Ch01_Limits Alternatives and Choices

CH 01:
LIMITS, ALTERNATIVES, AND
CHOICES
Rondi A. Schei

Preliminary Definitions
 Opportunity Cost represents the “price we pay” to
obtain something. In other words, it is that next best
alternative that you would have otherwise chosen.
 Utility refers to the “amount of satisfaction” you get
from consuming (using) a product or service.
 Marginal Analysis is the analytical process by which
we measure the benefits and costs of our decisions
or actions.
 Economizing Problem refers to issues revolving
around how to budget our limited time, money, and
resources

Preliminary Definitions

 Optimal Allocation is when the right mix of goods
and services are being produced for the product
market.
 This is determined via Marginal Analysis
 Economic Growth increases societies ability to
produce goods and services
 This happens in 3 ways:
1. There is an increase in the supply of resources
2. There is improvement in resource quality
3. There is an advancement in technology

Economic Principles
 Economic theories and principles are statements
about economic behavior that help predict outcomes
from various actions
 Three things to know:
1. They are GENERALIZATIONS and represent the
tendencies of average people and firms
2. They use the “OTHER-THINGS EQUAL” assumption
(aka ceteris paribus) meaning that any factors other
the ones of direct interest will have no effect on an
outcome.
3. They use GRAPHICAL EXPRESSION. Many theories
and principles can be shown as a graphical model.

Individual’s Economizing Problem

 Individuals have to make choices about what
products and services to buy or how to use their
time.
 People generally have a fixed amount of income
and only 24 hours in a day.
 A Budget Line represents the tradeoff between two
goods/choices with fixed income/time.

Budget Line Example:
Jack has $20 in his wallet and no credit/debit cards. He must
decide between two goods: pizza and beer from the local pub.
slice of pizza = $2 pint of Beer = $4

10

8 All possible

Slices of Pizza
combinations
6 for $20

4

2

0
1 2 3 4 5
Pints of Beer

Attainable Combinations
Combination Z:
Total Cost = (4x$4) + (8x$2) = $32

Combination X: 10 Unattainable
Total Cost = (1x$4) + (4x$2) = $12
8

Slices of Pizza
Z

 Unattainable 6

 The region to the right 4 X
of the budget line
2
Attainable
 Attainable
0
 The region to the left of 1 2 3 4 5
Pints of Beer
the budget line

Question
 What is Jack’s opportunity cost of consuming a
third pint of beer? (What do we give up?) What
else can we say about opportunity costs?
 If he is consuming a 3rd beer, then he has already had two.
 To obtain a 3rd beer costs $4
 With $4 he could buy 2 slices of pizza
 Therefore, he gives up the opportunity of eating two more slices
of pizza.
 Every time Jack drinks a beer he gives up the opportunity to
consume 2 slices of pizza. This means the opportunity cost is
constant.
 *Note: Opportunity cost measures from one choice to the next.
Therefore it is a MARGINAL COST!

Economic Resources
 Economic Resources are those natural, human, and
manufactured resources that go into the production of
goods and services. They are the factors of production.
 Four Categories:
1. Land: All natural resources.
2. Labor: The physical actions and mental activities that
people contribute to the production of goods.
3. Capital: All manufactured aids used in producing
consumer goods.
 Investment: the money used to purchase capital
resources.
4. Entrepreneurial Ability (EA): That human talent that
combines the above resources into innovative
products, who makes strategic decisions, and bears risk.

Society’s Economizing Problem

 With the individual we were looking at just one
resource such as time or money.
 When we look at society we have to consider
multiple resources.
 All resources are not made equal.
 All resources are SCARCE.
 A Production Possibilities Model shows the tradeoffs
between producing two different goods with scarce
resources.

Production Possibilities Model

 The Necessary Assumptions:
1. Full Employment: The economy is using all its available
resources
2. Fixed Resources: The quantity and quality of the
factors of production are fixed
3. Fixed Technology: The available methods used to
produce do not change
4. Two Goods: Assume there are only two goods in the
economy. We categorize them into capital goods and
consumer goods.

Example
We have 2 products: shoes & trucks. The table represents the units of
shoes and the units of trucks than can be produced with available
resources. 1 unit shoes = 100,000 and 1 unit trucks = 1,000

A
10
1 B
Shoes Trucks 8 2
C
A 0 10
Trucks 6
B 1 9 3
C 2 7 4 D
D 3 4
2 4
E 4 0
E
0
1 2 3 4 5
Shoes

Opportunity Costs


A
10
1 B
8 2

Trucks (1,000)
C
6
3
4 D

2 4

E
0
1 2 3 4 5
Shoes
(100,000)

Questions
 Are opportunity costs constant?
 No. The bowed out shape of the production possibilities
curve represents increasing opportunity costs and
diminishing marginal returns.
 Why do the opportunity costs increase rather than
remain constant?
 Because resources are not equally substitutable. Just
because a person is an awesome truck driver does not
mean they are also good at making shoes and vice versa.

Economic Growth
 Economic Growth will cause
the production possibilities
curve to shift outward.

Trucks
 If there is an increase in
available
resources, technology, or
quality improves, we can
produce more shoes AND Shoes
more trucks
 If there is an technological
improvement that only
affects the shoe Trucks
industry, then the curve will
shift outward on only the
shoe axis.
Shoes

Ch01_Limits Alternatives and Choices

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