chapter 2
Understand Decision
Making
2-1
The Economist’s Toolkit
2-2
Opportunity Costcompetition
2-3
Production Possibilities Curve
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
1
chapter 2
2-1
The Economist’s
Toolkit
Learning Objectives
LO1-1 Understand how economists use economic models.
LO1-2 Evaluate economic activity using graphs.
LO1-3 Explain why economists can disagree.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2
chapter 2
2-1
The Economist’s
Toolkit
Vocabulary
The Methodology of Economics
model
assumption
Applying Graphs to Economics
direct relationship
inverse relationship
Why Do Economists Disagree?
positive economics
normative economics
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
3
chapter 2
The Methodology of Economics
A model is a simplification of reality used to
understand the relationship between variables.
 A model is also called a theory.
 A model emphasizes those variables that are most
important by assuming that all other variables
remain unchanged.
 Using a model makes the relationship between the
chosen variables easier to understand.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-1 The Economist’s Toolkit
4
chapter 2
The Methodology of Economics
An assumption is something that is accepted as
being true.
 A model must include an assumption and is useful
only if it yields accurate predictions.
 When the evidence confirms a model, the assumption
is accepted as true.
 When the evidence does not support an assumption,
the model is rejected.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-1 The Economist’s Toolkit
5
chapter 2
The Methodology of Economics
Vocabulary
CHECKPOINT
model
assumption
Why is an assumption
important to a model?
A model must focus only on the most important variables. Therefore, it
must be assumed that other variables remind unchanged or constant. It
is too complex to include all variables in a model.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-1 The Economist’s Toolkit
6
chapter 2
Applying Graphs to Economics
A direct relationship is a positive relationship
between two variables.
 When one variable increases, the other variable
increases.
 When one variable decreases, the other variable
decreases.
 Both variables change in the same direction.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-1 The Economist’s Toolkit
7
chapter 2
Applying Graphs to Economics
An inverse relationship is a negative relationship
between two variables.
 When one variable increases, the other variable
decreases.
 Variables change in opposite directions.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-1 The Economist’s Toolkit
8
chapter 2
Applying Graphs to Economics
Vocabulary
CHECKPOINT
direct relationship
inverse relationship
Economists can use a
graph or table to present
date. Do you have a
preference? Why?
Most prefer a graph because the line clearly shows the relationship
between variables.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-1 The Economist’s Toolkit
9
chapter 2
Why Do Economists Disagree?
Positive economics is an analysis based on facts.
 Positive analysis uses statements that can be proven
either true or false.
 Often uses the words “if” and “then.”
 A positive statement does not have to be correct.
 The key is whether the statement is testable.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-1 The Economist’s Toolkit
10
chapter 2
Why Do Economists Disagree?
Normative economics is an analysis based on value
judgments.
 Normative statements express an opinion on a
subject.
 The opinion cannot be proven by facts to be true or
false.
 Statement will use normative words or phrases, such
as good, bad, should, and ought to be.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-1 The Economist’s Toolkit
11
chapter 2
Why Do Economists Disagree?
Vocabulary
CHECKPOINT
positive economics
normative economics
Assume an argument is
based on incorrect facts.
Is this a positive or normative analysis? Why?
This is a positive argument because facts are testable. Even if the facts
are wrong, the argument is not normative and based on opinion.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-1 The Economist’s Toolkit
12
chapter 2
2-2
Opportunity Cost
Learning Objectives
LO 2-1 Explain why all decisions have tradeoffs and opportunity costs.
LO 2-2 Understand how to perform marginal
analysis.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
13
chapter 2
2-2
Opportunity Cost
Vocabulary
Trade-offs and Opportunity Cost
trade-off
opportunity cost
Marginal Analysis
marginal analysis
marginal benefit
marginal cost
cost benefit
analysis
net benefit
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or duplicated, or posted to a publicly accessible website, in whole or in part.
14
chapter 2
Trade-offs and Opportunity Cost
A trade-off is all the options given up when a
decision is made.
Opportunity cost is the value of the next best option
sacrificed for a chosen option. It is the cost of not
choosing the best alternative.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-2 Opportunity Cost
15
chapter 2
Trade-offs and Opportunity Cost
Vocabulary
CHECKPOINT
trade-off
opportunity cost
Explain the difference
between trade-offs
and opportunity cost?
A trade-off includes all options given up when a decision is made.
An opportunity cost is only the best option sacrificed.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-2 Opportunity Cost
16
chapter 2
Marginal Analysis
Marginal analysis is the decision about how much
more or less to do.
Marginal benefit is the extra gain from an
additional unit of change.
Marginal cost is the extra cost from an additional
unit of change.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-2 Opportunity Cost
17
chapter 2
Marginal Analysis
Cost benefit analysis compares the additional
rewards and costs of an action to determine if the
benefits outweigh the costs.
Net benefit is the difference between the marginal
benefit and the marginal cost of an option.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-2 Opportunity Cost
18
chapter 2
Marginal Analysis
Vocabulary
CHECKPOINT
What does it mean
to “think at the
margin”?
marginal analysis
marginal benefit
marginal cost
cost benefit
analysis
net benefit
“Think at the margin” means make a decision about how much more or
less to do. This involves comparing marginal benefits to marginal cost.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-2 Opportunity Cost
19
chapter 2
2-3
Production
Possibilities
Curve
Learning Objectives
LO 3-1 Interpret a production possibilities curve.
LO 3-2 Understand how scarcity relates to the
production possibilities curve.
LO 3-2 Demonstrate how economic growth occurs
using the production possibilities curve.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
20
chapter 2
2-3
Production
Possibilities
Curve
Vocabulary
Production Possibilities Curve
production possibilities
curve
technology
efficiency
underutilization
Opportunity Costs and the Production
Possibilities Curve
law of increasing
opportunity
Source of Economic Growth
economic growth
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
21
chapter 2
Production Possibilities Curve
The production possibilities curve shows the
maximum possible output for an economy. The
model has two assumptions.
 Fixed Resources – All resources remain unchanged.
 Technology unchanged – Technology also is assumed
to be fixed.
► Technology is the body of knowledge
applied to how goods and services are
produced.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-3 Production Possibilities Curve
22
chapter 2
Production Possibilities Curve
Efficiency is producing the maximum output with
the given resources and technology.
Underutilization occurs when an economy fails to
fully use its resources. As a result, the economy
produces less than maximum output.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-3 Production Possibilities Curve
23
chapter 2
Production Possibilities Curve
Vocabulary
CHECKPOINT
Explain why all points
along the production
possibilities curve are
efficient points.
Production possibilities
curve
Technology
Efficiency
underutilization
All points along the production possibilities curve are efficient at full
capacity. They are maximum points because the economy is using all
its resources and the latest technology.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-3 Production Possibilities Curve
24
chapter 2
Opportunity Costs and the Production
Possibilities Curve
The law of increasing opportunity cost states that
the opportunity cost increases as production of an
output expands.
 As more of an economy’s resources are devoted to
producing one product, even greater quantities of
production of the other product must be given up.
 This law exists because not all resources are equally
suited to all types of production.
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or duplicated, or posted to a publicly accessible website, in whole or in part.
2-3 Production Possibilities Curve
25
chapter 2
Opportunity Costs and the Production
Possibilities Curve
Vocabulary
CHECKPOINT
law of increasing
opportunity cost
Explain the condition of
scarcity and opportunity
costs in terms of the
production possibilities
curve.
To move between points along the PPC, an economy must shift
resources. For example, labor is shifted out of tank production into
producing sailboats.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-3 Production Possibilities Curve
26
chapter 2
Sources of Economic Growth
Economic growth is the ability of an economy to
produce greater levels of output. For this growth to
occur the assumption the resources and technology
are fixed is removed.
 One way to achieve growth is to gain resources. Any increase
in resources shifts the production possibilities curve outward.
 Another way to achieve growth is new knowledge that makes
an economy more productive. The economy can produce
more from the same resources, so the curve shifts outward.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-3 Production Possibilities Curve
27
chapter 2
Sources of Economic Growth
Vocabulary
CHECKPOINT
economic growth
Explain how changing
an assumption shifts
the production
possibilities curve.
To shift the production possibilities curve requires changing either of
two assumptions of the model. An outward shift occurs when
resources are increased. Another way is an advance in technology.
© 2013 Cengage Learning. All rights reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
2-3 Production Possibilities Curve
28