LECTURE NOTES CHAPTER ONE

I. Learning objectives – After reading this chapter, students should be able to:
1. List the ten key concepts to retain for a lifetime
2. Define economics and the features of the economic way of thinking.
3. Describe the role of economic theory in economics.
4. Distinguish microeconomics from macroeconomics and between positive economics and
normative economics.
5. Explain the individual’s economic problem and how trade-offs, opportunity costs, and
attainable combination cab be illustrated with budget lines.

6. List the categories of scarce resources and delineate the nature of society’s economic problem.
7. Apply production possibilities analysis, increasing opportunity costs, and economic growth.
8. Explain how economic growth and international trade increase consumption possibilities.
A1-1(Appendix) Understand graphs, curves, and slopes as they relate to economics
II. Definition of Economics
A. The social science that studies how individuals, institutions, and society make optimal choices
under conditions of scarcity.
B. Human wants are unlimited, but the means to satisfy the wants are limited.
III. The Economic Perspective
A. Scarcity and choice
1. Resources can only be used for one purpose at a time.
2. Scarcity requires that choices be made.
3. The cost of any good, service, or activity is the value of what must be given up to obtain
it. (opportunity cost).

B. CONSIDER THIS … Free for All?

1. Products provided for “free” to an individual are not free for society because of
the required use of scarce resources to produce them.
2. Companies provide “free” goods as a marketing strategy to promote brand
awareness.
3. Products that are promoted as “free” to the individual may actually be bundled
with another good for which the consumer must pay. Because a
purchase is required to obtain them, these products are not
really free to the buyer.
C. Purposeful Behaviour
1. Rational self-interest entails making decisions to achieve maximum utility.
a. Utility is the pleasure or satisfaction obtained from consuming a good or service.
2. Different preferences and circumstances (including errors) lead to different choices.
3. Rational self-interest is not the same as selfishness.
D. Marginal Analysis: benefits and costs
1. Most decisions concern a change in current conditions; therefore the economic perspective
is largely focused on marginal analysis.
 2. Each option considered weighs the marginal benefit against the marginal cost.
3. Whether the decision is personal or one made by business or government, the principle is
the same.
4. The marginal cost of an action should not exceed its marginal benefits.
5. There is “no free lunch” and there can be “too much of a good thing.”
6. Conflicts between long and short-run objectives may result in decisions that appear to be
irrational, when if fact they are not.
E. 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 other information—cost of obtaining more
information is not worth the benefit.
a. Imperfect information may lead to an unexpected wait.
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 an economic perspective, these choices will be
made after the consumer compares the costs and benefits of possible choices.

IV. Theories, Principles, and Models

A. Economists use the scientific method to establish theories, laws, and principles.
1. The scientific method consists of:
a. The observation of facts (real data).
b. The formulations of explanations of cause and effect relationships (hypotheses) based
upon the facts.
c. The testing of the hypotheses.
d. The acceptance, rejection, or modification of the hypotheses.
e. The continued testing with an eye toward determination of a theory, law, principle,
or model.
2. Theories, principles, and models are “purposeful simplifications.”
3. Principles are used to explain and/or predict the behaviour of individuals and institutions.
4. Terminology—Principles, laws, theories, and models are all terms that refer to
generalizations about economic behaviour. They are used synonymously in the text, with
custom or convenience governing the choice in each particular case.
B. Generalizations—Economic principles are expressed as the tendencies of the typical
or average consumer, worker, or business firm.
C. “Other things equal” or ceteris paribus assumption—In order to judge the effect one
variable has upon another it is necessary to hold other contributing factors
constant. Natural scientists can test with much greater precision
than can economists. They have the advantage of controlled
laboratory experiment. Economists must test their theories using the
real world as their laboratory.
D. Graphical Expression—Many economic relationships are quantitative, and are
demonstrated efficiently with graphs. The “key graphs” are the most important.
V. Microeconomics and Macroeconomics
A. Microeconomics looks at specific economic units.
1. It is concerned with the individual industry, firm or household and the price of specific
products and resources.
2. It is an examination of trees, and not the forest.
B. Macroeconomics examines the economy as a whole.
1. It includes measures of total output, total employment, total income, aggregate
expenditures, and the general price level.
2. It is a general overview examining the forest, not the trees.

C. Positive and Normative Economics.

1. Positive economics describes the economy as it actually is, avoiding value judgments and
attempting to establish scientific statements about economic behaviour.
2. Normative economics involves value judgments about what the economy should be like
and the desirability of the policy options available.
3. Most disagreements among economists involve normative, value-based questions.
VI. Individual’s Economic Problem
A. Individuals are confronted with the need to make choices because their wants exceed their
means to satisfy them.
B. Limited income – everyone, even the most wealthy, has a finite amount of money to spend.
C. Unlimited wants – people’s wants are virtually unlimited.
1. Wants include both necessities and luxuries (although many economists don’t worry
about this distinction).
2. Wants change, especially as new products are introduced.
3. Both goods and services satisfy wants.
4. Even the wealthiest have wants that extend beyond their means (e.g. Bill Gates’
charitable efforts).
D. The combination of limited income and unlimited wants force us to choose those goods
and services that will maximize our utility.
E. Budget line
1. Definition: A schedule or curve that shows the various combinations of two
products a consumer can purchase with a specific money income.
2. The model assumes two goods, but the analysis generalizes to all goods available
to consumers.
3. The location of a budget line depends on a consumer’s money income, and the
prices of the two products under analysis.
4. The slope of the graphed budget line is the ratio of the price of the good
measured on the horizontal axis (Pb in the text) to the price of the good
measured on the vertical axis (Pdvd). A change in the price of
one of the goods will change the slope of the budget line and
change the purchasing power of the consumer.
5. The budget line illustrates a number of important ideas:
 a. Points on or inside the budget line represent points that are unattainable given
the relevant income and prices. Points outside (up and to the
right) the budget line are unattainable.
b. Tradeoffs and opportunity costs – the negative slope of the budget line
represents that consumers must make tradeoffs in their
consumption decisions; the value of the slope
measures precisely the opportunity cost of one more unit of a good under
analysis.
c. Limited income and positive prices force people to choose. Note that the
budget line does not indicate what a consumer will choose,
only what they can choose.
d. Income changes will shift the budget line. Greater income will shift the line
out and to the right, allowing consumers to purchase more of
both goods. Increasing income lessens scarcity, but
does not eliminate it.

VII. Society’s Economic Problem

A. Scarce resources
1. Economic resources are limited relative to wants.
2. Economic resources are sometimes called factors of production and include all natural,
human, and manufactured resources used to produce goods and services.
B. Resource categories:
1. Land or natural resources (“gifts of nature).
2. Labour or human resources, which include physical and mental abilities used in
production.
3. Capital or investment goods, which are all manufactured aids to production like
tools, equipment, factories, transportation, etc.
4. Entrepreneurial ability, a special kind of human resource that provides four
important functions:
a. Combines resources needed for production.
b. Makes basic business policy decisions.
c. Is an innovator for new products, production techniques, and organizational
forms.
d. Bears the risk of time, effort, and funds.

VIII. Production possibilities tables and curves are a device to illustrate and clarify society’s
economic problem.
A. Assumptions:
1. Economy is employing all available resources (Full employment).
2. Available supply of resources is fixed in quantity and quality at this point in time.
3. Technology is constant during analysis.
4. Economy produces only two types of products.
a. While any two goods or services could be used, the example in the chapter assumes
that one product is a consumer good (pizza), the other a capital good (industrial
robots).
 b. Consumer goods directly satisfy wants; capital goods, which are used to produce
consumer goods, indirectly satisfy wants.
B. Choices will be necessary because resources and technology are fixed. A production
possibilities table illustrates some of the possible choices (see Table 1.1).
C. A production possibilities curve is a graphical representation of choices.
1. Points on the curve represent maximum possible combinations of robots and pizza given
resources and technology.
2. Points inside the curve represent underemployment or unemployment.
3. Points outside the curve are unattainable at present.
D. Optimal or best product-mix:
1. It will be some point on the curve.
2. The exact point depends on society; this is a normative decision.
E. Law of increasing opportunity costs:
1. The amount of other products that must be foregone to obtain more of any given product
is called the opportunity cost.
2. Opportunity costs are measured in real terms rather than money (market prices are not part
of the production possibilities model.)
3. The more of a product produced the greater is its (marginal) opportunity cost.
4. The slope of the production possibilities curve becomes steeper, demonstrating increasing
opportunity cost. This makes the curve appear bowed out, concave from the origin.
5. Economic Rationale:
a. Economic resources are not completely adaptable to alternative uses.
b. To get increasing amounts of pizza, resources that are not particularly well suited for
that purpose must be used. Workers that are accustomed to producing robots on an
assembly line may not do well as kitchen help.
F. Optimal allocation revisited:
1. How does society decide its optimal point on the production possibilities curve?
2. Recall that society receives marginal benefits from each additional product consumed, and
as long as this marginal benefit is more than the additional cost of the product, it is
advantageous to have the additional product.
3. Conversely, if the additional (marginal) cost of obtaining an additional product is more
than the additional benefit received, then it is not “worth” it to society to produce the extra
unit.
4. Figure 1.3 reminds us that marginal costs rise as more of a product is produced.
5. Marginal benefits decline as society consumes more and more pizzas. In Figure 1.3 we
can see that the optimal amount of pizza is 200,000 units, where marginal benefit just
covers marginal cost.
a. Beyond that, the added benefits would be less than the added cost.
b. At less than 200,000, the added benefits will exceed the added costs, so it makes sense
to produce more.
6. Generalization: The optimal production of any item is where its marginal benefit is equal
to its marginal cost. In our example, this must occur at 7,000 robots.

IX. Unemployment, Growth, and the Future

 A. Unemployment occurs when the economy is producing at less than full employment or inside
the curve (point U in Figure 1.4).
B. In a growing economy, the production possibilities curve shifts outward.
1. When resource supplies expand in quantity or quality.
2. When technological advances are occurring.
C. Consider This … Women, the Workforce, and Production Possibilities
1. 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.
2. Whereas 40% of the women worked in 1965, 62% of the women are now working part
time or full time.
3. There are a number of reasons for this change:
a. An increase in women’s wage rates.
b. Greater access to jobs.
c. Changes in preferences and attitudes.
D. Present choices and future possibilities: Using resources to produce consumer goods and
services represents a choice for present over future consumption. Using resources to invest in
technological advance, education, and capital goods represents a choice for future over present
goods. The decision as to how to allocate resources in the present will create more or less
economic growth in the future.

E. A Qualification: International Trade

1. A nation can avoid the output limits of its domestic production possibilities through
international specialization and trade.
2. Specialization and trade have the same effect as having more and better resources of
improved technology.

X. LAST WORD: Pitfalls to Sound Reasoning

A. Biases—Preconceptions that are not based on facts.
B. Loaded terminology.
1. Terms that contain the prejudice and value judgments of others.
2. 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.
3. Often, however, there is a deliberate attempt to sway opinion by using loaded terminology.
(greedy owners, obscene profits, exploited workers, mindless bureaucrats, costly
regulations, creeping socialism)
C. Fallacy of Composition
1. Fallacy: What is true for one individual or part of a whole is necessarily true for
a group of individuals or the whole.
2. Examples: Standing at a football game, large crops and farm prices,
microeconomics v. macroeconomics (individual saving
behaviour v. aggregate saving)
D. Causation Fallacies
1. Post hoc fallacy: When two events occur in time sequence, the first event is not necessarily
the cause of the second event.
2. Correlation versus causation: Events may be related without a causal relationship.
a. 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?)
b. 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.