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Chapter 1
Prepared by Prof Jean-Pierre Mulumba, Ph. D.1
Limits, Alternatives, and Choices
Learning Objectives
Prepared by Prof Jean-Pierre Mulumba, Ph. D.2
• Define economics and the features of the
economic perspective
• Describe the role of economic theory in
economics
• Distinguish microeconomics from
macroeconomics
Learning Objectives (1)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.3
• Distinguish positive economics from normative
economics
• Explain the individual’s economizing problem
s
Learning Objectives (2)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.4
• List the categories of scarce resources
• Apply production possibilities analysis,
increasing opportunity costs, and economic
growth.
Introduction
Prepared by Prof Jean-Pierre Mulumba, Ph. D.5
 People are full of wants and needs
 Society possesses productive resources to satisfy
many of our wants
 Needs exceed our productive capacity
 Resources are limited
 We have to make choices
Introduction (1)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.6
 Economics is a social science concerned with
making optimal choices under conditions of
scarcity
The Economic Perspective
.
Prepared by Prof Jean-Pierre Mulumba, Ph. D.7
Scarcity and Choice
Prepared by Prof Jean-Pierre Mulumba, Ph. D.8
 The economic resources are in limited supply
 Choices must be made
 Opportunity costs
 To obtain more of one thing, society forgoes the opportunity
of getting the next best thing
 Core of economics: “There is no free lunch”
 Someone bears the cost
Purposeful Behavior
Prepared by Prof Jean-Pierre Mulumba, Ph. D.9
 Human behavior reflects “rational self-interest”
 Individuals look for to increase their utility
 They aim to maximize their satisfaction
 Firms are purposely acting to maximize their profit
 Purposeful behavior” means: people make
decisions with some desired outcome in mind.
Marginal Analysis
Prepared by Prof Jean-Pierre Mulumba, Ph. D.10
 Comparisons of marginal benefits and marginal
costs for decision making
 Marginal: extra, additional, or a change in
 Each option involves marginal benefits and,
marginal costs
Theories, Principles, and Models
.
Prepared by Prof Jean-Pierre Mulumba, Ph. D.11
The Scientific Method
Prepared by Prof Jean-Pierre Mulumba, Ph. D.12
 Like other sciences, economics relies on the
scientific method: elements
 Observation of the real world
 Hypothesis formulation
 Testing the hypothesis
 Accepting, rejecting, or modifying the hypothesis
The Scientific Method(1)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.13
 Economists develop individuals and institutions
behavior theories
 Theories, principles, and models are “purposeful
simplifications.”
 Economic principles and models are the tools for
ascertaining cause and effect
The Scientific Method(2)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.14
 Economic principles are
 Generalizations relating to economic behavior
 Using the ceteris paribus or other things-equal
assumption
 Factors other than those being considered do not change.
 Graphical expression
 Economic models are often expressed graphically
Microeconomics and
Macroeconomics
Economists develop economic principles and models at
two levels.
Prepared by Prof Jean-Pierre Mulumba, Ph. D.15
Microeconomics
Prepared by Prof Jean-Pierre Mulumba, Ph. D.16
 Decision making by individuals, households, or
business firms
 Details of their behavior
 Examples:
 Price of a specific product
 Number of workers
 Revenue or income of a particular firm or household
 Expenditures of a specific firm, government entity,
or family
Macroeconomics
Prepared by Prof Jean-Pierre Mulumba, Ph. D.17
 Examines the performance and behavior of the
economy as a whole. It
 focuses its attention on
 Economic growth
 Business cycle
 Interest rates
 Inflation
Macroeconomics(1)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.18
 Behavior of major economic aggregates such as
 Government
 Household
 Business sectors.
 An aggregate is a collection of specific economic
units treated as if they were one unit.
 Seeks to obtain an overview, or general outline
 Micro–macro distinction does not mean that
economics is so highly compartmentalized
Positive and Normative
Economics
Prepared by Prof Jean-Pierre Mulumba, Ph. D.19
 They concern both Microeconomics and
macroeconomics
 Positive economics focuses on facts and cause-
and-effect relationships.
 Includes description, theory development, and
theory testing.
 Avoids value judgments.
 Establishes scientific statements about economic
behavior
 Deals with what the economy is actually like.
 Critical to good policy analysis.
 Examples: “The unemployment rate in France is
higher than that in the United States.”
Positive and Normative
Economics(1)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.20
 Normative economics
 Incorporates value judgments about what the
economy should be like
 Concerns particular policy actions recommended to
achieve a desirable goal
 Looks at the desirability of certain aspects of the
economy
 Underlies expressions of support for particular
economic policies.
 Example: “France ought to undertake policies to
make its labor market more flexible to reduce
unemployment rates
Individual’s Economizing
Problem
.
Prepared by Prof Jean-Pierre Mulumba, Ph. D.21
Economizing Problem
Prepared by Prof Jean-Pierre Mulumba, Ph. D.22
 The need to make choices
 Caused because by economic wants exceed
economic means
 Implying
 to take account of a budget constraint
 to distinguish between unattainable and
unattainable options
 to take account of trade-offs and opportunity costs
 to make the best choice possible
 According to change in income
Limited Income
Prepared by Prof Jean-Pierre Mulumba, Ph. D.23
 We all have a finite amount of income
 even the wealthiest among us must decide how
to spend his money
 Income comes to us in the form of wages,
interest, rent, and profit
 Some people don’t earn any income
Unlimited Wants
Prepared by Prof Jean-Pierre Mulumba, Ph. D.24
 Most people have virtually unlimited wants.
 Biological
 Or sociological
 We desire goods and services that provide utility
 Economic wants tend to change over time
 For most people, their needs cannot be fully
satisfied.
 Because of limited income and insatiable wants,
we need to economize
A Budget Line
Prepared by Prof Jean-Pierre Mulumba, Ph. D.25
 The economizing problem is visualized by a
budget line
 A budget constraint
 A schedule or curve of various combinations of
products a consumer can afford with his income
 We assume two products
 See next slide
A Budget Line(1)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.26
 .  .12
10
8
6
4
2
0 2 4 6 8 10 12 14
Quantity of Paperback Books
QuantityofDVDs
Income = $120
Pdvd = $20
= 6
Income = $120
Pb = $10
= 12
Attainable
Unattainable
6
5
4
3
2
1
0
0
2
4
6
8
10
12
DVDs
$20
Books
$10
$120 Budget
A Budget Line(2)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.27
 Attainable and Unattainable Combinations
 From the $120 of money income
 All the combinations of DVDs and books on or
inside the budget line are
 What you can afford to buy with the $120
 The budget line shows all combinations that cost
exactly the full $120
 All the combinations beyond the budget line are
unattainable
A Budget Line
Prepared by Prof Jean-Pierre Mulumba, Ph. D.28
 Trade-Offs and Opportunity Costs
 The budget line iillustrates the idea of trade-offs
arising from limited income.
 To obtain more DVDs, you have to give up some
books
 2 books.
 So the opportunity cost of the first DVD is 2 books
 The constant slope of the line budget constraint is a
constant opportunity cost
A Budget Line(3)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.29
 Choice
 Limited income forces people to choose what
combination of goods to satisfy their needs
 You will select the combination that you think is “best.”
 You evaluate your marginal benefits and marginal
costs to make choices
 that maximize your satisfaction
A Budget Line(4)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.30
 Income Changes
 The location of the budget line varies with money
income
 An increase in money income shifts the budget line
to the right
 A decrease in money income shifts it to the left.
Society’s Economizing Problem
Society must also make choices under conditions of
scarcity
Prepared by Prof Jean-Pierre Mulumba, Ph. D.31
Society’s Economizing Problem
Prepared by Prof Jean-Pierre Mulumba, Ph. D.32
 Society must also make choices under conditions
of scarcity.
 It faces an economizing problem.
 Limited resources:
 Land.
 Labor
 Capital
 Entrepreneurial Ability
Society’s Economizing
Problem(1)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.33
 Scarce Resources
 Society has limited or scarce economic resources
 All natural, human, and manufactured resources
used in the production of goods and services
 Four general categories.
 Combined to produce goods and services
 Called factors of production, or “inputs.”
Society’s Economizing
Problem(2)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.34
 Resource Categories:
 Land : all natural resources (“gifts of nature”)
used in the production process.
 These include forests
 Mineral and oil deposits
 Water resources
 Wind power
 Sunlight,
 Arable land.
Society’s Economizing
Problem(3)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.35
 Resource Categories:
 Labor: people’s physical actions and mental
activities to produce goods and services.
 The work-related activities of a logger,
 Retail clerk,
 Machinist,
 Teacher
 Professional football player
 Nuclear physicist
Society’s Economizing
Problem(4)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.36
 Resource Categories
 Capital (or capital goods):
 Manufactured aids used in producing goods and
services.
 Factory, storage, transportation, and distribution facilities,
tools and machinery.
 Investment is spending for the production and
accumulation of capital goods.
Society’s Economizing
Problem(5)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.37
 Consumer goods satisfy wants directly, whereas
capital goods do so indirectly
 The term “capital” refers to productive equipment
 Money (financial capital): a means for purchasing
consumer goods and capital goods
Society’s Economizing
Problem(6)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.38
 Resource Categories
 Entrepreneurial Ability
 Resources supplied by entrepreneurs, who
perform important economic functions
 The entrepreneur takes the initiative to produce a
good or a service.
 He is the driving force behind production
 the agent who combines the other resources
 The agent who makes the strategic business
decisions
Society’s Economizing
Problem(7)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.39
 The entrepreneur innovates
 The entrepreneur bears risk
 Innovation is risky
Production Possibilities Model
Society uses its scarce resources to produce goods and
services
Prepared by Prof Jean-Pierre Mulumba, Ph. D.40
Production Possibilities Model
Prepared by Prof Jean-Pierre Mulumba, Ph. D.41
 The macroeconomic model of production
possibilities
 It shows alternatives and choices it faces
 Assumptions:
 Full employment
 The economy employs all its available resources.
 Fixed resources
 The quantity and quality of the factors of production are
fixed.
 Fixed technology
 The state of technology is constant.
 Two goods
 The economy is producing only two goods: pizzas and
Production Possibilities Table
Prepared by Prof Jean-Pierre Mulumba, Ph. D.42
 A production possibilities
table lists the different
combinations of two products
that can be produced with a
specific set of resources
 Table 1.1 presents a simple,
hypothetical economy that is
producing pizzas and
industrial robots.
 At alternative A, this
economy uses all its
available resources to
produce industrial robots
 at alternative E, all resources
would go to pizza production
 An economy typically
produces both capital goods
and consumer goods, as in
B, C, and D.
Production Possibilities Table(1)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.43
 At alternative A, this economy uses all its
available resources to produce industrial robots
 at alternative E, all resources would go to pizza
production
 An economy typically produces both capital
goods and consumer goods, as in B, C, and D.
Production Possibilities Table(2)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.44
 Moving from alternative A to E, we increase the
production of pizzas at the expense of the
production of industrial robots.
 But there is a cost: More pizzas mean fewer
industrial robots.
 Thereby reducing potential future production.
Production Possibilities Table(3)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.45
 By moving toward A, society chooses to forgo
current consumption
 Thereby freeing up resources that can be used to
increase the production of capital goods.
 By building up its stock of capital this way, society
will have greater future production
 Greater future consumption
Production Possibilities Curve
Prepared by Prof Jean-Pierre Mulumba, Ph. D.46
 The production
possibilities table is
shown graphically as a
production possibilities
curve
 It displays the different
combinations of goods
and services that
society can produce in
 A full employment
economy
 Assuming a fixed
availability of supplies of
resources and fixed
Production Possibilities Curve(1)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.47
 Each point on the curve represents the two goods
maximum production
 The curve is a “constraint” because it shows the
limit of attainable outputs.
 Points on the curve are attainable with its available
resources.
 Points inside the curve are attainable, but they are
not as desirable as points on the curve.
 Points lying beyond the curve are unattainable with
the current availability of resources and technology.
Law of Increasing Opportunity Costs
Prepared by Prof Jean-Pierre Mulumba, Ph. D.48
 The opportunity cost of pizzas: the number of
industrial robots units that must be given up to
obtain another unit of pizzas
 In moving from alternative A to alternative E: the
opportunity cost of each additional unit of pizzas
is greater than the opportunity cost of the
preceding one.
 To get an additional pizza we sacrifice 1, 2, 3, 4
robots
Law of Increasing Opportunity
Costs(1)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.49
 Conversely, moving from E to A, the cost of an
additional unit of industrial robots is 1/4, 1/3, 1/2,
and 1 unit of pizzas,
 Our example illustrates the law of increasing
opportunity costs reflected in the shape of the
curve
Economic Rationale
Prepared by Prof Jean-Pierre Mulumba, Ph. D.50
 The law of increasing opportunity costs:
economic resources are not completely adaptable
to alternative uses.
 Many resources are better at producing one type of
good than at others.
 By increasing resources to produce one good, we
are making them increasingly scarce.
 The resources lack of perfect interchangeability
causes the increasing opportunity costs
Optimal Allocation
Prepared by Prof Jean-Pierre Mulumba, Ph. D.51
 Which of the attainable combinations of pizzas
and industrial robots is optimal (best)?
 That is to maximize satisfaction?
 Any economic decision is based s on
comparisons of marginal benefit (MB) and
marginal cost (MC).
Optimal Allocation(1)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.52
 The optimal amount of the activity occurs where
MB = MC.
 Society needs to make a similar assessment about
its production decision
 Each successive unit of pizza brings with it both
increasing marginal costs and decreasing
marginal benefits.
Optimal Allocation(2)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.53
 In Figure 1.3, net
gains can continue to
be realized until pizza
production has been
increased to 200,000.
 So resources are
efficiently allocated
when the marginal
benefit and marginal
cost of its output are
equal (MB = MC)
Unemployment, Growth,
and the Future
Economic growth and international trade increase
consumption possibilities
Prepared by Prof Jean-Pierre Mulumba, Ph. D.54
Unemployment and the PP Curve
Prepared by Prof Jean-Pierre Mulumba, Ph. D.55
 Any point inside the
production possibilities
curve U represents
unemployment or a
failure to full
employment. The
arrows
 indicate that by realizing
full employment, the
economy could operate
on the curve.
 This means it could
produce more of one or
both products than it is
producing at point U.
A Growing Economy
Prepared by Prof Jean-Pierre Mulumba, Ph. D.56
 When we drop the
assumptions, the
production
possibilities curve
shifts positions
A Growing Economy:
Increases in Resource Supplies
Prepared by Prof Jean-Pierre Mulumba, Ph. D.57
 Resource supplies are fixed at any specific
moment, but they change over time.
 Growing population increases in the labor supplies
and entrepreneurial ability.
 More education improves labor quality
 Increased supplies of the factors of production
equals the ability to produce more
 The production possibilities curve shifts outward
and to the right
A Growing Economy:
Advances in Technology
Prepared by Prof Jean-Pierre Mulumba, Ph. D.58
 An advancing technology brings both new and
better goods and improved ways of producing
them
 It allows society to produce more goods with
available resources
 It causes outward shifts of the nation’s production
possibilities curve
Present Choices and Future
Possibilities
Prepared by Prof Jean-Pierre Mulumba, Ph. D.59
Present Choices and Future
Possibilities (1)
Prepared by Prof Jean-Pierre Mulumba, Ph. D.60
 An economy’s current choice of positions on its
production possibilities curve helps determine the
future location of that curve.
 Goods for the future such as capital goods
 Goods for the present are consumer goods
A Qualification: International
Trade
Prepared by Prof Jean-Pierre Mulumba, Ph. D.61
 In this analysis an individual nation is limited to
the combinations of output indicated by its
production possibilities curve
 International specialization and trade allow a
nation to get more of a desired good at less
sacrifice of some other good
 Expansion of domestic production possibilities
and international trade are two separate routes
for obtaining greater output
Pitfalls to Sound Economic
Reasoning
Some common pitfalls to avoid in successfully applying
the economic perspective
Prepared by Prof Jean-Pierre Mulumba, Ph. D.62
Biases
Prepared by Prof Jean-Pierre Mulumba, Ph. D.63
 Biases and preconceptions to the field of
economics
 Biases cloud thinking and interfere with objective
analysis
 All of us must be willing to shed biases and
preconceptions that are not supported by facts
Loaded Terminology
Prepared by Prof Jean-Pierre Mulumba, Ph. D.64
 The economic terminology used is sometimes
emotionally biased, or loaded
 Reject or discount such terminology
Fallacy of Composition
Prepared by Prof Jean-Pierre Mulumba, Ph. D.65
 Thinking that the assumption that what is true for
one individual is necessarily true for a group of
individuals
 A statement that is valid for an individual or part is
not necessarily valid for the larger group or whole
Post Hoc Fallacy
Prepared by Prof Jean-Pierre Mulumba, Ph. D.66
 Because event A precedes event B, don’t assume
that A is the cause of B.
 This kind of faulty reasoning is known as the post
hoc, ergo propter hoc, or “after this, therefore
because of this,” fallacy
Correlation but Not Causation
Prepared by Prof Jean-Pierre Mulumba, Ph. D.67
 Correlation between two sets of data indicates
an association in some systematic and
dependable way
 The relationship could be purely coincidental or
dependent on some other factor not included in the
analysis.
 Causation: cause and effect

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Limits, alternatives, and choices

  • 1. Chapter 1 Prepared by Prof Jean-Pierre Mulumba, Ph. D.1 Limits, Alternatives, and Choices
  • 2. Learning Objectives Prepared by Prof Jean-Pierre Mulumba, Ph. D.2 • Define economics and the features of the economic perspective • Describe the role of economic theory in economics • Distinguish microeconomics from macroeconomics
  • 3. Learning Objectives (1) Prepared by Prof Jean-Pierre Mulumba, Ph. D.3 • Distinguish positive economics from normative economics • Explain the individual’s economizing problem
  • 4. s Learning Objectives (2) Prepared by Prof Jean-Pierre Mulumba, Ph. D.4 • List the categories of scarce resources • Apply production possibilities analysis, increasing opportunity costs, and economic growth.
  • 5. Introduction Prepared by Prof Jean-Pierre Mulumba, Ph. D.5  People are full of wants and needs  Society possesses productive resources to satisfy many of our wants  Needs exceed our productive capacity  Resources are limited  We have to make choices
  • 6. Introduction (1) Prepared by Prof Jean-Pierre Mulumba, Ph. D.6  Economics is a social science concerned with making optimal choices under conditions of scarcity
  • 7. The Economic Perspective . Prepared by Prof Jean-Pierre Mulumba, Ph. D.7
  • 8. Scarcity and Choice Prepared by Prof Jean-Pierre Mulumba, Ph. D.8  The economic resources are in limited supply  Choices must be made  Opportunity costs  To obtain more of one thing, society forgoes the opportunity of getting the next best thing  Core of economics: “There is no free lunch”  Someone bears the cost
  • 9. Purposeful Behavior Prepared by Prof Jean-Pierre Mulumba, Ph. D.9  Human behavior reflects “rational self-interest”  Individuals look for to increase their utility  They aim to maximize their satisfaction  Firms are purposely acting to maximize their profit  Purposeful behavior” means: people make decisions with some desired outcome in mind.
  • 10. Marginal Analysis Prepared by Prof Jean-Pierre Mulumba, Ph. D.10  Comparisons of marginal benefits and marginal costs for decision making  Marginal: extra, additional, or a change in  Each option involves marginal benefits and, marginal costs
  • 11. Theories, Principles, and Models . Prepared by Prof Jean-Pierre Mulumba, Ph. D.11
  • 12. The Scientific Method Prepared by Prof Jean-Pierre Mulumba, Ph. D.12  Like other sciences, economics relies on the scientific method: elements  Observation of the real world  Hypothesis formulation  Testing the hypothesis  Accepting, rejecting, or modifying the hypothesis
  • 13. The Scientific Method(1) Prepared by Prof Jean-Pierre Mulumba, Ph. D.13  Economists develop individuals and institutions behavior theories  Theories, principles, and models are “purposeful simplifications.”  Economic principles and models are the tools for ascertaining cause and effect
  • 14. The Scientific Method(2) Prepared by Prof Jean-Pierre Mulumba, Ph. D.14  Economic principles are  Generalizations relating to economic behavior  Using the ceteris paribus or other things-equal assumption  Factors other than those being considered do not change.  Graphical expression  Economic models are often expressed graphically
  • 15. Microeconomics and Macroeconomics Economists develop economic principles and models at two levels. Prepared by Prof Jean-Pierre Mulumba, Ph. D.15
  • 16. Microeconomics Prepared by Prof Jean-Pierre Mulumba, Ph. D.16  Decision making by individuals, households, or business firms  Details of their behavior  Examples:  Price of a specific product  Number of workers  Revenue or income of a particular firm or household  Expenditures of a specific firm, government entity, or family
  • 17. Macroeconomics Prepared by Prof Jean-Pierre Mulumba, Ph. D.17  Examines the performance and behavior of the economy as a whole. It  focuses its attention on  Economic growth  Business cycle  Interest rates  Inflation
  • 18. Macroeconomics(1) Prepared by Prof Jean-Pierre Mulumba, Ph. D.18  Behavior of major economic aggregates such as  Government  Household  Business sectors.  An aggregate is a collection of specific economic units treated as if they were one unit.  Seeks to obtain an overview, or general outline  Micro–macro distinction does not mean that economics is so highly compartmentalized
  • 19. Positive and Normative Economics Prepared by Prof Jean-Pierre Mulumba, Ph. D.19  They concern both Microeconomics and macroeconomics  Positive economics focuses on facts and cause- and-effect relationships.  Includes description, theory development, and theory testing.  Avoids value judgments.  Establishes scientific statements about economic behavior  Deals with what the economy is actually like.  Critical to good policy analysis.  Examples: “The unemployment rate in France is higher than that in the United States.”
  • 20. Positive and Normative Economics(1) Prepared by Prof Jean-Pierre Mulumba, Ph. D.20  Normative economics  Incorporates value judgments about what the economy should be like  Concerns particular policy actions recommended to achieve a desirable goal  Looks at the desirability of certain aspects of the economy  Underlies expressions of support for particular economic policies.  Example: “France ought to undertake policies to make its labor market more flexible to reduce unemployment rates
  • 21. Individual’s Economizing Problem . Prepared by Prof Jean-Pierre Mulumba, Ph. D.21
  • 22. Economizing Problem Prepared by Prof Jean-Pierre Mulumba, Ph. D.22  The need to make choices  Caused because by economic wants exceed economic means  Implying  to take account of a budget constraint  to distinguish between unattainable and unattainable options  to take account of trade-offs and opportunity costs  to make the best choice possible  According to change in income
  • 23. Limited Income Prepared by Prof Jean-Pierre Mulumba, Ph. D.23  We all have a finite amount of income  even the wealthiest among us must decide how to spend his money  Income comes to us in the form of wages, interest, rent, and profit  Some people don’t earn any income
  • 24. Unlimited Wants Prepared by Prof Jean-Pierre Mulumba, Ph. D.24  Most people have virtually unlimited wants.  Biological  Or sociological  We desire goods and services that provide utility  Economic wants tend to change over time  For most people, their needs cannot be fully satisfied.  Because of limited income and insatiable wants, we need to economize
  • 25. A Budget Line Prepared by Prof Jean-Pierre Mulumba, Ph. D.25  The economizing problem is visualized by a budget line  A budget constraint  A schedule or curve of various combinations of products a consumer can afford with his income  We assume two products  See next slide
  • 26. A Budget Line(1) Prepared by Prof Jean-Pierre Mulumba, Ph. D.26  .  .12 10 8 6 4 2 0 2 4 6 8 10 12 14 Quantity of Paperback Books QuantityofDVDs Income = $120 Pdvd = $20 = 6 Income = $120 Pb = $10 = 12 Attainable Unattainable 6 5 4 3 2 1 0 0 2 4 6 8 10 12 DVDs $20 Books $10 $120 Budget
  • 27. A Budget Line(2) Prepared by Prof Jean-Pierre Mulumba, Ph. D.27  Attainable and Unattainable Combinations  From the $120 of money income  All the combinations of DVDs and books on or inside the budget line are  What you can afford to buy with the $120  The budget line shows all combinations that cost exactly the full $120  All the combinations beyond the budget line are unattainable
  • 28. A Budget Line Prepared by Prof Jean-Pierre Mulumba, Ph. D.28  Trade-Offs and Opportunity Costs  The budget line iillustrates the idea of trade-offs arising from limited income.  To obtain more DVDs, you have to give up some books  2 books.  So the opportunity cost of the first DVD is 2 books  The constant slope of the line budget constraint is a constant opportunity cost
  • 29. A Budget Line(3) Prepared by Prof Jean-Pierre Mulumba, Ph. D.29  Choice  Limited income forces people to choose what combination of goods to satisfy their needs  You will select the combination that you think is “best.”  You evaluate your marginal benefits and marginal costs to make choices  that maximize your satisfaction
  • 30. A Budget Line(4) Prepared by Prof Jean-Pierre Mulumba, Ph. D.30  Income Changes  The location of the budget line varies with money income  An increase in money income shifts the budget line to the right  A decrease in money income shifts it to the left.
  • 31. Society’s Economizing Problem Society must also make choices under conditions of scarcity Prepared by Prof Jean-Pierre Mulumba, Ph. D.31
  • 32. Society’s Economizing Problem Prepared by Prof Jean-Pierre Mulumba, Ph. D.32  Society must also make choices under conditions of scarcity.  It faces an economizing problem.  Limited resources:  Land.  Labor  Capital  Entrepreneurial Ability
  • 33. Society’s Economizing Problem(1) Prepared by Prof Jean-Pierre Mulumba, Ph. D.33  Scarce Resources  Society has limited or scarce economic resources  All natural, human, and manufactured resources used in the production of goods and services  Four general categories.  Combined to produce goods and services  Called factors of production, or “inputs.”
  • 34. Society’s Economizing Problem(2) Prepared by Prof Jean-Pierre Mulumba, Ph. D.34  Resource Categories:  Land : all natural resources (“gifts of nature”) used in the production process.  These include forests  Mineral and oil deposits  Water resources  Wind power  Sunlight,  Arable land.
  • 35. Society’s Economizing Problem(3) Prepared by Prof Jean-Pierre Mulumba, Ph. D.35  Resource Categories:  Labor: people’s physical actions and mental activities to produce goods and services.  The work-related activities of a logger,  Retail clerk,  Machinist,  Teacher  Professional football player  Nuclear physicist
  • 36. Society’s Economizing Problem(4) Prepared by Prof Jean-Pierre Mulumba, Ph. D.36  Resource Categories  Capital (or capital goods):  Manufactured aids used in producing goods and services.  Factory, storage, transportation, and distribution facilities, tools and machinery.  Investment is spending for the production and accumulation of capital goods.
  • 37. Society’s Economizing Problem(5) Prepared by Prof Jean-Pierre Mulumba, Ph. D.37  Consumer goods satisfy wants directly, whereas capital goods do so indirectly  The term “capital” refers to productive equipment  Money (financial capital): a means for purchasing consumer goods and capital goods
  • 38. Society’s Economizing Problem(6) Prepared by Prof Jean-Pierre Mulumba, Ph. D.38  Resource Categories  Entrepreneurial Ability  Resources supplied by entrepreneurs, who perform important economic functions  The entrepreneur takes the initiative to produce a good or a service.  He is the driving force behind production  the agent who combines the other resources  The agent who makes the strategic business decisions
  • 39. Society’s Economizing Problem(7) Prepared by Prof Jean-Pierre Mulumba, Ph. D.39  The entrepreneur innovates  The entrepreneur bears risk  Innovation is risky
  • 40. Production Possibilities Model Society uses its scarce resources to produce goods and services Prepared by Prof Jean-Pierre Mulumba, Ph. D.40
  • 41. Production Possibilities Model Prepared by Prof Jean-Pierre Mulumba, Ph. D.41  The macroeconomic model of production possibilities  It shows alternatives and choices it faces  Assumptions:  Full employment  The economy employs all its available resources.  Fixed resources  The quantity and quality of the factors of production are fixed.  Fixed technology  The state of technology is constant.  Two goods  The economy is producing only two goods: pizzas and
  • 42. Production Possibilities Table Prepared by Prof Jean-Pierre Mulumba, Ph. D.42  A production possibilities table lists the different combinations of two products that can be produced with a specific set of resources  Table 1.1 presents a simple, hypothetical economy that is producing pizzas and industrial robots.  At alternative A, this economy uses all its available resources to produce industrial robots  at alternative E, all resources would go to pizza production  An economy typically produces both capital goods and consumer goods, as in B, C, and D.
  • 43. Production Possibilities Table(1) Prepared by Prof Jean-Pierre Mulumba, Ph. D.43  At alternative A, this economy uses all its available resources to produce industrial robots  at alternative E, all resources would go to pizza production  An economy typically produces both capital goods and consumer goods, as in B, C, and D.
  • 44. Production Possibilities Table(2) Prepared by Prof Jean-Pierre Mulumba, Ph. D.44  Moving from alternative A to E, we increase the production of pizzas at the expense of the production of industrial robots.  But there is a cost: More pizzas mean fewer industrial robots.  Thereby reducing potential future production.
  • 45. Production Possibilities Table(3) Prepared by Prof Jean-Pierre Mulumba, Ph. D.45  By moving toward A, society chooses to forgo current consumption  Thereby freeing up resources that can be used to increase the production of capital goods.  By building up its stock of capital this way, society will have greater future production  Greater future consumption
  • 46. Production Possibilities Curve Prepared by Prof Jean-Pierre Mulumba, Ph. D.46  The production possibilities table is shown graphically as a production possibilities curve  It displays the different combinations of goods and services that society can produce in  A full employment economy  Assuming a fixed availability of supplies of resources and fixed
  • 47. Production Possibilities Curve(1) Prepared by Prof Jean-Pierre Mulumba, Ph. D.47  Each point on the curve represents the two goods maximum production  The curve is a “constraint” because it shows the limit of attainable outputs.  Points on the curve are attainable with its available resources.  Points inside the curve are attainable, but they are not as desirable as points on the curve.  Points lying beyond the curve are unattainable with the current availability of resources and technology.
  • 48. Law of Increasing Opportunity Costs Prepared by Prof Jean-Pierre Mulumba, Ph. D.48  The opportunity cost of pizzas: the number of industrial robots units that must be given up to obtain another unit of pizzas  In moving from alternative A to alternative E: the opportunity cost of each additional unit of pizzas is greater than the opportunity cost of the preceding one.  To get an additional pizza we sacrifice 1, 2, 3, 4 robots
  • 49. Law of Increasing Opportunity Costs(1) Prepared by Prof Jean-Pierre Mulumba, Ph. D.49  Conversely, moving from E to A, the cost of an additional unit of industrial robots is 1/4, 1/3, 1/2, and 1 unit of pizzas,  Our example illustrates the law of increasing opportunity costs reflected in the shape of the curve
  • 50. Economic Rationale Prepared by Prof Jean-Pierre Mulumba, Ph. D.50  The law of increasing opportunity costs: economic resources are not completely adaptable to alternative uses.  Many resources are better at producing one type of good than at others.  By increasing resources to produce one good, we are making them increasingly scarce.  The resources lack of perfect interchangeability causes the increasing opportunity costs
  • 51. Optimal Allocation Prepared by Prof Jean-Pierre Mulumba, Ph. D.51  Which of the attainable combinations of pizzas and industrial robots is optimal (best)?  That is to maximize satisfaction?  Any economic decision is based s on comparisons of marginal benefit (MB) and marginal cost (MC).
  • 52. Optimal Allocation(1) Prepared by Prof Jean-Pierre Mulumba, Ph. D.52  The optimal amount of the activity occurs where MB = MC.  Society needs to make a similar assessment about its production decision  Each successive unit of pizza brings with it both increasing marginal costs and decreasing marginal benefits.
  • 53. Optimal Allocation(2) Prepared by Prof Jean-Pierre Mulumba, Ph. D.53  In Figure 1.3, net gains can continue to be realized until pizza production has been increased to 200,000.  So resources are efficiently allocated when the marginal benefit and marginal cost of its output are equal (MB = MC)
  • 54. Unemployment, Growth, and the Future Economic growth and international trade increase consumption possibilities Prepared by Prof Jean-Pierre Mulumba, Ph. D.54
  • 55. Unemployment and the PP Curve Prepared by Prof Jean-Pierre Mulumba, Ph. D.55  Any point inside the production possibilities curve U represents unemployment or a failure to full employment. The arrows  indicate that by realizing full employment, the economy could operate on the curve.  This means it could produce more of one or both products than it is producing at point U.
  • 56. A Growing Economy Prepared by Prof Jean-Pierre Mulumba, Ph. D.56  When we drop the assumptions, the production possibilities curve shifts positions
  • 57. A Growing Economy: Increases in Resource Supplies Prepared by Prof Jean-Pierre Mulumba, Ph. D.57  Resource supplies are fixed at any specific moment, but they change over time.  Growing population increases in the labor supplies and entrepreneurial ability.  More education improves labor quality  Increased supplies of the factors of production equals the ability to produce more  The production possibilities curve shifts outward and to the right
  • 58. A Growing Economy: Advances in Technology Prepared by Prof Jean-Pierre Mulumba, Ph. D.58  An advancing technology brings both new and better goods and improved ways of producing them  It allows society to produce more goods with available resources  It causes outward shifts of the nation’s production possibilities curve
  • 59. Present Choices and Future Possibilities Prepared by Prof Jean-Pierre Mulumba, Ph. D.59
  • 60. Present Choices and Future Possibilities (1) Prepared by Prof Jean-Pierre Mulumba, Ph. D.60  An economy’s current choice of positions on its production possibilities curve helps determine the future location of that curve.  Goods for the future such as capital goods  Goods for the present are consumer goods
  • 61. A Qualification: International Trade Prepared by Prof Jean-Pierre Mulumba, Ph. D.61  In this analysis an individual nation is limited to the combinations of output indicated by its production possibilities curve  International specialization and trade allow a nation to get more of a desired good at less sacrifice of some other good  Expansion of domestic production possibilities and international trade are two separate routes for obtaining greater output
  • 62. Pitfalls to Sound Economic Reasoning Some common pitfalls to avoid in successfully applying the economic perspective Prepared by Prof Jean-Pierre Mulumba, Ph. D.62
  • 63. Biases Prepared by Prof Jean-Pierre Mulumba, Ph. D.63  Biases and preconceptions to the field of economics  Biases cloud thinking and interfere with objective analysis  All of us must be willing to shed biases and preconceptions that are not supported by facts
  • 64. Loaded Terminology Prepared by Prof Jean-Pierre Mulumba, Ph. D.64  The economic terminology used is sometimes emotionally biased, or loaded  Reject or discount such terminology
  • 65. Fallacy of Composition Prepared by Prof Jean-Pierre Mulumba, Ph. D.65  Thinking that the assumption that what is true for one individual is necessarily true for a group of individuals  A statement that is valid for an individual or part is not necessarily valid for the larger group or whole
  • 66. Post Hoc Fallacy Prepared by Prof Jean-Pierre Mulumba, Ph. D.66  Because event A precedes event B, don’t assume that A is the cause of B.  This kind of faulty reasoning is known as the post hoc, ergo propter hoc, or “after this, therefore because of this,” fallacy
  • 67. Correlation but Not Causation Prepared by Prof Jean-Pierre Mulumba, Ph. D.67  Correlation between two sets of data indicates an association in some systematic and dependable way  The relationship could be purely coincidental or dependent on some other factor not included in the analysis.  Causation: cause and effect