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Limits, Alternatives, and Choices
In this Chapter You Will Learn
1. The definition of economics and the features of the
2. The role of economic theory in economics.
3. The distinction between microeconomics and
4. The categories of scarce resources and the nature of
the economizing problem.
5. About production possibilities analysis, increasing
opportunity costs, and economic growth.
6. (Appendix) About graphs, curves, and slopes as they
relate to economics.
(An appendix on understanding graphs follows this
chapter. If you need a quick review of this mathematical
tool, you might benefit by reading the appendix first.)
People’s wants are numerous and varied. Biologically,
people need only air, water, food, clothing, and shelter. But
in modern society people also desire goods and services
that provide a more comfortable or affluent standard of living.
We want bottled water, soft drinks, and fruit juices, not just
water from the creek. We want salads, burgers, and pizzas,
not just berries and nuts. We want jeans, suits, and coats,
not just woven reeds. We want apartments, condominiums,
or houses, not just mud huts. And, as the saying goes, “that
is not the half of it.” We also want flat-panel TVs, Internet
service, education, homeland security, cell phones, health
care, and much more.
Fortunately, society possesses productive resources, such
as labor and managerial talent, tools and machinery, and
land and mineral deposits. These resources, employed in
the economic system (or simply the economy), help us
produce goods and services that satisfy many of our
economic wants. But the blunt reality is that our economic
wants far exceed the productive capacity of our scarce
(limited) resources. We are forced to make choices. This
unyielding truth underlies the definition of economics, which
is the social science concerned with how individuals,
institutions, and society make optimal (best) choices under
conditions of scarcity.
Origin of the Idea
Origin of the term “Economics”
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.
Scarcity and Choice
From our definition of economics, we can easily see why
economists view the world through the lens of scarcity.
Scarce economic resources mean limited goods and
services. 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.
Consider This...: Free for All?
Courtesy of Robbins Recreation,
and artist Katherine Robbins.
Free products are seemingly everywhere. Sellers offer free
software, free cell phones, and free checking accounts.
Dentists give out free toothbrushes. At state visitor centers,
there are free brochures and maps.
Does the presence of so many free products contradict the
economist’s assertion “There is no free lunch”? No!
Resources are used to produce each of these products, and
because those resources have alternative uses, society
gives up something else to get the “free” good. Where
resources are used to produce goods or services, there is no
So why are these goods offered for free? In a word:
marketing! Firms sometimes offer free products to entice
people to try them, hoping they will then purchase those
goods later. The free software may eventually entice you to
buy the producer’s upgraded software. In other instances,
the free brochures contain advertising for shops and
restaurants, and that free e-mail program is filled with ads. In
still other cases, the product is free only in conjunction with a
larger purchase. To get the free bottle of soda, you must buy
the large pizza. To get the free cell phone, you need to sign
up for a year’s worth of cell phone service.
So “free” products may or may not be truly free to
individuals. They are never free to society.
At the core of economics is the idea that “there is no free
lunch.” You may be treated to lunch, making it “free” from
your perspective, but someone bears a cost. Because all
resources are either privately or collectively owned by
members of society, ultimately society bears the cost.
Scarce inputs of land, equipment, farm labor, the labor of
cooks and waiters, and managerial talent are required.
Because society could have used these resources to
produce something else, it sacrifices those other goods and
services in making the lunch available. Economists call such
sacrifices opportunity costs: To obtain more of one thing,
society forgoes the opportunity of getting the next best thing.
That sacrifice is the opportunity cost of the choice.
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.
They allocate their time, energy, and money to maximize
their satisfaction. Because they weigh costs and benefits,
their economic decisions are “purposeful” or “rational,” not
“random” or “chaotic.”
Origin of the Idea
Consumers are purposeful in deciding what goods and
services to buy. Business firms are purposeful in deciding
what products to produce and how to produce them.
Government entities are purposeful in deciding what public
services to provide and how to finance them.
“Purposeful behavior” does not assume that people and
institutions are immune from faulty logic and therefore are
perfect decision makers. They sometimes make mistakes.
Nor does it mean that people’s decisions are unaffected by
emotion or the decisions of those around them. “Purposeful
behavior” simply means that people make decisions with
some desired outcome in mind.
Rational self-interest is not the same as selfishness. In the
economy, increasing one’s own wage, rent, interest, or profit
normally requires identifying and satisfying somebody else’s
wants! Also, people make personal sacrifices to others. They
contribute time and money to charities because they derive
pleasure from doing so. Parents help pay for their children’s
education for the same reason. These self-interested, but
unselfish, acts help maximize the givers’ satisfaction as
much as any personal purchase of goods or services. Selfinterested behavior is simply behavior designed to increase
personal satisfaction, however it may be derived.
Consider This...: Fast-Food Lines
© Syracuse Newspapers/The
The economic perspective is useful in analyzing all sorts of
behaviors. Consider an everyday example: the behavior of
fast-food customers. When customers enter the restaurant,
they go to the shortest line, believing that line will minimize
their time cost of obtaining food. They are acting
purposefully; time is limited, and people prefer using it in
some way other than standing in line.
If one fast-food line is temporarily shorter than other lines,
some people will move to that line. These movers apparently
view the time saving from the shorter line (marginal benefit)
as exceeding the cost of moving from their present line
(marginal cost). The line switching tends to equalize line
lengths. No further movement of customers between lines
occurs once all lines are about equal.
Fast-food customers face another cost-benefit decision
when a clerk opens a new station at the counter. Should
they move to the new station or stay put? Those who shift to
the new line decide that the time saving from the move
exceeds the extra cost of physically moving. In so deciding,
customers must also consider just how quickly they can get
to the new station compared with others who may be
contemplating the same move. (Those who hesitate in this
situation are lost!)
Customers at the fast-food establishment do not have
perfect information when they select lines. Thus, not all
decisions turn out as expected. For example, you might
enter a short line and find someone in front of you is ordering
hamburgers and fries for 40 people in the Greyhound bus
parked out back (and the employee is a trainee)!
Nevertheless, at the time you made your decision, you
thought it was optimal.
Finally, customers must decide what food to order when they
arrive at the counter. In making their choices, they again
compare marginal costs and marginal benefits in attempting
to obtain the greatest personal satisfaction for their
Economists believe that what is true for the behavior of
customers at fast-food restaurants is true for economic
behavior in general. Faced with an array of choices,
consumers, workers, and businesses rationally compare
marginal costs and marginal benefits in making decisions.
Marginal Analysis: Benefits and Costs
The economic perspective focuses largely on marginal
analysis—comparisons of marginal benefits and marginal
costs, usually for decision making. To economists,
“marginal” means “extra,” “additional,” or “a change in.” Most
choices or decisions involve changes in the status quo,
meaning the existing state of affairs.
Should you attend school for another year? Should you
study an extra hour for an exam? Should you supersize your
fries? Similarly, should a business expand or reduce its
output? Should government increase or decrease its funding
for a missile defense system?
Each option involves marginal benefits and, because of
scarce resources, marginal costs. In making choices
rationally, the decision maker must compare those two
amounts. Example: You and your fiancée are shopping for
an engagement ring. Should you buy a
-carat diamond, a
-carat diamond, a -carat diamond, a 1-carat diamond, or
something even larger? The marginal cost of a larger-size
diamond is the added expense beyond the cost of the
smaller-size diamond. The marginal benefit is the perceived
lifetime pleasure (utility) from the larger-size stone. If the
marginal benefit of the larger diamond exceeds its marginal
cost (and you can afford it), buy the larger stone. But if the
marginal cost is more than the marginal benefit, buy the
smaller diamond instead, even if you can afford the larger
Origin of the Idea
In a world of scarcity, the decision to obtain the marginal
benefit associated with some specific option always includes
the marginal cost of forgoing something else. The money
spent on the larger-size diamond means forgoing some
other product. An opportunity cost—the value of the next
best thing forgone—is always present whenever a choice is
made. (Key Question 3)
Theories, Principles, and Models
Like the physical and life sciences, as well as other social
sciences, economics relies on the scientific method. That
procedure consists of several elements:
• Observing real-world behavior and outcomes.
• Based on those observations, formulating a possible
explanation of cause and effect (hypothesis).
• Testing this explanation by comparing the outcomes of
specific events to the outcome predicted by the
• Accepting, rejecting, and modifying the hypothesis, based
on these comparisons.
• Continuing to test the hypothesis against the facts. As
favorable results accumulate, the hypothesis evolves
into a theory. A very well-tested and widely accepted
theory is referred to as an economic law or an
economic principle—a statement about economic
behavior or the economy that enables prediction of the
probable effects of certain actions. Combinations of
such laws or principles are incorporated into models,
which are simplified representations of how something
works, such as a market or segment of the economy.
Economists develop theories of the behavior of individuals
(consumers, workers) and institutions (businesses,
governments) engaged in the production, exchange, and
consumption of goods and services. Theories, principles,
and models are “purposeful simplifications.” The full scope of
economic reality itself is too complex and bewildering to be
understood as a whole. In developing theories, principles,
and models economists remove the clutter and simplify.
Economic principles and models are highly useful in
analyzing economic behavior and understanding how the
economy operates. They are the tools for ascertaining cause
and effect (or action and outcome) within the economic
system. Good theories do a good job of explaining and
predicting. They are supported by facts concerning how
individuals and institutions actually behave in producing,
exchanging, and consuming goods and services.
There are some other things you should know about
• 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. For example, economists say that consumers buy
more of a particular product when its price falls.
Economists recognize that some consumers may
increase their purchases by a large amount, others by a
small amount, and a few not at all. This “price-quantity”
principle, however, holds for the typical consumer and
for consumers as a group.
• Other-Things-Equal Assumption In constructing their
theories, economists use the ceteris paribus or otherthings-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. For example, consider the
relationship between the price of Pepsi and the amount
of it purchased. Assume that of all the factors that might
influence the amount of Pepsi purchased (for example,
the price of Pepsi, the price of Coca-Cola, and
consumer incomes and preferences), only the price of
Pepsi varies. This is helpful because the economist can
then focus on the relationship between the price of
Pepsi and purchases of Pepsi in isolation without being
confused by changes in other variables.
• Graphical Expression Many economic models are
expressed graphically. Be sure to read the special
appendix at the end of this chapter as a review of
Origin of the Idea
Economists develop economic principles and models at two
Microeconomics is the part of economics concerned with
individual units such as a person, a household, a firm, or an
industry. At this level of analysis, the economist observes the
details of an economic unit, or very small segment of the
economy, under a figurative microscope. In microeconomics
we look at decision making by individual customers, workers,
households, and business firms. We measure the price of a
specific product, the number of workers employed by a
single firm, the revenue or income of a particular firm or
household, or the expenditures of a specific firm,
government entity, or family. In microeconomics, we
examine the sand, rock, and shells, not the beach.
Macroeconomics examines either the economy as a whole
or its basic subdivisions or aggregates, such as the
government, household, and business sectors. An
aggregate is a collection of specific economic units treated
as if they were one unit. Therefore, we might lump together
the millions of consumers in the U.S. economy and treat
them as if they were one huge unit called “consumers.”
In using aggregates, macroeconomics seeks to obtain an
overview, or general outline, of the structure of the economy
and the relationships of its major aggregates.
Macroeconomics speaks of such economic measures as
total output, total employment, total income, aggregate
expenditures, and the general level of prices in analyzing
various economic problems. No or very little attention is
given to specific units making up the various aggregates.
Figuratively, macroeconomics looks at the beach, not the
pieces of sand, the rocks, and the shells.
The micro–macro distinction does not mean that
economics is so highly compartmentalized that every topic
can be readily labeled as either micro or macro; many topics
and subdivisions of economics are rooted in both. Example:
While the problem of unemployment is usually treated as a
macroeconomic topic (because unemployment relates to
aggregate production), economists recognize that the
decisions made by individual workers on how long to search
for jobs and the way specific labor markets encourage or
impede hiring are also critical in determining the
unemployment rate. (Key Question 5)
Positive and Normative Economics
Both microeconomics and macroeconomics contain
elements of positive economics and normative economics.
Positive economics focuses on facts and cause-and-effect
relationships. It includes description, theory development,
and theory testing (theoretical economics). Positive
economics avoids value judgments, tries to establish
scientific statements about economic behavior, and deals
with what the economy is actually like. Such scientific-based
analysis is critical to good policy analysis.
Economic policy, on the other hand, involves normative
economics, which incorporates value judgments about what
the economy should be like or what particular policy actions
should be recommended to achieve a desirable goal (policy
economics). Normative economics looks at the desirability of
certain aspects of the economy. It underlies expressions of
support for particular economic policies.
Positive economics concerns what is, whereas normative
economics embodies subjective feelings about what ought to
be. Examples: Positive statement: “The unemployment rate
in France is higher than that in the United States.” Normative
statement: “France ought to undertake policies to make its
labor market more flexible to reduce unemployment rates.”
Whenever words such as “ought” or “should” appear in a
sentence, you are very likely encountering a normative
Most of the disagreement among economists involves
normative, value-based policy questions. Of course,
economists sometime disagree about which theories or
models best represent the economy and its parts, but they
agree on a full range of economic principles. Most economic
controversy thus reflects differing opinions or value
judgments about what society should be like.
Quick Review 1.1
• Economics examines how individuals, institutions, and
society make choices under conditions of scarcity.
• The economic perspective stresses (a) resource scarcity
and the necessity of making choices, (b) the
assumption of purposeful (or rational) behavior, and (c)
comparisons of marginal benefit and marginal cost.
• In choosing among alternatives, people incur opportunity
costs—the value of their next-best option.
• Economists use the scientific method to establish
economic theories—cause-effect generalizations about
the economic behavior of individuals and institutions.
• Microeconomics focuses on specific decision-making units
of the economy, macroeconomics examines the
economy as a whole.
• Positive economics deals with factual statements (“what
is”); normative economics involves value judgments
(“what ought to be”).
Individuals’ Economizing Problem
A close examination of the economizing problem—the
need to make choices because economic wants exceed
economic means—will enhance your understanding of
economic models and the difference between
microeconomic and macroeconomic analysis. Let’s first build
a microeconomic model of the economizing problem faced
by an individual.
We all have a finite amount of income, even the wealthiest
among us. Even Donald Trump must decide how to spend
his money! And the majority of us have much more limited
means. Our income comes to us ...
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