The Economic
Perspective
Chapter 1
Economic Problem
• The problem is that, although
your wants, or desires, are
virtually unlimited, the
resources available to satisfy
these wants are scarce.
Scarcity
All resources are scarce
Scarcity
• Means limited goods and
services
• Restricts options and demands
choices
• Price > ZERO
Rational Self-Interest
• Means that individuals try to
maximize the expected benefit
achieved with a given cost or to
minimize the expected cost of
achieving a given benefit
Making decisions at the
margin
• Margin: the cutoff point; decision
making at the margin refers to
deciding on one more or one less of
something
• Weighing and balancing of
alternatives
– Marginal benefit
– Marginal cost
– Benefits > Costs
Scientific Method
• Elements
– Observation of real-world behavior and
outcomes
– Formulation of hypothesis
– Testing of this explanation by comparing
the outcomes of specific events to
predict outcome
– The acceptance, rejection, or
modification of the hypothesis
– The continued testing of the hypothesis
against the facts.
Microeconomics
• Analyzes the individual components
of the economy, such as the choices
made by people, firms, and
industries.
• Markets – make possible the
voluntary exchange of resources,
goods and services; can take
physical, electronic, and other forms.
• Market prices – serve as signals that
guide the allocation of resources
Macroeconomics
• Analyzes economic aggregates
such as aggregate employment,
output, growth, and inflation
• Most important is GDP
– Gross domestic product
Normative Economics
• A statement that
represents an
opinion, which
cannot be
proved or
disproved
• What ought to be
• Ethical value
judgments
Positive Economics
• A statement that
can be proved or
disproved by
reference to
facts
• What is
• Scientific
portion
Society’s Economizing
Problem
• The need to make choices
because economic wants
exceed economic means
Scarce resources
• Society has limited economic
resources
Resources
• The inputs, or factors of
production, used to produce the
goods and services that people
want resources
• Also called factors of production
Land
• Includes all the
natural
resources used
in the
production
process
Labor
• The physical and
mental effort
used to produce
goods and
services
Labor - mental
• Mental effort
– Consists of the
knowledge and
skill people
acquire to
enhance their
productivity
Capital
• The buildings, equipment, and
human skill used to produce
goods and services
– Physical capital
– Human capital
Capital
• Physical capital
– Consists of
factories,
machines, tools,
buildings,
airports,
highways, and
other human
creation
Entrepreneurial Ability
• Managerial and organizational
skills needed to start a firm,
combined with the willingness
to take risks
Functions of
Entrepreneur
• Entrepreneur takes
the initiative in
combining the
resources of land,
labor, and capital
• The entrepreneur
makes the
strategic business
decisions that set
the course of an
enterprise
• Innovator
• Risk bearer
Entrepreneurs
• Pick
Anita Roddick
William H. Gates
Payments to Resources
• Wages
– Payment to resource owners for their
labor
• Interest
– Payment to resource owners for the use
of their capital
• Rent
– Payment to resource owners for the use
of their natural resources.
• Profits
– The reward for entrepreneurial ability.
Production Possibilities
Frontier
• Assumptions
– Output is limited to two products:
consumer goods and capital goods
– Resources are FIXED in both
quantity and quality during that
period
– Technology does not change
– Full employment
Production Possibilities
Frontier
• A curve showing alternative
combinations of goods that can be
produced when available resources
are used fully and efficiently.
Product
A
B
C
D
E
Consumer
0
1
2
3
4
Capital
10
9
7
4
0
Production Possibilities
Frontier
Consumer
goods
Points on
line are
efficient
0
D.
A
C
Inefficient
Unattainable
B
Production
possibilities
curve
Capital Goods
Production Possibilities
Frontier
• Efficient points
– Any point found on the production
possibilities frontier such as A and B
• Inefficient points
– Inside the curve
• Unattainable
– Outside the curve
Economic growth
• An increase in the economy’s
ability to produce goods and
services
• An outward shift of the
production possibilities frontier
• Caused by
– Changes in resource availability
– Increases in capital stock
– Technological change
Economic Growth
Caused by
– Increases in capital stock
– Technological change
Economic Growth
Consumer
goods
Shift
in PPF
0
Production
possibilities
curve
Capital Goods
Economic Analysis
• Fallacy of composition
– What is true at the micro level is also
true at the macro level
• What is true for the individual is true for the
whole
• Fallacy of that association is
causation
– The incorrect idea that if two variables
are associated in time, one must
necessarily cause the other
Economic Analysis
• Secondary Effects
– Unintended consequences of
economic actions that may develop
slowly over time as people react to
events.