CH1 Microeconomics

Define economics and explain the economic perspective.

Economics is the social science that examines how individuals, institutions, and society make optimal choices under conditions of scarcity. Central to economics is the idea of opportunity cost: the value of the next-best good or service forgone to obtain something.

The economic perspective includes three elements: scarcity and choice, purposeful behavior, and marginal analysis. It sees individuals and institutions as making rational decisions based on comparisons of marginal costs and marginal benefits.

LO1.2 Describe the role of economic theory in economics.

Economists employ the scientific method, in which they form and test hypotheses of cause-and-effect relationships to generate theories, laws, and principles. Economists often combine theories into representations called models.

LO1.3 Distinguish microeconomics from macroeconomics and positive economics from normative economics.

Microeconomics examines the decision making of specific economic units or institutions. Macroeconomics looks at the economy as a whole or its major aggregates.

Positive economic analysis deals with facts; normative economics reflects value judgments.

LO1.4 Explain the individual’s economizing problem and illustrate trade-offs, opportunity costs, and attainable combinations with budget lines.

Individuals face an economizing problem. Because their wants exceed their incomes, they must decide what to purchase and what to forgo. Society also faces an economizing problem. Societal wants exceed the available resources necessary to fulfill them. Society therefore must decide what to produce and what to forgo.

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Graphically, a budget line (or budget constraint) illustrates the economizing problem for individuals. The line shows the various combinations of two products that a consumer can purchase with a specific money income, given the prices of the two products.

LO1.5 List the categories of scarce resources and explain society’s economizing problem.

Economic resources are inputs into the production process and can be classified as land, labor, capital, or entrepreneurial ability. Economic resources are also known as factors of production or inputs.

Economists illustrate society’s economizing problem through production possibilities analysis. Production possibilities tables and curves show the different combinations of goods and services that can be produced in a fully employed economy, assuming that resource quantity, resource quality, and technology are fixed.

LO1.6 Apply production possibilities analysis.

An economy that is fully employed and thus operating on its production possibilities curve must sacrifice the output of some types of goods and services to increase the production of others. The gain of one type of good or service is always accompanied by an opportunity cost in the form of the loss of some of the other type of good or service.

Because resources are not equally productive in all possible uses, shifting resources from one use to another creates increasing opportunity costs. The production of additional units of one product requires the sacrifice of increasing amounts of the other product.

The optimal (best) point on the production possibilities curve represents the most desirable mix of goods. It requires the expanded production of each good until its marginal benefit (MB) equals its marginal cost (MC).

LO1.7 Explain how economic growth and international trade increase consumption possibilities.

Over time, technological advances and increases in the quantity and quality of resources enable the economy to produce more of all goods and services—that is, to experience economic growth. Society’s choice regarding the mix of consumer goods and capital goods in current output determines the future location of the production possibilities curve and the extent of economic growth.

International trade enables a nation to obtain more goods from its limited resources than its production possibilities curve indicates.

LO1.8 Understand graphs, curves, and slopes as they relate to economics.

Graphs are a convenient and revealing way to represent economic relationships.

Two variables are positively (or directly) related when their values change in the same direction. The line or curve representing two directly related variables slopes upward.

Two variables are negatively (or inversely) related when their values change in opposite directions. The line or curve representing two inversely related variables slopes downward.

The value of the dependent variable (the “effect”) is determined by the value of the independent variable (the “cause”).

When the “other factors” that might affect a two-variable relationship are allowed to change, the graph of the relationship will likely shift to a new location.

The slope of a straight line is the ratio of the vertical change to the horizontal change between any two points. The slope of an upward sloping line is positive; the slope of a downward sloping line is negative.

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The slope of a line or curve depends on the units used in measuring the variables. The slope is especially relevant for economics because it measures marginal changes.

The slope of a horizontal line is zero; the slope of a vertical line is infinite.

Together, the vertical intercept and slope of a line determine its location; they are used in expressing the line—and the relationship between the two variables—as an equation.

The slope of a curve at any point is determined by calculating the slope of a straight line tangent to the curve at that point.