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ECO 2013
Chapter 1: Limits, Alternatives, and Choices
The Economic Problem:
The problem is that, although your wants, or
desires, are virtually unlimited, the resources
available to satisfy these wants are scarce.
Scarce resources:
 means limited goods and services.
 Restricts options and demands choices.
 Price exceeds ZERO
 Because resources are scarce, you must choose
from among your many wants, and you must
forego some choices.
 No such thing as a free lunch
Someone bears a cost
Purposeful Behavior
 We assume that human behavior reflects “rational
self interest”
Created by: Maria Mari
Fall, 2007
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ECO 2013
Chapter 1: Limits, Alternatives, and Choices
 Individuals look for and pursue opportunities
to increase their utility
The satisfaction, pleasure,
happiness, obtained from
consuming a good or
service.
Purposeful behavior
Does not assume that people
and institutions are immune from
faulty logic and therefore are perfect decision
makers.
 Rational Self-Interest
o Means that individuals try to maximize the
expected benefit achieved with a given cost or to
minimize the expected cost of achieving a given
benefit.
o Marginal benefits to exceed Marginal cost
Marginal Analysis:
 Comparison of marginal benefits and marginal costs
usually for decision making.
 Marginal means extra, additional, or change in
 Always choices are made where
o Marginal benefits > Marginal Costs
Theories, Principles, and Models:
 The Scientific Method:
o Elements:
 The observation of real-world behavior and
outcomes.
 Based on those observations, the formulation
of a possible explanation of cause and effect
( hypothesis)
Created by: Maria Mari
Fall, 2007
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ECO 2013
Chapter 1: Limits, Alternatives, and Choices
 The testing of this explanation by comparing
the outcomes of specific events to the
outcome predicted by the hypothesis.
 The acceptance, rejection, or modification of
the hypothesis based on these comparisons.
 The continued testing of the hypothesis
against the facts.
 Economic principle
o A very well tested and widely
accepted theory.
Microeconomics and Macroeconomics
o Microeconomics
 This study of the economic behavior in
particular markets, such as that for
computers or unskilled labor.
o Macroeconomics
 The study of the economic behavior of the
entire economy
Normative versus Positive

Normative: a statement that
represents an opinion, which cannot be
proved or disproved.
Created by: Maria Mari
Fall, 2007
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ECO 2013
Chapter 1: Limits, Alternatives, and Choices
 Incorporates value judgments about
what the economy should be like or
what particular policy actions should be
recommended to achieve a desirable
goal.
 Basis of economic policy
 Looks at the desirability of certain
aspects of the economy
 What ought to be
 Ethical value judgments

Positive: a statement that can be
proved or disproved by reference to facts
 Focuses on facts and cause-and-effect
relationships.
 Includes description, theory,
development, and theory testing
 Avoids value judgments, tries to
establish scientific statements about
economic behavior, and deals with what
the economy is actually like.
 Critical to good policy analysis
 What is
 Scientific portion
Society’s Economizing Problem
 The need to make choices because economic wants
exceed economic means
Created by: Maria Mari
Fall, 2007
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ECO 2013
Chapter 1: Limits, Alternatives, and Choices
 Scarce resources:
o Society has limited or scarce economic resources
 Meaning all natural, human, and
manufactured resources that go into the
production of goods and services.
Resources:
 The inputs, or factors of production, used to produce
the goods and services that people want resources
consist of:
o Land: includes all the natural resources used in
the production process.
 Land
 Forest
 Mineral
 Water resources
Also called
factors of
production
o Labor: the physical and mental effort used to
produce goods and services.
o Capital: the buildings, equipment, and human skill
used to produce goods and service
 Physical capital: consists of factories,
machines, tools, buildings, airports,
highways, and other human creations
employed to produce goods and services
 Human capital: consists of the knowledge
and skill people acquire to enhance their
productivity, such as entrepreneurial ability.
o Entrepreneurial ability: managerial and
organizational skills needed to start a firm,
combined with the willingness to take risks.
 Functions
 The entrepreneur takes the initiative in
combining the resources of land, labor,
Created by: Maria Mari
Fall, 2007
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ECO 2013
Chapter 1: Limits, Alternatives, and Choices
and capital to produce a good or a
service
 The entrepreneur makes the strategic
business decisions that set t he course
of an enterprise
 The entrepreneur is the innovator
 The entrepreneur is the risk bearer
 Payments to Resources:
o Wages: payment to resource owners for their
labor
o Interest: payment to resource owners for the use
of their capital
o Rent: payment to resource owners for the use of
their natural resources.
o Profit: the reward for entrepreneurial ability. The
revenue from sales minus the cost of resources
used by the entrepreneur.
Production Possibilities Frontier
o Assumptions for our model
o Two goods: Output in economy is limited to two
products: consumer goods and capital goods.
o Fixed resources: Economy’s resources are fixed
in both quantity and quality during that period
o Fixed techonology: Society’s knowledge about
how these resources combine to produce output,
the available technology does not change.
Created by: Maria Mari
Fall, 2007
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ECO 2013
Chapter 1: Limits, Alternatives, and Choices
o Full employment: the economy is employing all
its available resources.
Production Possibilities Table
A list the different combinations of two products that
can be produced with a specific set of resources,
assuming full employment.
Type of
Product
Consumer good
Capital good
A
0
10
Production Alternatives
B
C
D
1
9
2
7
3
4
E
4
0
Notice: the more we produce of one good, the less
of the other good is produced. Society must give up
one good to get the other.
o Production Possibilities Frontier
o A curve showing alternative combinations of goods
that can be produced when available resources are
used fully and efficiently; a boundary between
inefficient and unattainable combinations.
o Resources are employed fully and efficiently when
there is no change that could increase the
production of one good without decreasing the
production of the other good
o EFFICIENCY
 Involves getting the maximum possible
output from available resources
 It is a point ON THE CURVE
 Points on the curve are attainable as long as
the economy uses all its available resources.
Created by: Maria Mari
Fall, 2007
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ECO 2013
Chapter 1: Limits, Alternatives, and Choices
Consumer Goods
60
Unattainable:
points outside
the curve
A
40
30
B
Efficient:
Points on
the line
20
Inefficient :
points inside
the curve
10
0
10
20
30
40
50
o Efficient points: any point found on the production
possibilities frontier such as A and B.
o Inefficient points: any point inside the production
possibilities frontier. We have idle resources such as
unemployment
o Unattainable points: any point outside the
production possibilities frontier. Requires more than
the resources and technology available to achieve.
o Law of increasing opportunity cost
o To produce each additional increment of a good, a
successively larger increment of an alternative
good must be sacrificed if the economy’s
resources are already being used efficiently.
o
o Shifting the PPF
o Economic growth
 An increase in the economy’s ability to
produce goods and services; an outward shift
of the production possibilities frontier
 Changes in resource availability
Created by: Maria Mari
Fall, 2007
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Capital
goods
ECO 2013
Chapter 1: Limits, Alternatives, and Choices
 Increases in capital stock
 Technological change
Consumer Goods
60
Shift in the
PPF
40
30
20
10
0
10
20
30
40
50
Capital
goods
Some Pitfalls of Faulty Economic Analysis
 The fallacy that association is causation
 The incorrect idea that if two variables
are associated in time, one must
necessarily cause the other
 The fallacy of composition
 The incorrect belief that what is true for
the individual, or part, must necessarily
be true for the group or whole.
 Secondary Effects
 Unintended consequences of economic
actions that may develop slowly over
time as people react to events.
Created by: Maria Mari
Fall, 2007
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