d. Income changes will shift the budget line. Greater income will shift the lineout and to the right, allowing consumers to purchase more of both goods. Increasingincome lessens scarcity, but does not eliminate it.

F. Consider This … Did Gates, Winfrey, and Rodriguez Make Bad Choices?

1. The college decision requires weighing future benefits, including projected lifetimeearnings, against present costs, including direct costs (tuition) and indirect costs (forgonewages).

2. Despite the success of celebrities such as Bill Gates, Oprah Winfrey, and AlexRodriguez, in general those attending and completing college will earn greater lifetime

earnings (about 50% more) than those holding only high school diplomas.

3. For Gates, Winfrey, Rodriguez, and others like them, the opportunity cost of college wasextremely high, and it would be hard to argue that they made a wrong decision.

VII. Society’s Economizing Problem

A. Scarce resources

1. Economic resources are limited relative to wants.

2. Economic resources are sometimes called factors of production and include all natural,human, and manufactured resources used to produce goods and services.

B. Resource categories:

1. Land or natural resources (“gifts of nature”).2. Labor or human resources, which include physical and mental abilities used in production.

3. Capital or investment goods, which are all manufactured aids to production like tools,equipment, factories, transportation, etc.

4. Entrepreneurial ability, a special kind of human resource that provides four importantfunctions:

a. Combines resources needed for production.

b. Makes basic business policy decisions.

c. Is an innovator for new products, production techniques, organizational forms.

d. Bears the risk of time, effort, and funds.

VIII. Production possibilities tables and curves are devices used to illustrate and clarifysociety’s economizing problem.

A. Assumptions:

1. Economy is employing all available resources (Full employment).

2. Available supply of resources is fixed in quantity and quality at this point in time.

3. Technology is constant during analysis.

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4. Economy produces only two types of products.

a. While any two goods or services could be used, the example in the chapter assumesthat one product is a consumer good (pizza), the other a capital good (industrial robots).

b. Consumer goods directly satisfy wants; capital goods, which are used to produceconsumer goods, indirectly satisfy wants.

B. Choices will be necessary because resources and technology are fixed. A production

possibilities table illustrates some of the possible choices (see Table 1.1).

C. A production possibilities curve is a graphical representation of choices.

1. Points on the curve represent maximum possible combinations of robots and pizza givenresources and technology.

2. Points inside the curve represent underemployment or unemployment.

3. Points outside the curve are unattainable at present.

D. Optimal or best product-mix:

1. It will be some point on the curve.

2. The exact point depends on society; this is a normative decision.

E. Law of increasing opportunity costs:

1. The amount of other products that must be foregone to obtain more of any given productis called the opportunity cost.

2. Opportunity costs are measured in real terms rather than money (market prices are not part of the production possibilities model).

3. The more of a product produced the greater is its (marginal) opportunity cost.

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4. The slope of the production possibilities curve becomes steeper, demonstratingincreasing opportunity cost. This makes the curve appear bowed out, concave from theorigin.

5. Economic Rationale:

a. Economic resources are not completely adaptable to alternative uses.

b. To get increasing amounts of pizza, resources not particularly well suited for the

purpose of making pizza must be used. For example, workers that are accustomed to producing robots on an assembly line may not do well as kitchen help.

F. Optimal allocation revisited:

1. How does society decide its optimal point on the production possibilities curve?

2. Recall that society receives marginal benefits from each additional product consumed,and as long as this marginal benefit is more than the additional cost of the product, it isadvantageous to have the additional product.

3. Conversely, if the additional (marginal) cost of obtaining an additional product is morethan the additional benefit received, then it is not “worth” it to society to produce theextra unit.

4. Figure 1.3 reminds us that marginal costs rise as more of a product is produced.

5. Marginal benefits decline as society consumes more and more pizzas. In Figure 1.3 wecan see that the optimal amount of pizza is 200,000 units, where marginal benefit just

covers marginal cost.a. Beyond 200,000 pizzas, the added benefits would be less than the added cost.

b. At less than 200,000, the added benefits will exceed the added costs, so it makessense to produce more.

6. Generalization: The optimal production of any item is where its marginal benefit isequal to its marginal cost. In our example, this must occur at 7,000 robots.

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G. Consider This … The Economics of War

1. The costs of the war on terrorism at the end of 2007 were estimated to be around $400 billion.

2. The war on terrorism can be represented by a movement along the production possibilities curve, as resources are reallocated from “civilian goods” to “defense goods.”The decision of how much to reallocate should be made by weighing the marginal benefitsagainst the marginal costs of more defense goods.

3. Marginal benefit – marginal cost analysis is needed to find the optimal mix of defenseand civilian goods. The September 11, 2001, terrorist attacks caused a perceivedincrease the MB curve for defense goods, and shifts in resources toward defense goodssince the attacks reflect that perception. As the model reveals, however, it is possible togo too far, sacrificing too many civilian goods to obtain defense goods.

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IX. Unemployment, Growth, and the Future

A. Unemployment occurs when the economy is producing at less than full employment or inside the curve (point U in Figure 1.4).

B. A growing economic results in larger total output, and is illustrated by an outward shift of the production possibilities curve.

C. There are three main causes of economic growth.

1. Increases in the quantity of resources supplied.

2. Increases or improvements in the quality of resources supplied.

3. Advances in technology employed in the production or distribution process.

D. Present choices and future possibilities

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1. Using resources to produce consumer goods and services represents a choice for presentover future consumption.

2. Using resources to invest in technological advance, education, and capital goodsrepresents a choice for future over present goods.

3. The decision as to how to allocate resources in the present will create more or lesseconomic growth in the future.

E. A Qualification: International Trade

1. A nation can avoid the output limits of its domestic production possibilities throughinternational specialization and trade.

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2. Specialization and trade have the same effect as having more and better resources of improved technology.

X. LAST WORD: Pitfalls to Sound Reasoning

A. Biases—Preconceptions that are not based on facts.

B. Loaded terminology.

1. Terms that contain the prejudice and value judgments of others.

2. It is very difficult for a person to describe economic behavior without letting their options about that behavior creep into their discussion. The distinction between positiveand normative statements is not always clearly apparent.

3. Often, however, there is a deliberate attempt to sway opinion by using loadedterminology (greedy owners, obscene profits, exploited workers, mindless bureaucrats,costly regulations, creeping socialism).

C. Fallacy of Composition

1. Fallacy: What is true for one individual or part of a whole is necessarily true for a groupof individuals or the whole.

2. Examples: An individual stockholder’s sales of shares v. a large number of stockholdersselling large numbers of shares; revenues of an individual cattle rancher v. falling pricesdue to the actions of a large group of cattle ranchers

D. Causation Fallacies

1. Post hoc fallacy: When two events occur in time sequence, the first event is notnecessarily the cause of the second event.

2. Correlation versus causation: Events may be related without a causal relationship.

a. The positive relationship between education and income does not tell us whichcauses the increase in the other. (Which is the independent variable and which is thedependent variable?)

b. It may be that the increase income that occurs with increased education is due tosome other third factor that is not under direct consideration.

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裙子經濟學經濟低迷今年興穿長裙

時裝潮流反映經濟，一個世紀以來的智慧，是迷你裙熱經濟也熱，長裙興起則經濟低迷。今年，美國經濟現危機，在骨牌效應下，全球經濟都唉聲嘆氣，這個夏天，女性時裝潮流興穿長裙，還要長至足踝。這股「長風」還至少要持續至明年，慘了。

時裝名牌如 Chanel 及 Stella McCartney 等，早於去年 10 月舉行的夏季時裝展上，率先示範多款曳地長裙。名牌帶動潮流，即使天氣轉熱應該越穿越少，荷李活女星安琪蓮娜祖莉（ Angelina Jolie ）、 Kylie Minogue 以至曼聯球星朗尼妻子高蓮（ Coleen Mcloughlin ）等，最近都紛紛穿上長裙。

「經濟不景不想招搖」

長裙成今夏大熱，時裝界相信又一次證明了一套時裝經濟學：裙子長度會隨經濟好壞而轉變，經濟越好，裙子越短，經濟轉壞，裙子越長，因為悲觀情緒，會讓人們傾向把身體遮掩起來。

著名時裝顧問桑德林（ Hannah Sandling ）說：「經濟不景時，人們消費信心下降，

不想穿得太招搖，傾向選擇端莊低調的衣，減少露肉。」但也有例外，車路士班主阿巴莫域治女友茹科娃（ Dasha Zhukova ）就常以短裙示人，桑德林解釋：「由於俄羅斯人太有錢，當地經濟仍很蓬勃，信貸危機根本威脅不到他們」。

信不信由你，裙子長度與金融市況的互動關係，至少存在了近一個世紀。 1920 年代，美國經濟繁榮，裙子開始變短。大蕭條時代來臨，長裙再次抬頭。 1960 年代，戰後重建帶動經濟起飛，女性玉腿才得以重見天日。 1970 年代通脹來臨，長裙又再流行。 1980 至 1990 年代經濟復蘇，迷你裙更當道。

迷你裙當道顯示繁榮

今次長裙再成熱潮，要拜一眾時裝設計師有先見之明，預料這股「長風」至少持續至明年，長及足踝的大衣將會是今冬的必買之選，各位太太小姐，準備好入貨沒有？

英國《星期日電訊報》

時裝潮流反映經濟

1920 年代：美國經濟繁榮，裙子開始變短。1960 年代：戰後經濟起飛，短裙當道。1970 年代：通脹來臨，長裙又再流行。1980 年代：經濟復蘇，迷你裙大行其道。 Appledaily 21/7/08

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APPENDIX TO CHAPTER 1

I. Graphs and Their Meaning

A. Graphs help students to visualize and understand economic relationships. Most of our economic models explain relationships between just two sets of economic facts.

B. Constructing a two-dimensional graph involves drawing a horizontal and a vertical axis.

1. Mark the axis using convenient increments and fitting the data given.

2. Each point on the graph yields two pieces of information, the quantity of the variable onthe horizontal axis and the corresponding quantity of the variable on the vertical axis.

C. Direct and inverse relationships

1. If two variables change in the same direction (an increase in one is associated with anincrease in the other) it is a direct or positive relationship.

2. If the two sets of data move in opposite directions, they are inversely or negativelyrelated.

D. Dependent and independent variables:

1. Economists are often interested in determining which variable is the “cause” and whichis the “effect” when two variables appear to be related.

2. Mathematicians are always consistent in applying the rule that the independent variableor “cause” is placed on the horizontal axis and the dependent variable or outcome (effect)is placed on the vertical axis.

3. Economists are less tidy, and traditionally have put price and cost data on the verticalaxis.

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享受單身「代價」早死

獨身主義危害性命！美國最新研究指出，終生未婚的單身人士，生活也許較自由自在，但卻可能要負

上「早死」的代價，即使他們較已婚人士多做運動、少喝酒，亦較少超重，但也無補於事。

多做運動少飲酒無補於事負責研究的美國加州大學（ University of California ）洛杉磯分校科學家卡普蘭

(Robert M. Kaplan) 及克羅力（ Richard G. Kronick ），分析了接近 67,000 名 19 歲至退休年齡的人士，在 1989 年至 1997 年間的婚姻及健康狀況，發現獨身生活對任何年齡人士的健康都有影響，婚姻跟壽命長短有明顯關係。

調查發現，在 1989 年，有近 50% 受訪者已婚， 10% 喪偶，約 12.5% 已離婚， 3% 處於分居狀態， 5% 則跟伴侶同居， 20% 的人獨身。研究人員在排除了年老和本身健康的影響後，發現到了 1997 年，單身、喪偶和離婚人士，早死比率高於結了婚而伴侶健在的人。當中以獨身人士早逝的機會最高，較伴侶在生的人高出 58% ；其次為喪偶人士，高近 40% ，離婚及分居人士則高出 27% 。另外，單身男士死亡風險也較單身女士高， 19 至 44 歲的未婚男士，較同齡已婚男士死亡機會高出超過一倍。

研究發現，獨身人士生活其實較健康，他們較有家室的人略少飲酒，多做一點運動，較少發生超重，但會做較多「高風險」活動，例如年輕獨身人士可能較多進行不安全性行為，也較多發生意外，而年老獨身人士則多死於心血管和慢性疾病。

研究員相信，婚姻可作為社會聯繫，即使離婚、喪偶人士仍可得到子女或家人的關心及支持，相反單身人士處境孤立，增加死亡危機。

該研究已發表於周四出版的英國《流行病學與社區保健期刊》（ Journal of Epidemiology and Community Health ）。

法新社 / 英國《泰晤士報》 Appledaily 11 Aug 06




4. Note that inverse relationships are downward sloping to the right and direct relationshipsare upward sloping to the right regardless of which variable is placed on the horizontal or vertical axis.

E. Other things equal

1. When economists plot the relationship between two variables, all other influences areassumed to remain exactly the same (ceteris paribus).

2. If any of the other factors do change, a new plot of the relationship must be made.

3. This point is extremely important for student understanding of the market modeldeveloped in chapter 3. It provides the distinction between a “slide” along an existingcurve, and the “shift” of a curve that is required if a variable not labeled on the axis ischanged.

F. The slope of a straight line is the ratio of the vertical change to horizontal change betweenany two points on the line. Some students will remember this as “rise over run.”

1. The slope of a line will be positive if both variables change in the same direction (a positive or direct relationship).

2. The slope of a line will be negative if the variables change in the opposite direction (aninverse or negative relationship).

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3. The numerical value of the slope will depend on the way the relevant variables aremeasured.

4. Economic analysis is often concerned with marginal changes, the relative change in onevariable with respect to another; it is this rate of change that is measured by the slope.

5. Lines that are parallel with either the horizontal or vertical axis indicate that the twovariables are unrelated, that is, a change in one variable has no effect on the value of theother.

a. A vertical line has an infinite slope. It is worth noting that often students learn in

mathematics courses that the slope of a vertical line has an undefined slope. b. A horizontal line has a zero slope.

G. The vertical intercept of a line is the point where the line intersects the vertical axis.

H. Equation of a linear relationship

1. If the vertical intercept and the slope are known, the general form y = a + bx describesthe line.

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2. y represents the variable on the vertical axis (the dependent variable in standardmathematical form) a is the vertical intercept, b is the slope of the line, and x representsthe variable on the horizontal axis (the independent variable in standard mathematicalform).

3. The income—consumption example places the dependent and the independent in proper mathematical form.

4. The price-quantity example reverses their position and places price (the independentvariable) on the vertical axis and quantity (the dependent variable) on the horizontal axis.

I. Slope of a nonlinear curve

1. The slope of a nonlinear relationship changes from one point to another.

2. The slope of a curve at point a is equal to the slope of a line tangent to the curve at point.

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11 Mic 1 Ch1 Opp Cost