Chapter 1 - Limits, Alternatives, and Choices PDF

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September 5, 2018

Limits, Alternatives, and Choices 1.2 THE ECONOMIC WAY OF THINKING

Scarcity and Choice

- Unlimited wants and limited (or scarcity) resources defines what economics is about.

- Unlimited wants include non-material wants i.e. wanting to live a longer life, but still require resources

- Scarcity of economics resources restricts options and requires choices to be made - There’s no free lunch: a lunch has to be made by someone, even if it is free for the individual

- The opportunity cost of a choice is what forgone for that choice: if you choose to party, you can’t study

- Everything has an opportunity cost Purposeful Behaviour

- Individuals maximize utility (pleasure or usefulness) Marginal Analysis: Comparing Benefits and Costs

- Our choices are made on weighing the marginal (extra) costs and marginal (extra) benefits Consider this… Fast Food Lines 1. People choose the shortest line to reduce time cost 2. Lines tend to have equal lengths as people shift from longer to shorter lines in effort to save time 3. Lines are chosen based on length without much information — cost of obtaining more information is not worth the benefit A. Imperfect information may lead to an unexpected wait

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September 5, 2018 B. Imperfect information may cause some people to leave when they see a long line 4. When a customer reaches the counter, other economic decisions are made about what to order. From and economic perspectives these choices will be made after the consumer compares the costs and benefits of possible choices. 1.3 THEORIES, PRINCIPLES, AND MODELS

The Scientific Method and Models

- Observing real-work behaviour and outcomes - Formulating a hypothesis based of those observations - Testing this hypothesis by comparing the actual outcomes to the hypothesis predictions

- Accepting, rejecting, or modifying the hypothesis - Continuing to test the hypothesis against the facts - As favourable results accumulate, the hypothesis evolves into a theory or model - A widely accepted theory is referred to law or economic principle Purposeful simplifications

- We simply try to understand the economic world arrows us Generalizations

- Thats what economic principles are i.e. when the price of a product falls the average consumer buys more of that product

Other-Things-Equal Assumption (ceteris paribus)

- we keep other variables constant to better understand a particular issue. - For example: if the price of Coke rises,

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September 5, 2018 1.4 - MICROECONOMICS AND MACROECONOMICS

Microeconomics

- It examines individual units (household, firm or industry) and their decision making process

Macroeconomics

- It examines the whole economy • National output of goods and services (GDP) - The subdivisions or aggregates Positive Economics

- The analysis of facts to establish cause and effect relationships - What is - Without value judgements: the temperature is 24 degrees — an assertion that can be tested

Normative economics

- The part of economics involving value judgements about the economy should be like - what ought to be: “there should not be any pool people in Canada” — an assertion that cannot be tested 1.6 - THE INDIVIDUALS ECONOMIC PROBLEMS

Economic Problem

- Individuals need to make choices because: • Wants are unlimited • But that means to get those wants are limited (finite) 3

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Limited Income

- Income is finite even for the wealthiest Unlimited Wants

- Wants are insatiable - Wants change over time The Budget Line: with an income of $120

- Attainable and Unattainable Combinations • Points above the budget line cannot be attained - Trade-Offs and Opportunity Costs • The more books you buy, the fewer DVDs you can purchase - Choice • Make the best choice possible given your preferences and income - Income Changes • An increase in income shifts the budget line up and to the right. A drop in prices of books and DVD will have the same impact

- The average income per capita per country differs, therefore individual budget constraints vary greatly among nations. 1.6 - SOCIETY’S ECONOMIC PROBLEM

Scarce Resources (Factors of Production)

- Land • All natural resources (gifts of nature) - Labour • Physical and mental talents of individuals used in producing good and services • Also called Human Capital 4

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- Capital • Or capital goods - manufacturing aids to produce goos and services such as a factory, storage, transportation, distribution facilities, and tools and machinery

• Also referred to as Investment - Entrepreneurial Ability • Entrepreneurs’ economic functions - Takes initiative - Makes business decisions - Innovates - Bears risk 1.7 PRODUCTION POSSIBILITIES MODEL

Production Possibilities Model

- Illustrates production choices - Assumptions: • Full employment and productive efficiency (lowest cost of producing) • Fixed resources - Factors of production • Fixed technology • Two Goods - Consumer Goods: pizza - Capital Goods: industrial robots Law of Increasing Opportunity Cost

- Opportunity cost increases with amount of goods produced - As we make more pizzas, the # of robots we have to give up (per pizza) increases because economic resources are not completely adaptable to alternative uses 5

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- The more pizzas we make, the more each one costs in terms of robots foregone - Example: some land is better suited for wheat than vineyards, while other land is better suited for vineyards than wheat. As land is increasingly converted to vineyards, less desirable lands where wheat was grown has to be used, thus less productive.

Optimal Allocation of Resources

- Decide on optimal allocation of resources by comparing Marginal (extra) Cost (MC) to Marginal Benefit (MB)

- Marginal benefit is the extra benefit associated with consumer one more unit - Marginal cost is the extra opportunity cost of that extra unit

1.8 - UNEMPLOYMENT, GROWTH, AND THE FUTURE

To Get a Growing Economy

- Increases in Factor Supplies • More land, labour, capital, and entrepreneurial activity - Improved Factor Quality • i.e better trained and educated labour force - Technological Advances 6

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• Getting more output from a given amount of factor input Unemployment

- The economy might not be operating at full employment • Points inside the production possibility curve (PPC) • A move toward full employment yields a greater output A Qualification: International Trade

- An individual nation is limited by the production possibilities curve - But NOT when there is international specialization and trade! - Possible to consume ABOVE the production possibility curve because with trade each trading nation will have more Goods and Services available to it

- If one country specializes in robots (for which it is the lower cost producer) and another in pizzas (for which it is the lower cost producer) and then trade, each nation will be able to consume more robots and pizza and then each nation produced both

Consider This… Women, the Workforce and Production Possibilities

- There has been an increase in the number of women who are working. This has had the effect of shifting the production possibilities curve outward

- Whereas 40% of the women worked in 1965, more than 62% of the women are not working part time or full time

- There are a number of reasons for this change: • An increase in women’s wage rates • Greater access to jobs • Changes in preferences and attitudes Pitfalls to Sound Economic Reasoning

- Biases • preconceptions that are not based on facts 7

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- Loaded Terminology • Terms that contain the prejudice and value judgements of others • It is very difficult for a person to describe economic behaviour without letting their options about that behaviour creep into their discussion. The distinction between positive and normative statements is not always clearly apparent

• Often, there is a deliberate attempt to sway opinion by using loaded terminology. (greedy owners, obscene profits, exploited workers, mindless bureaucrats, costly regulations, creeping socialism)

- Fallacy of Composition • What is true for one individual or part of a whole is not necessarily true for a group of individuals. If you stand up at a baseball game you may get a better view, but if everyone stands up, no one will see better.

• What holds for one individual may not hold for the whole group - Causation Fallacies • Post Hoc Fallacy: When two events occur in time sequence, the first event is not necessarily the cause of the second event. (Example: If the Toronto Maple Leafs hire a new coach and its record improves, was he the cause? Maybe. It could be an easier schedule, or some other unknown factor)

- Correlation versus Causation • Events may be related without a causal relationship • The positive relationship between education and income does not tell us which causes the increase in the other, (Which is the independent variable and which is the dependent variable?)

• It may be that the increase income that occurs with increased education is due to some other third factor that is not under direct consideration

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