Economics Notes: Limits, Alternatives, and Choices

Economics: Limits, Alternatives, and Choices

The Economic Perspective

  • Economics is a social science focused on making optimal choices under scarcity.
  • Economic wants surpass society's productive capacity.
  • The economic perspective involves individuals and institutions making rational decisions in their self-interest.
  • It considers:
    • Scarcity and choice: Resources are limited, so choices must be made.
    • Opportunity cost: The value of the next best alternative that is forgone when a choice is made. "There is no free lunch."
    • Purposeful behavior: Rational self-interest guides individuals and firms to increase utility and profit, respectively, to achieve a desired outcome.
    • Marginal analysis: Comparing marginal benefits and marginal costs to make decisions. Marginal means "extra" or "additional."

Theories, Principles, and Models

  • The scientific method is used to systematically pursue knowledge. It includes:
    • Observation of facts.
    • Formulation of a hypothesis.
    • Testing the hypothesis.
    • Accepting, rejecting, or modifying the hypothesis.
    • Continued testing, if necessary.
  • Economic principles are generalizations, often expressed graphically.
  • The "other-things-equal" assumption (ceteris paribus) assumes that factors other than those being considered do not change.

Microeconomics and Macroeconomics

  • Microeconomics studies individual consumers, firms, or markets.
  • Macroeconomics studies the entire economy or major aggregates of the economy.

Positive and Normative Economics

  • Positive economics deals with factual economic statements.
  • Normative economics involves value judgments.

The Economizing Problem

  • The economizing problem arises from limited income and unlimited wants.
  • The budget line illustrates attainable and unattainable combinations, trade-offs, opportunity costs, and choice.
  • Changes in income shift the budget line.
  • A Consumer’s Budget Line
    • Consider a consumer with an income of 120120, who can buy T-shirts (price = 2020) and Paperback Books (price=1010).
    • The budget line shows various combinations of T-shirts and books that can be bought with the income.
    • For example, the consumer could buy 6 T-shirts and 0 books, or 5 T-shirts and 2 books, and so on.
    • Combinations beyond the budget line are unattainable.

Society’s Economizing Problem

  • Four categories of economic resources:
    • Land: All natural resources used in production.
    • Labor: Physical and mental activities people contribute to production.
    • Capital (investment): Human-produced physical objects and intangible ideas used in production.
    • Entrepreneurial ability: A special human resource distinct from labor.
  • Functions of entrepreneurs:
    • Employ the other factors of production.
    • Take initiative.
    • Make strategic business decisions.
    • Innovate.
    • Take risks.

Production Possibilities Model: Overview

  • An economic model showing different combinations of two goods an economy can produce.
  • Assumptions:
    • Full employment
    • Fixed resources
    • Fixed technology
    • Two goods: consumer goods and capital goods
  • Production Possibilities Curve
    • Illustrates the maximum output of two goods given fixed resources and technology.
    • Points inside the curve are attainable but represent inefficient use of resources.
    • Points outside the curve are unattainable given current resources and technology.
    • Example production possibilities:
      • Pizzas (in hundred thousands): 0, 1, 2, 3, 4
      • Industrial Robots (in thousands): 10, 9, 7, 4, 0

Increasing Opportunity Costs

  • Law of increasing opportunity costs: As more of a particular good is produced, its marginal opportunity costs increase.
  • Production possibilities curve:
    • Concave shape
    • Economic rationale

Optimal Output: MB = MC

  • Marginal benefit (MB) and marginal cost (MC) should be compared to determine the optimal output level.
  • The optimal point is where MB=MCMB = MC.

Unemployment, Growth, and the Future

  • Economic growth expands the production possibilities curve.
  • The future possibilities depends on current choices between goods.
  • International Trade
    • Leads to Specialization
    • Results in Increased production possibilities

Pitfalls to Sound Economic Reasoning

  • Common pitfalls to avoid:
    • Biases.
    • Loaded terminology.
    • Fallacy of composition.
    • Post hoc fallacy.
    • Correlation but not causation.