Mc Connell and

Brue

Introduction to
Economics and
the Economy
Chapter 01
Limits
alternatives and
Choices

Prof. Dr. Musarrat Adnan

 Learning Objectives
 Define economics and the features of the
economic perspective
 Describe the role of economic theory in
economics.
 Distinguish microeconomics from
macroeconomics and positive economics from
normative economics.
 Explain the individual’s economizing problem and
how trade-offs, opportunity costs, and attainable
combinations can be illustrated with budget lines.
 List the categories of scarce resources and
delineate the nature of society’s economizing
problem
 Learning Objectives
 Apply production possibilities analysis,
increasing opportunity costs, and economic
growth.
 Explain how economic growth and international
trade increase consumption possibilities.
 (Appendix) Understand graphs, curves, and
slopes as they relate to economics.
 Chapter 1 Topics
 The Economic Perspective
 Theories Principles and Models
 Macroeconomics & Microeconomics
 Individual’s Economizing Problem
 Society’s Economizing Problem
 Production Possibility Model
 Unemployment, Growth, and the Future
 Pitfalls to Sound Economic Reasoning
The Economic Perspective
 Economists view things from a
unique perspective. This
economic perspective, or
economic way of thinking, has
several critical and closely
interrelated features.
The Economic Perspective
 Scarcity and Choice
The economic resources needed to
make goods and services are in
limited supply. This scarcity restricts
options and demands choices.
Because we “can’t have it all,” we
must decide what we will have and
what we must forgo
The Economic Perspective
Opportunity Cost
Economists call such sacrifices opportunity
costs: To obtain more of one thing,
society forgoes the opportunity of getting
the next best thing that could have been
created with those resources. That
sacrifice is the opportunity cost of the
choice.
 The Economic Perspective
 Purposeful Behavior
Choices are not random or chaotic but
purposeful.
Economics assumes that human behavior
reflects “rational self-interest.” Individuals
look for and pursue opportunities to
increase their utility—the pleasure,
happiness, or satisfaction obtained from
consuming a good or service.
 The Economic Perspective
 Marginal Analysis: Comparing
Benefits and Costs.
The economic perspective focuses largely
on marginal analysis—comparisons of
marginal benefits and marginal costs,
usually for decision making.
Marginal Cost: The additional cost of an
additional activity.
Marginal Benefit: The additional benefit of
an additional activity.
 Comparing Marginal Benefit and
Marginal Cost.
 MB ˃ MC
 MB ˂ MC
 MB = MC
 Big Economic Questions

 What is to be produced
 How is to be produced
 For whom to be produced
 Theories, Principles, and
Models

The scientific method:

 observe the world
Theories, Principles, and Models

The scientific method:

 observe the world
 formulate hypotheses
 test by comparing outcomes to
predictions
 theories, laws, principles,
models
 Theories, Principles, and Models

 generalizations: on average
 other-things-equal assumption:
change one thing at a time
 abstractions: omit irrelevant
facts & circumstances
 graphical expression
 Theories, Principles, and Models

Economic Principle
 A very well-tested and widely
accepted theory is referred to as
an economic law or an economic
principle
 Theories, Principles, and Models

 Generalizations:
Economic principles are
generalizations relating to economic
behavior or to the economy itself.
Economic principles are expressed
as the tendencies of typical or
average consumers, workers, or
business firms.
 Theories, Principles, and Models

 Other-things-equal assumption:
In constructing their theories,
economists use the ceteris paribus
or other-things-equal assumption—
the assumption that factors other
than those being considered do not
change. They assume that all
variables except those under
immediate consideration are held
constant for a particular analysis.
 Theories, Principles, and Models

Policy economics
 apply theories to set policies to
resolve economic problems or
further economic goals
FORMULATING ECONOMIC POLICY

STATE GOALS

POLICY OPTIONS

IMPLEMENTATION
& EVALUATION
Microeconomics and Macroeconomics

– Microeconomics is the study of

choices made by individuals and
businesses, and the influence of
government on those choices.
– Macroeconomics is the study of
the effects on the national and
global economy of the choices that
individuals, businesses, and
governments make.
 Positive & Normative
Economics
POSITIVE STATEMENTS.…
 based upon facts — without
value judgments “what is”
NORMATIVE STATEMENTS…
 based upon subjective beliefs —
“what ought to be”
 Individual’s Economizing Problem

 Limited Income
 Unlimited Wants
 A Budget Line
Individual’s Economizing Problem
Budget Line
 Individual’s Economizing Problem
Budget Line

Attainable and Unattainable

Combinations
All the combinations of movies and books on or
inside the budget line are attainable from the $120
of money income.

In contrast, all combinations beyond the budget line

are unattainable
 Individual’s Economizing Problem
Budget Line

Trade-Offs and Opportunity Costs.

The budget line illustrates the idea of trade-

offs arising from limited income. To obtain
more movies, you have to give up some
books.
 Individual’s Economizing Problem
Budget Line

Choice:
Limited income forces people to choose
what to buy and what to forgo to fulfill
wants. You will select the combination of
movies and paperback books that you
think is “best.” That is, you will evaluate
your marginal benefits and marginal costs
(here, product price) to make choices that
maximize your satisfaction.
 Individual’s Economizing Problem
Budget Line

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.
Shifts their budget lines outward enables them to
buy more goods and services. But even with
more income, people will still face spending
trade-offs, choices, and opportunity costs.
 Price Changes
The slope of the budget line varies with
change in price of one commodity. A
change in the price of one commodity
rotates the budget line to the right or left;
Rotation in the budget lines outward
enables them to buy more goods and
services of that commodity whose price
has reduced and vice versa.
 Society’s Economizing Problem

 Society must also make choices

under conditions of scarcity. It,
too, faces an economizing
problem.
 Devoting more on one action
means less on the other. Trade-
off
 Society’s Economizing Problem

 ScarceResources.
Resource Categories:
Economists classify economic resources
into four general categories
Land
Labour
Capital
Entrepreneur
 Society’s Economizing Problem

 Land.
Land means much more to the economist
than it does to most people. To the
economist land includes all natural
resources (“gifts of nature”) used in the
production process. These include
forests, mineral and oil deposits, water
resources, wind power, sunlight, etc.
 Society’s Economizing Problem
Labor.
The resource labor consists of the physical actions
and mental activities that people contribute to the
production of goods and services.

Capital
For economists, capital (or capital goods) includes
all manufactured aids used in producing
consumer goods and services. Included are all
factory, storage, transportation, and distribution
facilities, as well as tools and machinery.
Economists use the term investment to describe
spending that pays for the production and
accumulation of capital goods.
 Society’s Economizing Problem

Capital Versus Consumer Goods

Human Capital
The quality of labor depends on human
capital, which is the knowledge and skill
that people obtain from education, on-the-
job training, and work experience.
 Society’s Economizing Problem

Entrepreneurial Ability
Finally, there is the special human resource,
distinct from labor, called entrepreneurial
ability. It is supplied by entrepreneurs,
who perform several critically important
economic functions as:
– The entrepreneur takes the initiative in
combining the resources of land, labor,
and capital to produce a good or a service.
 Society’s Economizing Problem

 The entrepreneur makes the strategic business

decisions and set the business Enterprise
 The entrepreneur innovates.
 The entrepreneur bears risk.

 Because land, labor, capital, and entrepreneurial

ability are combined to produce goods and
services, they are called the factors of
production, or simply “inputs.”
 Production Possibilities Model

Assumptions
Full employment The economy is employing
all of its available resources.
Fixed resources The quantity and quality of
the factors of production are fixed.
Fixed technology The state of technology
(the methods used to produce output) is
constant.
 Production Possibilities Model

Two goods The economy is producing only

two goods: pizzas and industrial robots.
Pizzas symbolize consumer goods,
products that satisfy our wants directly;
industrial robots (for example, the kind
used to weld automobile frames)
symbolize capital goods, products that
satisfy our wants indirectly by making
possible more efficient production of
consumer goods.
 Production Possibilities Model

Production Possibilities Table lists the different combinations

of two products that can be produced with a specific set of
resources, assuming full employment
 Production Possibilities Curve

Opportunity Cost
To get some pizza, we must give up some
robots!
Production Possibilities Curve
Q Unattainable
A B
10
Robots (thousands)
C
9 W
Robots (thousands)

8
7 D
6 Attainable and
5 attainable efficient
4
3 but
2 inefficient
1 E
Q
1 2 3 4 5 6 7 8
Pizzas (hundred thousands)
 Production Possibilities Curve

Production Possibilities Curve

displays the different combinations
of goods and services that society
can produce in a fully employed
economy, assuming a fixed
availability of supplies of resources
and fixed technology
 Production Possibilities Curve

 The production possibilities curve

(frontier) marks the boundary
between attainable & unattainable
production levels
 Points on the curve are attainable &
efficient
 Points above the curve are
unattainable
 Points below the curve are attainable
& inefficient
 Production Possibilities Curve
PIZZA 0 1 2 3 4
(in hundred thousands)
ROBOTS 10 9 7 4 0
(in thousands)

 Opportunity Cost 1st Pizza Unit = 1 Robot Unit

 Opportunity Cost 2nd Pizza Unit = 2 Robot Units
 Opportunity Cost 3rd Pizza Unit = 3 Robot Units
 Opportunity Cost 4th Pizza Unit = 4 Robot Units

the more pizzas we make, the more each one

costs, in terms of robot units foregone
Law of Increasing Opportunity Costs

 As the production of a particular

good increases, the opportunity cost
of producing an additional unit rises.
 Means a graph of the production
possibilities curve will be CONCAVE
— bowed out from the origin
 Economic resources are not
completely adaptable to other uses
Optimal Allocation of Resources

Optimal Output: MB = MC
 Optimal Output
Achieving the optimal output requires
the expansion of a good’s output
until its marginal benefit (MB) and
marginal cost (MC) are equal. No
resources beyond that point should
be allocated to the product. Here,
optimal output occurs at point e,
where 200,000 units of pizzas are
produced.
Unemployment, Growth & the Future

Relationship of Production Possibility

curve and Unemployment, Growth
and the Future
Unemployment

Q
Unemployment &
10 Underemployment
Robots (thousands)
Robots (thousands)

9
8 Shown by Point U
7
6
5 U
4
3
2
1
Q
1 2 3 4 5 6 7 8
Pizzas (hundred thousands)
Unemployment
Q
Unemployment &
10 Underemployment
Robots (thousands)
Robots (thousands)

9
8 Shown by Point U
7
6
5
4 U More of either or
3
2 both is possible
1
Q
1 2 3 4 5 6 7 8
Pizzas (hundred thousands)
 Economic Growth
A rightward shift of the production
possibilities curve caused by....
1. Increases in resource supplies
2. Advances in technology
A Growing
A’
Economy
Q 14 Economic Growth
13 B’
12
11
Robots (thousands)

10
C’
9
8
7
6 D’
5
4
3
2
1 E’

1 2 3 4 5 6 7 8 Q
Pizzas (hundred thousands)
 A Growing Economy
Two Examples of Economic Growth
Favouring Favouring
Present goods Future goods
Goods for the Future

Goods for the Future

Future Future
Curve Curve

Goods for the Present Goods for the Present

Pitfalls to Sound Economic Reasoning

 Biases
 Loaded Terminology
 Fallacy of Composition

 Causation Fallacies
– Post Hoc Fallacy
– Correlation vs Causation
Pitfalls to Sound Economic Reasoning

Biases
Biases cloud thinking and interfere with
objective analysis.
Loaded Terminology
Examples:
 High profits may be labeled “obscene”
 Low wages may be labeled “exploitative”
 Self-interested behavior may be “greed”
Pitfalls to Sound Economic Reasoning

Fallacy of Composition
what is true for one individual or part of a
whole is necessarily true for a group of
individuals or the whole.
Pitfalls to Sound Economic Reasoning

Causation Fallacies
Post Hoc Fallacy
Because event A precedes event B, means A
is the cause of B.
Correlation but Not Causation
Correlation between two events or two sets
of data indicates only that they are
associated in some systematic way but
not causing each other in either one way
or both ways.
 Quick Questions
If you initially have $100 to spend on books or movie
tickets. Price of book $25 each and price movie
tickets $10 each. For each of the following situations,
would the attainable set of combinations that you can
afford increase or decrease?.
a. Your budget increases from $100 to $150 while the
prices stay the same.
b. Your budget remains $100, the price of books
remains $25, but the price of movie tickets rises to
$20.
c. Your budget remains $100, the price of movie
tickets remains $10, but the price of a book falls to
$15
 Quick Questions
Normative and Positive Statements:
a. Economics is a very interesting subject.
b. Government-provided healthcare increases public
expenditures.
c. Smoking may cause lungs cancers.
d. The government should increase taxes on tobacco
products in order to reduce smoking.
e. It is wrong for people to discriminate against others
based on their race or ethnicity.
f. Higher education should be free for all students.
Tuition fees should be abolished.
 Quick Questions
Microeconomics or Macroeconomics.
a. The unemployment rate in the Pakistan was 11 percent in
September 2022.
b. A U.S. software firm laid off, 1500workers last month and
transferred the work to Pakistan.
c. An unexpected freeze in central Florida reduced the citrus crop
and caused the price of oranges to rise.
d. The Inflation rate rose by 20 percent from July 2022 to June 2023,
in Pakistan.
 Quick Questions

1. Draw Production possibility curve.

2. Draw new PPC if:
i. Improvement occurs in the technology of
producing forklifts.
ii. A technological advance occurs in producing
automobiles but not in producing forklifts.
 Quick Questions

Construct the table and find the slope

 Quick Questions

Find the slope of the curve at point ‘A’, ‘B’ and

‘C”
Chapter 1- END