4 LO1.7 Explain how economic growth and international trade increase consumption possibilities. LO1.8 (Appendix) Understand graphs, curves, and slopes as they relate to economics. Learning Objectives LO1.1 Define economics and the features of the economic perspective. LO1.2 Describe the role of economic theory in economics. LO1.3 Distinguish microeconomics from macroeconomics and positive economics from normative economics. LO1.4 Explain the individual’s economizing problem and how trade-offs, opportunity costs, and attainable combinations can be illustrated with budget lines. LO1.5 List the categories of scarce resources and delineate the nature of society’s economizing problem. LO1.6 Apply production possibilities analysis, increasing opportunity costs, and economic growth. Limits, Alternatives, and Choices CHAPTER 1 (An appendix on understanding graphs follows this chapter. If you need a quick review of this mathe- matical tool, you might benefit by reading the ap- pendix first.) People’s wants are numerous and varied. Biologically, people need only air, water, food, clothing, and shelter. But in modern societies 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, burg- ers, 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
Transcript
4
LO1.7 Explain how economic growth and international trade increase consumption possibilities.
LO1.8 (Appendix) Understand graphs, curves, and slopes as they relate to economics.
Learning Objectives
LO1.1 Define economics and the features of the economic perspective.
LO1.2 Describe the role of economic theory in economics.
LO1.3 Distinguish microeconomics from macroeconomics and positive economics from normative economics.
LO1.4 Explain the individual’s economizing problem and how trade-offs, opportunity costs, and attainable combinations can be illustrated with budget lines.
LO1.5 List the categories of scarce resources and delineate the nature of society’s economizing problem.
LO1.6 Apply production possibilities analysis, increasing opportunity costs, and economic growth.
Limits, Alternatives, and Choices
CHAPTER 1
(An appendix on understanding graphs follows this chapter. If you need a quick review of this mathe-matical tool, you might benefit by reading the ap-pendix first.) People’s wants are numerous and
varied. Biologically, people need only air, water,
food, clothing, and shelter. But in modern societies
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, burg-
ers, 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
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CHAPTER 1 Limits, Alternatives, and Choices 5
economic wants far ex-
ceed the productive
capacity of our scarce
(limited) resources. We
are forced to make
choices. This unyield-
ing 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.
the half of it.” We also want flat-panel TVs, Internet
service, education, national defense, cell phones,
health care, and much more.
Fortunately, society possesses productive re-
sources, such as labor and managerial talent, tools
and machinery, and land and mineral deposits.
These resources, employed in the economic sys-
tem (or simply the economy), help us produce
goods and services that satisfy many of our
economic wants. But the blunt reality is that our
The Economic PerspectiveLO1.1 Define economics and the features of the economic perspective.Economistsviewthingsfromauniqueperspective.Thiseconomic perspective,oreconomicwayofthinking,hasseveralcriticalandcloselyinterrelatedfeatures.
Scarcity and ChoiceTheeconomicresourcesneededtomakegoodsandser-vicesareinlimitedsupply.Thisscarcityrestrictsoptionsanddemandschoices.Becausewe“can’thave itall,”wemustdecidewhatwewillhaveandwhatwemustforgo. Atthecoreofeconomicsistheideathat“thereisnofreelunch.”Youmaybetreatedtolunch,makingit“free”fromyourperspective,butsomeonebearsacost.Becauseallresourcesareeitherprivatelyorcollectivelyownedbymembers of society, ultimately society bears the cost.Scarceinputsofland,equipment,farmlabor,thelaborofcooks and waiters, andmanagerial talent are required.Becausesocietycouldhaveusedtheseresourcestoproducesomethingelse,itsacrificesthoseothergoodsandservicesinmakingthelunchavailable.Economistscallsuchsacri-ficesopportunity costs:Toobtainmoreofonething,so-cietyforgoestheopportunityofgettingthenextbestthing.Thatsacrificeistheopportunitycostofthechoice.
Purposeful BehaviorEconomicsassumesthathumanbehaviorreflects“rationalself-interest.”Individualslookforandpursueopportunitiestoincreasetheirutility—thepleasure,happiness,orsatisfac-tionobtainedfromconsumingagoodorservice.Theyallo-cate their time, energy, and money to maximize their
CONSIDER THIS . . .
Free for All?Free products are seemingly everywhere. Sellers offer free apps, free cell phones, and free checking accounts. Dentists give out free tooth
brushes. At state visitor centers, there are free brochures and maps. Does the presence of so many free products contradict the economist’s assertion that “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. Because alternatives must be forsaken, there is no such thing as a free lunch. 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. Getting to try out the free version of an app may eventually entice you to buy the pay version that has more features. In other cases, a 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. But while “free” products may come at no cost to the individuals receiving them, they are never free to society because their manufacture requires the use of resources that could have been put to alternative uses.
O1.1
Origin of the term “Economics”
ORIGIN OF THE IDEA
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PART ONE Introduction to Economics and the Economy6
satisfaction. Because theyweigh costs and benefits,theireconomicdecisionsare“purposeful” or “rational,”not“random”or“chaotic.”
Consumers are pur-poseful in deciding whatgoodsand services tobuy.
Marginal Analysis: Comparing Benefits and CostsTheeconomicperspective focuses largelyonmarginal analysis—comparisonsofmarginalbenefitsandmarginalcosts,usuallyfordecisionmaking.Toeconomists,“mar-ginal”means“extra,”“additional,”or“achangein.”Mostchoices or decisions involve changes in the status quo,meaningtheexistingstateofaffairs. Shouldyouattendschoolforanotheryear?Shouldyoustudyanextrahourforanexam?Shouldyousupersizeyourfries?Similarly,shouldabusinessexpandorreduceitsout-
Each option involvesmarginalbenefits and,be-cause of scarce resources,marginal costs. Inmakingchoicesrationally,thedeci-
O1.2
Utility
ORIGIN OF THE IDEA CONSIDER THIS . . .
Fast-Food LinesThe economic perspective is useful in analyzing all sorts of behaviors. Consider an everyday example: the behavior of
fastfood 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 fastfood 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. Fastfood customers face another costbenefit 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 fastfood 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 only to find that someone in front of you is ordering hamburgers and fries for 40 people in the Greyhound bus parked out back (and also that the guy taking orders in your new line 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 expenditure. Economists believe that what is true for the behavior of customers at fastfood 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 when making decisions.
O1.3
Marginal analysis
ORIGIN OF THE IDEA
sionmakermustcomparethosetwoamounts.Example:You and your fiancée are shopping for an engagementring.Shouldyoubuya12-caratdiamond,a34-caratdiamond,a1-caratdiamond,orsomethingevenlarger?Themarginalcostofalarger-sizediamondistheaddedexpensebeyond
Microeconomics and MacroeconomicsLO1.3 Distinguish microeconomics from macroeconomics and positive economics from normative economics.Economistsdevelopeconomicprinciplesandmodelsattwolevels.
thecostofthesmaller-sizediamond.Themarginalbenefitistheperceivedlifetimepleasure(utility)fromthelarger-sizestone.Ifthemarginalbenefitofthelargerdiamondexceedsitsmarginalcost(andyoucanaffordit),buythelarger stone.But if themarginal cost ismore than themarginal benefit, you shouldbuy the smaller diamondinstead—evenifyoucanaffordthelargerstone! Inaworldofscarcity,thedecisiontoobtainthemar-ginalbenefitassociatedwithsomespecificoptionalwaysincludes themarginal cost of forgoing something else.Themoneyspentonthelarger-sizediamondmeansfor-goingsomeotherproduct.Anopportunitycost—thevalueofthenextbestthingforgone—isalwayspresentwhen-everachoiceismade.
Theories, Principles, and ModelsLO1.2 Describe the role of economic theory in economics.Likethephysicalandlifesciences,aswellasothersocialsciences,economicsreliesonthescientific method.Thatprocedureconsistsofseveralelements:
Economistsdeveloptheoriesofthebehaviorofindividu-als(consumers,workers)andinstitutions(businesses,gov-ernments) engaged in the production, exchange, andconsumptionofgoodsandservices.Theories,principles,andmodelsare“purposefulsimplifications.”Thefullscopeofeconomicrealityitselfistoocomplexandbewilderingtobeunderstoodasawhole.Indevelopingtheories,principles,andmodelseconomistsremovetheclutterandsimplify. Economicprinciplesandmodelsarehighlyusefulinanalyzingeconomicbehaviorandunderstandinghowtheeconomy operates.They are the tools for ascertaining
O1.4
Ceteris paribus
ORIGIN OF THE IDEA
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PART ONE Introduction to Economics and the Economy8
Positive economicsfocusesonfactsandcause-and-effectrelationships.Itincludesdescription,theorydevelopment,andtheorytesting.Positiveeconomicsavoidsvaluejudg-ments.Ittriestoestablishscientificstatementsabouteco-nomic behavior and deals with what the economy isactually like.Such scientific-basedanalysis is critical togoodpolicyanalysis. Economicpolicy,ontheotherhand,involvesnorma-tive economics, which incorporates value judgmentsaboutwhattheeconomyshouldbelikeorwhatparticularpolicyactionsshouldberecommendedtoachieveadesir-ablegoal.Normativeeconomicslooksatthedesirabilityofcertainaspectsoftheeconomy.Itunderliesexpressionsofsupportforparticulareconomicpolicies. Positiveeconomicsconcernswhat is,whereasnorma-tiveeconomicsembodies subjective feelingsaboutwhat ought to be.Examples:Positivestatement:“Theunemploy-ment rate in France is higher than that in theUnitedStates.”Normativestatement:“Franceoughttoundertakepoliciestomakeitslabormarketmoreflexibletoreduceunemploymentrates.”Wheneverwordssuchas“ought”or“should”appearinasentence,youareverylikelyencoun-teringanormativestatement. Mostofthedisagreementamongeconomistsinvolvesnormative,value-basedpolicyquestions.Ofcourse,econ-omistssometimedisagreeaboutwhichtheoriesormodelsbestrepresenttheeconomyanditsparts,buttheyagreeona full rangeof economicprinciples.Mosteconomiccontroversythusreflectsdifferingopinionsorvaluejudg-mentsaboutwhatsocietyshouldbelike.
MicroeconomicsMicroeconomicsisthepartofeconomicsconcernedwithdecisionmakingbyindividualcustomers,workers,house-holds,andbusinessfirms.Atthislevelofanalysis,weob-serve the details of their behavior under a figurativemicroscope.Wemeasurethepriceofaspecificproduct,thenumberofworkersemployedbyasinglefirm,therev-enueorincomeofaparticularfirmorhousehold,ortheexpendituresofaspecificfirm,governmententity,orfam-ily.Inmicroeconomics,weexaminethesand,rocks,andshells,notthebeach.
MacroeconomicsMacroeconomicsexaminestheperformanceandbehav-ioroftheeconomyasawhole.Itfocusesitsattentiononeconomicgrowth,thebusinesscycle,interestrates,infla-tion,andthebehaviorofmajoreconomicaggregatessuchasthegovernment,household,andbusinesssectors.Anaggregate is a collection of specific economic unitstreated as if theywere one unit.Therefore,wemightlump together the millions of consumers in the U.S.economyand treat themas if theywereonehugeunitcalled“consumers.” In using aggregates,macroeconomics seeks to ob-tain anoverview,orgeneraloutline,ofthestructureoftheeconomyandtherelationshipsof itsmajoraggre-gates.Macroeconomicsspeaksofsucheconomicmea-sures as totaloutput, total employment, total income,aggregateexpenditures,andthegenerallevelofpricesin analyzing various economic problems. Very littleattention is given to the specific unitsmakingup thevariousaggregates. Figuratively,macroeconomicslooksatthebeach,notthepiecesofsand,therocks,andtheshells. Themicro–macrodistinctiondoesnotmeanthateco-nomics is sohighlycompartmentalized thatevery topiccanbereadilylabeledaseithermicroormacro;manytop-ics and subdivisions of economics are rooted in both.Example:Whiletheproblemofunemploymentisusuallytreatedasamacroeconomictopic(becauseunemploymentrelates to aggregate production), economists recognizethatthedecisionsmadebyindividualworkersonhowlongtosearchfor jobsandtheway specific labormarketsen-courageorimpedehiringarealsocriticalindeterminingtheunemploymentrate.
Positive and Normative EconomicsBothmicroeconomicsandmacroeconomicscontainele-mentsofpositiveeconomicsandnormativeeconomics.
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 the best option, people incur an opportunity cost—the value of the nextbest option.
• Economists use the scientific method to establish economic theories—causeeffect generalizations about the economic behavior of individuals and institutions.
• Microeconomics focuses on specific decisionmaking units within 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”).
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CHAPTER 1 Limits, Alternatives, and Choices 9
wantsforhimself,buthismassivecharitablegivingsug-gests that he keenly wants better health care for theworld’spoor.Ourdesiresforaparticulargoodorservicecanbesatisfied;overashortperiodoftimewecansurelygetenoughtoothpasteorpasta.Andoneappendectomyisplenty.Butourbroaderdesireformoregoodsandser-vicesandhigher-qualitygoodsandservicesseemstobeanotherstory. Becausewehaveonlylimitedincome(usuallythroughourwork)butseeminglyinsatiablewants,itisinourself-interesttoeconomize:topickandchoosegoodsandservicesthatmaximizeoursatisfactiongiventhelimitationsweface.
A Budget LineWecanclarifytheeconomizingproblemfacingconsum-ersbyvisualizingabudget line (or,moretechnically,abudget constraint).Itisascheduleorcurvethatshowsvari-ouscombinationsof twoproductsaconsumercanpur-chasewithaspecificmoneyincome.Althoughweassumetwoproducts,theanalysisgeneralizestothefullrangeofproductsavailabletoconsumers.
Individual’s Economizing ProblemLO1.4 Explain the individual’s economizing problem and how trade-offs, opportunity costs, and attainable combinations can be illustrated with budget lines.Acloseexaminationoftheeconomizing problem—theneed tomake choices because economicwants exceedeconomicmeans—will enhance your understanding ofeconomic models and the difference between micro-economicandmacroeconomicanalysis.Let’sfirstbuildamicroeconomicmodeloftheeconomizingproblemfacedbyanindividual.
Limited IncomeWeallhaveafiniteamountofincome,eventhewealthiestamongus.EvenDonaldTrumpmustdecidehowtospendhismoney!Andthemajorityofushavemuchmorelim-itedmeans.Ourincomecomestousintheformofwages,interest, rent, andprofit, althoughwemay also receivemoneyfromgovernmentprogramsorfamilymembers.AsGlobal Perspective 1.1 shows, the average income ofAmericansin2011was$48,450.Inthepoorestnations,itwaslessthan$500.
Unlimited WantsForbetterorworse,mostpeoplehavevirtuallyunlimitedwants.Wedesirevariousgoodsandservicesthatprovideutility.Ourwantsextendoverawiderangeofproducts,fromnecessities(forexample,food,shelter,andclothing)toluxuries(forexample,perfumes,yachts,andsportscars).Somewantssuchasbasicfood,clothing,andshelterhavebiologicalroots.Otherwants,forexample,specifickindsoffood,clothing,andshelter,arisefromtheconventionsandcustomsofsociety. Over time, as new and improvedproducts are intro-duced,economicwantstendtochangeandmultiply.OnlyrecentlyhavepeoplewantediPods,Internetservice,orcam-eraphonesbecausethoseproductsdidnotexistafewde-cadesago.Also,thesatisfactionofcertainwantsmaytriggerothers:theacquisitionofaFordFocusoraHondaCivichasbeenknowntowhettheappetiteforaLexusoraMercedes. Services,aswellasgoods,satisfyourwants.Carrepairwork,theremovalofaninflamedappendix,legalandac-counting advice, and haircuts all satisfy human wants.Actually,webuymanygoods, such as automobiles andwashingmachines,fortheservicestheyrender.Thediffer-encesbetweengoodsandservicesareoftensmallerthantheyappeartobe. Formostpeople, thedesires forgoodsandservicescannotbefullysatisfied.BillGatesmayhaveallthathe
GLOBAL PERSPECTIVE 1.1
Average Income, Selected NationsAverage income (total income/population) and therefore typical individual budget constraints vary greatly among nations.
Source: World Bank, www.worldbank.org.
CountryPer Capita Income, 2011
(U.S. dollars, based on exchange rates)
Norway $88,890
Switzerland
Singapore
United States
France
South Korea
Mexico
China
India
Iraq
Madagascar
Congo
76,380
42,930
48,450
42,420
20,870
9240
4940
1410
2640
430
190
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PART ONE Introduction to Economics and the Economy10
utilityyouwillwanttospendthefull$120.Thebudgetlineshowsallcombinationsthatcostexactlythefull$120. Incontrast,allcombinationsbeyondthebudgetlineareunattainable.The$120limitsimplydoesnotallowyoutopurchase,forexample,5DVDsat$20eachand5booksat$10each.That$150expenditurewouldclearlyexceedthe$120limit.InFigure1.1theattainablecombinationsare on and within the budget line; the unattainablecombinationsarebeyondthebudgetline.
Trade-Offs and Opportunity Costs ThebudgetlineinFigure1.1illustratestheideaoftrade-offsarisingfromlimitedincome.ToobtainmoreDVDs,youhavetogiveupsomebooks. For example,to obtain the first DVD,you trade off 2 books. Sotheopportunitycostofthefirst DVD is 2 books.ToobtainthesecondDVDtheopportunity cost is also 2books. The straight-linebudgetconstraint,withitsconstantslope,indicatesconstantopportunitycost.Thatis,theopportunitycostof1extraDVDremainsthesame(52books)asmoreDVDsarepur-chased.And,inreverse,theopportunitycostof1extrabookdoesnotchange15 1
Tounderstandtheideaofabudgetline,supposethatyou received aBarnes&Noble gift card as a birthdaypresent.The$120cardissoontoexpire.Youtakethecardtothestoreandconfineyourpurchasedecisionstotwoalternatives:DVDsandpaperbackbooks.DVDsare$20eachandpaperbackbooksare$10each.Yourpurchaseop-tionsareshowninthetableinFigure1.1. At one extreme, youmight spend all of your $120“income”on6DVDsat$20eachandhavenothinglefttospendonbooks.Or,bygivingup2DVDsand therebygaining$40,youcanhave4DVDsat$20eachand4booksat$10each.Andsoontotheotherextreme,atwhichyoucouldbuy12booksat$10each,spendingyourentiregiftcardonbookswithnothinglefttospendonDVDs. ThegraphinFigure1.1showsthebudgetline.NotethatthegraphisnotrestrictedtowholeunitsofDVDsandbooksasisthetable.Everypointonthegraphrepresentsa possible combination ofDVDs and books, includingfractional quantities.The slope of the graphed budgetline measures theratioof thepriceofbooks (Pb) to theprice of DVDs (Pdvd); more precisely, the slope isPbyPdvd 5 $210y$120 5 21
Attainable and Unattainable Combinations Allthe combinationsofDVDsandbooksonor inside thebudgetlineareattainablefromthe$120ofmoneyincome.Youcanaffordtobuy,forexample,3DVDsat$20eachand6booksat$10each.Youalsocanobviouslyaffordtobuy2DVDsand5books,therebyusinguponly$90ofthe$120availableonyourgiftcard.Buttoachievemaximum
Income = $120Pdvd = $20
12
10
8
6
4
2
2 4 6 8 10 12 14
Quantity of paperback books
Qua
ntit
y of
DV
Ds
Unattainable
Attainable
Income = $120Pb = $10
0
= 6
= 12
FIGURE 1.1 A consumer’s budget line. The budget line (or budget constraint) shows all the combinations of any two products that can be purchased, given the prices of the products and the consumer’s money income.
The Budget Line: Whole-Unit Combinations of DVDs and Paperback Books Attainable with an Income of $120
Units of DVDs Units of Books (Price 5 $20) (Price 5 $10) Total Expenditure
6 0 $120 (5 $120 1 $0)
5 2 $120 (5 $100 1 $20)
4 4 $120 (5 $80 1 $40)
3 6 $120 (5 $60 1 $60)
2 8 $120 (5 $40 1 $80)
1 10 $120 (5 $20 1 $100)
0 12 $120 (5 $0 1 $120)
O1.5
Opportunity costs
ORIGIN OF THE IDEA
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CHAPTER 1 Limits, Alternatives, and Choices 11
Income Changes The location of the budget line varies with money income. An increase in money income shifts the budget line to the right; a decrease in money income
shifts it to the left. To ver-ify this, recalculate the ta-ble in Figure 1.1, assuming the card value (income) is (a) $240 and (b) $60, and plot the new budget lines in the graph. No wonder people like to have more income: That shifts their
budget lines outward and enables them to buy more goods and services. But even with more income, people will still face spending trade-offs, choices, and opportunity costs.
CONSIDER THIS . . .
Did Zuckerberg, Winfrey, and James Make Bad Choices?Opportunity costs come into play in decisions well beyond simple buying decisions. Consider the different choices people make with respect to college. The average salaries earned by college graduates are nearly twice as high as those earned by persons with just high school diplo-
mas. For most capable students, “Go to college, stay in col-lege, and earn a degree” is very sound advice. Yet Facebook founder Mark Zuckerberg and talk show host Oprah Winfrey* both dropped out of college, and basketball star LeBron James never even bothered to start classes. What were they thinking? Unlike most students, Zukerberg faced enormous opportunity costs for staying in college. He had a vi-sion for his company, and dropping out helped to ensure Facebook’s success. Similarly, Winfrey landed a spot in local television news when she was a teenager, eventually producing and starring in the Oprah Winfrey Show when she was 32 years old. Getting a degree in her twenties might have interrupted the string of successes that made her famous talk show possible.* And James knew that professional athletes have short careers. Therefore, going to college directly after high school would have taken away four years of his peak earning potential. So Zuckerberg, Winfrey, and James understood opportu-nity costs and made their choices accordingly. The size of op-portunity costs matters greatly in making individual decisions.
*Winfrey eventually went back to school and earned a degree from Tennessee State University when she was in her thirties.
Society’s Economizing ProblemLO1.5 List the categories of scarce resources and delineate the nature of society’s economizing problem.Society must also make choices under conditions of scar-city. It, too, faces an economizing problem. Should it de-vote more of its limited resources to the criminal justice system (police, courts, and prisons) or to education (teach-ers, books, and schools)? If it decides to devote more re-sources to both, what other goods and services does it forgo? Health care? Energy development?
Scarce ResourcesSociety has limited or scarce economic resources, mean-ing all natural, human, and manufactured resources that go into the production of goods and services. This in-cludes the entire set of factory and farm buildings and all the equipment, tools, and machinery used to produce manufactured goods and agricultural products; all trans-portation and communication facilities; all types of labor; and land and mineral resources.
Resource CategoriesEconomists classify economic resources into four general categories.
Land Land means much more to the economist than it does to most people. To the economist land includes all natural resources (“gifts of nature”) used in the production process. These include forests, mineral and oil deposits, water resources, wind power, sunlight, and arable land.
Labor The resource labor consists of the physical ac-tions and mental activities that people contribute to the production of goods and services. The work-related activi-ties of a logger, retail clerk, machinist, teacher, profes-sional football player, and nuclear physicist all fall under the general heading “labor.”
Capital For economists, capital (or capital goods) in-cludes all manufactured aids used in producing consumer
W1.1
Budget lines
WORKED PROBLEMS
• Because wants exceed incomes, individuals face an economizing problem; they must decide what to buy and what to forgo.
• A budget line (budget constraint) shows the various combinations of two goods that a consumer can pur-chase with a specific money income.
• Straight-line budget constraints imply constant oppor-tunity costs for both goods.
QUICK REVIEW 1.2
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PART ONE Introduction to Economics and the Economy12
• Two goods Theeconomyisproducingonlytwogoods:pizzasandindustrialrobots.Pizzassymbolizeconsumer goods,productsthatsatisfyourwantsdirectly;industrialrobots(forexample,thekindusedtoweldautomobileframes)symbolizecapital goods,productsthatsatisfyourwantsindirectlybymakingpossiblemoreefficientproductionofconsumergoods.
Production Possibilities TableAproductionpossibilitiestableliststhedifferentcombina-tionsoftwoproductsthatcanbeproducedwithaspecificsetofresources,assumingfullemployment.Table1.1presentsasimple,hypotheticaleconomythatisproducingpizzasandindustrialrobots;thedataare,ofcourse,hypothetical.Atal-ternativeA,thiseconomywouldbedevotingallitsavailableresources to the production of industrial robots (capitalgoods);atalternativeE,allresourceswouldgotopizzapro-duction(consumergoods).Thosealternativesareunrealisticextremes;aneconomytypicallyproducesbothcapitalgoodsandconsumergoods,asinB,C,andD.AswemovefromalternativeAtoE,weincreasetheproductionofpizzasattheexpenseoftheproductionofindustrialrobots. Becauseconsumergoodssatisfyourwantsdirectly,anymovementtowardElookstempting.Inproducingmorepizzas,societyincreasesthesatisfactionofitscurrentwants.Butthereisacost:Morepizzasmeanfewerindustrialro-bots.Thisshiftofresourcestoconsumergoodscatchesupwithsocietyovertimebecausethestockofcapitalgoodsexpandsmore slowly, thereby reducing potential futureproduction. By moving toward alternative E, societychooses“morenow”attheexpenseof“muchmorelater.” BymovingtowardA,societychoosestoforgocurrentconsumption,therebyfreeingupresourcesthatcanbeusedtoincreasetheproductionofcapitalgoods.Bybuildingup
Entrepreneurial Ability Finally, there is the specialhuman resource, distinct from labor, called entrepre-neurial ability. It is supplied by entrepreneurs, whoperformseveralcriticallyimportanteconomicfunctions:
Becauseland,labor,capital,andentrepreneurialabilityare combined to produce goods and services, they arecalledthefactors of production,orsimply“inputs.”
Production Possibilities ModelLO1.6 Apply production possibilities analysis, increasing opportunity costs, and economic growth.Society uses its scarce resources to produce goods andservices.Thealternativesandchoicesitfacescanbestbe
TABLE 1.1 Production Possibilities of Pizzas and Industrial Robots
Production Alternatives
Type of Product A B C D E
Pizzas (in hundred thousands) 0 1 2 3 4
Robots (in thousands) 10 9 7 4 0
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CHAPTER 1 Limits, Alternatives, and Choices 13
13
andservicesthatsocietycanproduceinafullyemployedeconomy,assumingafixedavailabilityofsuppliesofre-sourcesandfixedtechnology.Wearbitrarilyrepresenttheeconomy’soutputof capitalgoods (here, industrial ro-bots) on the vertical axis and the output of consumergoods(here,pizzas)onthehorizontalaxis,asshowninFigure 1.2 (Key Graph). Eachpointontheproductionpossibilitiescurverepre-sents somemaximumoutput of the twoproducts.Thecurveisa“constraint”becauseitshowsthelimitofattain-ableoutputs.Pointsonthecurveareattainableaslongastheeconomyusesallitsavailableresources.Pointslyinginsidethecurvearealsoattainable,buttheyreflect lesstotaloutputandthereforearenotasdesirableaspointsonthecurve.Pointsinsidethecurveimplythattheeconomycouldhavemoreofboth industrial robotsandpizzas ifit achievedfullemploymentofitsresources.Pointslying
itsstockofcapitalthisway,societywillhavegreaterfutureproductionand,therefore,greaterfutureconsumption.BymovingtowardA,societyischoosing“morelater”atthecostof“lessnow.” Generalization:Atanypointintime,afullyemployedeconomymustsacrificesomeofonegoodtoobtainmoreof another good. Scarce resources prohibit a fully em-ployedeconomyfromhavingmoreofbothgoods.Societymustchooseamongalternatives.Thereisnosuchthingasafreepizza,orafreeindustrialrobot.Havingmoreofonethingmeanshavinglessofsomethingelse.
Production Possibilities CurveThedatapresentedinaproductionpossibilitiestableareshowngraphicallyasaproduction possibilities curve.Suchacurvedisplaysthedifferentcombinationsofgoods
a. themarginalbenefit ofpizzasdeclines asmorepizzas areconsumed.
b. thecurvegetssteeperaswemovefromEtoA. c. itreflectsthelawofincreasingopportunitycosts. d. resourcesarescarce.2. Themarginalopportunitycostofthesecondunitofpizzais: a. 2unitsofrobots. b. 3unitsofrobots. c. 7unitsofrobots. d. 9unitsofrobots.
3. Thetotalopportunitycostof7unitsofrobotsis: a. 1unitofpizza. b. 2unitsofpizza. c. 3unitsofpizza. d. 4unitsofpizza.4. Allpointsonthisproductionpossibilitiescurvenecessarily
represent: a. society’soptimalchoice. b. lessthanfulluseofresources. c. unattainablelevelsofoutput. d. fullemployment.
FIGURE 1.2 The production possibilities curve. Each point on the production possibilities curve represents some maximum combination of two products that can be produced if resources are fully employed. When an economy is operating on the curve, more industrial robots means fewer pizzas, and vice versa. Limited resources and a fixed technology make any combination of industrial robots and pizzas lying outside the curve (such as at W) unattainable. Points inside the curve are attainable, but they indicate that full employment is not being realized.
Answers: 1. c; 2. a; 3. b; 4. d
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productionofrobots,itmustuselandthatislessandlesssuitedtomakingtheircomponents. IfwestartatAandmovetoBinFigure1.2,wecanshiftresourceswhoseproductivityisrelativelyhighinpizzapro-ductionandlowinindustrialrobots.ButaswemovefromBtoC,CtoD,andsoon,re-sources highly productivein pizzas become increas-ingly scarce.To getmorepizzas, resources whoseproductivity in industrialrobots is relatively greatwillbeneeded.Increasinglymoreofsuchresources,andhencegreatersacrificesofindustrialrobots,willbeneededtoachieveeach1-unitincreaseinpizzas.Thislackofperfectflexibility,orinterchangeability,onthepartofresourcesisthecauseofincreasingopportunitycostsforsociety.
Optimal AllocationOfalltheattainablecombinationsofpizzasandindustrialrobotsonthecurveinFigure1.2,whichisoptimal(best)?Thatis,whatspecificquantitiesofresourcesshouldbeal-locatedtopizzasandwhatspecificquantitiesshouldbeal-locatedtoindustrialrobotsinordertomaximizesatisfaction? Recallthateconomicdecisionscenteroncomparisonsofmarginalbenefit(MB)andmarginalcost(MC).Anyeco-nomicactivityshouldbeexpandedaslongasmarginalben-efitexceedsmarginalcostandshouldbereducedifmarginalcostexceedsmarginalbenefit.TheoptimalamountoftheactivityoccurswhereMB5MC.Societyneedstomakeasimilarassessmentaboutitsproductiondecision. Considerpizzas.Wealreadyknowfromthelawofin-creasingopportunitycoststhatthemarginalcostofaddi-tionalunitsofpizzawillriseasmoreunitsareproduced.Atthesametime,weneedtorecognizethattheextraormar-ginalbenefits that come fromproducingandconsumingpizzadeclinewitheachsuccessiveunitofpizza. Consequently,eachsuccessiveunitofpizzabringswithitbothincreasingmarginalcostsanddecreasingmarginalbenefits. TheoptimalquantityofpizzaproductionisindicatedbypointeattheintersectionoftheMBandMCcurves:200,000unitsinFigure1.3.Whyisthisamounttheopti-malquantity? Ifonly100,000unitsofpizzaswerepro-duced,themarginalbenefitofanextraunitofpizza(pointa)wouldexceeditsmarginalcost(pointb).Inmoneyterms,MBis$15,whileMCisonly$5.Whensocietygainssome-thingworth$15atamarginalcostofonly$5,itisbetteroff.InFigure1.3,netgainscancontinuetoberealizedun-tilpizza-productproductionhasbeenincreasedto200,000.
Law of Increasing Opportunity CostsFigure1.2clearlyshowsthatmorepizzasmeanfewerin-dustrialrobots.Thenumberofunitsofindustrialrobotsthatmustbegivenuptoobtainanotherunitofpizzas,ofcourse,istheopportunitycostofthatunitofpizzas. In moving from alternative A to alternative B inTable 1.1,thecostof1additionalunitofpizzasis1fewerunitof industrial robots.Butwhenadditionalunits areconsidered—BtoC,CtoD,andDtoE—animportanteconomicprincipleisrevealed:Forsociety,theopportu-nitycostofeachadditionalunitofpizzasisgreaterthantheopportunitycostoftheprecedingone.WhenwemovefromAtoB,just1unitofindustrialrobotsissacrificedfor1moreunitofpizzas;butingoingfromBtoCwesacri-fice2additionalunitsofindustrialrobotsfor1moreunitofpizzas;then3moreofindustrialrobotsfor1moreofpizzas;andfinally4for1.Conversely,confirmthataswemovefromEtoA,thecostofanadditionalunitofindus-trial robots (on average) is 1
4,13,
12, and 1 unit of pizzas,
respectively,forthefoursuccessivemoves. Ourexampleillustratesthelaw of increasing opportu-nity costs.Astheproductionofaparticulargoodincreases,theopportunitycostofproducinganadditionalunitrises.
Shape of the Curve Thelawofincreasingopportu-nitycostsisreflectedintheshapeoftheproductionpos-sibilitiescurve:Thecurveisbowedoutfromtheoriginofthegraph.Figure1.2showsthatwhentheeconomymovesfromAtoE,itmustgiveupsuccessivelylargeramountsofindustrialrobots(1,2,3,and4)toacquireequalincrementsofpizzas(1,1,1,and1).Thisisshownintheslopeoftheproductionpossibilitiescurve,whichbecomessteeperaswemovefromAtoE.
Economic Rationale Thelawofincreasingopportu-nitycostsisdrivenbythefactthateconomicresourcesarenot completely adaptable to alternative uses.Many re-sourcesarebetteratproducingonetypeofgoodthanatproducing others. Consider land. Some land is highlysuitedtogrowingtheingredientsnecessaryforpizzapro-duction.Butaspizzaproductionexpands,societyhastostartusinglandthatislessbountifulforfarming.Otherlandisrichinmineraldepositsandthereforewell-suitedto producing the materials needed to make industrialrobots.That landwill be the first land devoted to theproductionofindustrialrobots.Butassocietystepsupthe
PART ONE Introduction to Economics and the Economy14
W1.2
Production possibilities
WORKED PROBLEMS
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CHAPTER 1 Limits, Alternatives, and Choices 15
Incontrast,theproductionof300,000unitsofpizzasisexcessive.TheretheMCofanaddedunitis$15(pointc)anditsMBisonly$5(pointd ).Thismeansthat1unitofpizzaisworthonly$5tosocietybutcostsit$15toobtain.Thisisalosingpropositionforsociety! So resources are being efficiently allocated to anyproductwhenthemarginalbenefitandmarginalcostofitsoutputareequal(MB5MC).Supposethatbyapplyingthesameanalysistoindustrialrobots,wefindthattheop-timal(MB5MC)quantityofrobotsis7,000.ThiswouldmeanthatalternativeC(200,000unitsofpizzasand7,000unitsofindustrialrobots)ontheproductionpossibilitiescurveinFigure1.2wouldbeoptimalforthiseconomy.
$15
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FIGURE 1.3 Optimal output: MB 5 MC. Achieving the optimal output requires the expansion of a good’s output until its marginal benefit (MB) and marginal cost (MC) are equal. No resources beyond that point should be allocated to the product. Here, optimal output occurs at point e, where 200,000 units of pizzas are produced.
CONSIDER THIS . . .
The Economics of WarProduction possibilities analysis is helpful in assessing the costs and benefits of waging the broad war on terrorism, including the wars in
Afghanistan and Iraq. At the end of 2011, the estimated cost of these efforts exceeded $1.4 trillion. If we categorize all U.S. production as either “defense goods” or “civilian goods,” we can measure them on the axes of a production possibilities diagram such as that shown in Figure 1.2. The opportunity cost of using more resources for defense goods is the civilian goods sacrificed. In a fully employed economy, more defense goods are achieved at the opportunity cost of fewer civilian goods—health care, education, pollution control, personal computers, houses, and so on. The cost of war and defense is the other goods forgone. The benefits of these activities are numerous and diverse but clearly include the gains from protecting against future loss of American lives, assets, income, and wellbeing. Society must assess the marginal benefit (MB) and marginal cost (MC) of additional defense goods to determine their optimal amounts—where to locate on the defense goods–civilian goods production possibilities curve. Although estimating marginal benefits and marginal costs is an imprecise art, the MBMC framework is a useful way of approaching choices. An optimal allocation of resources requires that society expand production of defense goods until MB 5 MC. The events of September 11, 2001, and the future threats they foreshadowed increased the marginal benefits of defense goods, as perceived by Americans. If we label the horizontal axis in Figure 1.3 “defense goods” and draw in a rightward shift of the MB curve, you will see that the optimal quantity of defense goods rises. In view of the concerns relating to September 11, the United States allocated more of its resources to defense. But the MBMC analysis also reminds us we can spend too much on defense, as well as too little. The United States should not expand defense goods beyond the point where MB 5 MC. If it does, it will be sacrificing civilian goods of greater value than the defense goods obtained.
Unemployment, Growth, and the FutureLO1.7 Explain how economic growth and international trade increase consumption possibilities.InthedepthsoftheGreatDepressionofthe1930s,one-quarterofU.S.workerswereunemployedandone-thirdof
QUICK REVIEW 1.3
• Economists categorize economic resources as land, labor, capital, and entrepreneurial ability.
• The production possibilities curve illustrates several ideas: (a) scarcity of resources is implied by the area of unattainable combinations of output lying outside the production possibilities curve; (b) choice among outputs is reflected in the variety of attainable combinations of goods lying along the curve; (c) opportunity cost is illustrated by the downward slope of the curve; (d) the law of increasing opportunity costs is reflected in the bowedoutward shape of the curve.
• A comparison of marginal benefits and marginal costs is needed to determine the best or optimal output mix on a production possibilities curve.
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PART ONE Introduction to Economics and the Economy16
A Growing EconomyWhenwe drop the assumptions that the quantity andqualityofresourcesandtechnologyarefixed,theproduc-tionpossibilitiescurveshiftspositionsandthepotentialmaximumoutputoftheeconomychanges.
Increases in Resource Supplies Althoughresourcesuppliesare fixedatanyspecificmoment, theychangeover time.Forexample,anation’sgrowingpopulationbringsaboutincreasesinthesuppliesoflaborandentre-preneurial ability.Also, labor quality usually improvesovertimeviamoreeducationandtraining.Historically,theeconomy’sstockofcapitalhasincreasedatasignifi-cant, thoughunsteady,rate.Andalthoughsomeofourenergy andmineral resources arebeingdepleted,newsourcesarealsobeingdiscovered.Thedevelopmentofirrigation systems, for example, adds to the supply ofarableland. Thenetresultoftheseincreasedsuppliesofthefactorsofproductionistheabilitytoproducemoreofbothcon-sumergoodsandcapitalgoods.Thus,20yearsfromnow,theproductionpossibilitiesmaysupersedethoseshowninTable1.1.Thenewproductionpossibilitiesmight looklikethose inthetable inFigure1.5.Thegreaterabun-danceofresourceswillresultinagreaterpotentialoutputofoneorbothproductsateachalternative.Theeconomywillhaveachievedeconomicgrowth in the formofex-pandedpotentialoutput.Thus,whenanincrease inthequantity or quality of resources occurs, theproductionpossibilitiescurveshiftsoutwardandtotheright,asillus-trated by the move from the inner curve to curveA9B9C9D9E9 inFigure1.5.This sortof shift representsgrowthofeconomiccapacity,which,whenused,meanseconomic growth:alargertotaloutput.
Advances in Technology Anadvancingtechnologybringsbothnewandbettergoodsandimprovedwaysofproducing them.Fornow, let’s thinkof technologicaladvanceasbeingonlyimprovementsinthemethodsofproduction,forexample,theintroductionofcomputer-izedsystems tomanage inventoriesandschedulepro-duction.Theseadvancesalterourpreviousdiscussionofthe economizingproblemby allowing society topro-ducemoregoodswithavailableresources.Aswith in-creases in resource supplies, technological advancesmakepossibletheproductionofmoreindustrialrobotsandmorepizzas. Areal-worldexampleofimprovedtechnologyistherecentsurgeofnewtechnologiesrelatingtocomputers,communications, and biotechnology.Technological ad-vanceshavedroppedthepricesofcomputersandgreatly
U.S.productioncapacitywasidle.Subsequentdownturnshavebeenmuchlesssevere.Duringthedeep2007–2009recession, for instance,production fellby a comparablysmaller3.7percentand1-in-10workerswaswithoutajob. Almostallnationshaveexperiencedwidespreadunem-ploymentandunusedproductioncapacityfrombusinessdownturnsatonetimeoranother.Since2000,forexam-ple,manynations—includingArgentina,Japan,Mexico,Germany,andSouthKorea—havehadeconomicdown-turnsandunemployment. Howdotheserealitiesrelatetotheproductionpossi-bilitiesmodel?Ouranalysisandconclusionschangeifwerelaxtheassumptionthatallavailableresourcesarefullyemployed.The five alternatives inTable 1.1 representmaximumoutputs;theyillustratethecombinationsofpiz-zasandindustrialrobotsthatcanbeproducedwhentheeconomy isoperating at full employment.Withunem-ployment, this economywould produce less than eachalternativeshowninthetable. Graphically,werepresentsituationsofunemploymentbypointsinsidetheoriginalproductionpossibilitiescurve(reproducedhereinFigure1.4).PointUisonesuchpoint.Heretheeconomyisfallingshortofthevariousmaximumcombinationsofpizzasandindustrialrobotsrepresentedbythepointsontheproductionpossibilitiescurve.ThearrowsinFigure1.4indicatethreepossiblepathsbacktofullemployment.Amovetowardfullemploymentwouldyieldagreateroutputofoneorbothproducts.
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FIGURE 1.4 Unemployment and the production possibilities curve. Any point inside the production possibilities curve, such as U, represents unemployment or a failure to achieve full employment. The arrows indicate that by realizing full employment, the economy could operate on the curve. This means it could produce more of one or both products than it is producing at point U.
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CHAPTER 1 Limits, Alternatives, and Choices 17
increasedtheirspeed.Improvedsoftwarehasgreatlyin-creased the everyday usefulness of computers.CellularphonesandtheInternethaveincreasedcommunicationscapacity, enhancingproductionand improving theeffi-ciency ofmarkets.Advances in biotechnologyhave re-sultedinimportantagriculturalandmedicaldiscoveries.These and other new and improved technologies havecontributedtoU.S.economicgrowth(outwardshiftsofthenation’sproductionpossibilitiescurve). Conclusion:Economicgrowthistheresultof(1)in-creasesinsuppliesofresources,(2)improvementsinre-source quality, and (3) technological advances. Theconsequenceofgrowthis thata full-employmentecon-omy can enjoy a greater output of both consumptiongoodsandcapitalgoods.Whereasstatic,no-growthecon-omiesmustsacrificesomeofonegoodtoobtainmoreofanother, dynamic, growing economies can have largerquantitiesofbothgoods.
FIGURE 1.5 Economic growth and the production possibilities curve. The increase in supplies of resources, improvements in resource quality, and technological advances that occur in a dynamic economy move the production possibilities curve outward and to the right, allowing the economy to have larger quantities of both types of goods.
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Present Choices and Future PossibilitiesAneconomy’scurrentchoiceofpositionsonitsproductionpossibilitiescurvehelpsdeterminethefuturelocationofthatcurve.Let’sdesignatethetwoaxesoftheproductionpossibilitiescurveas“goodsforthefuture”and“goodsforthepresent,”asinFigure1.6.Goodsforthefuturearesuch
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FIGURE 1.6 Present choices and future locations of production possibilities curves. (a) Presentville’s current choice to produce more “present goods” and fewer “future goods,” as represented by point P, will result in a modest outward shift of the production possibilities curve in the future. (b) Futureville’s current choice of producing fewer “present goods” and more “future goods,” as depicted by point F, will lead to a greater outward shift of the production possibilities curve in the future.
Biases Mostpeoplebringabundleofbiasesandpreconcep-tionstothefieldofeconomics.Forexample,somemightthinkthatcorporateprofitsareexcessiveorthatlendingmoneyisal-wayssuperiortoborrowingmoney.Othersmightbelievethatgovernmentisnecessarilylessefficientthanbusinessesorthatmoregovernmentregulation isalwaysbetter than less.Biasescloud thinkingand interferewithobjectiveanalysis.Allofusmustbewillingtoshedbiasesandpreconceptionsthatarenotsupportedbyfacts.
Loaded Terminology Theeconomicterminologyusedinnewspapersandbroadcastmediaissometimesemotionallybi-ased,orloaded.Thewriterorspokespersonmayhaveacausetopromoteoranaxtogrindandmayslantcommentsaccord-ingly.Highprofitsmaybelabeled“obscene,”lowwagesmaybe called “exploitative,” or self-interested behaviormay be“greed.”Governmentworkersmaybereferredtoas“mindlessbureaucrats”andthosefavoringstrongergovernmentregula-tionsmay be called“socialists.”Toobjectively analyze eco-nomicissues,youmustbepreparedtorejectordiscountsuchterminology.
Fallacy of Composition Anotherpitfallineconomicthink-ingistheassumptionthatwhatistrueforoneindividualorpartofawholeisnecessarilytrueforagroupofindividualsorthewhole.Thisisalogicalfallacycalledthefallacy of composition;theassumptionisnotcorrect.Astatementthatisvalidforanindi-vidualorpart isnotnecessarily valid for the largergrouporwhole.Noneconomicexample:Youmayseetheactionbetterif
Because They Affect Us So Personally, We Often Have Difficulty Thinking Accurately and Objectively About Economic Issues.
LAST WORD
18
forgoodsforthepresent,attheexpenseof lessgoodsforthefuture.Futureville,incontrast,makesacurrentchoicethatstresseslargeramountsoffuturegoodsandsmalleramountsofpresentgoods,asshownbypointFinFigure1.6b. Now,otherthingsequal,wecanexpectFutureville’sfutureproductionpossibilitiescurvetobefarthertotheright than Presentville’s future production possibilitiescurve.Bycurrentlychoosinganoutputmorefavorabletotechnological advancesand to increases in thequantityandqualityofresources,Futurevillewillachievegreatereconomicgrowth thanPresentville. In termsof capitalgoods, Futureville is choosing to make larger currentadditions to its“national factory” by devotingmore ofits currentoutputtocapitalthandoesPresentville.The
thingsascapitalgoods,researchandeducation,andpre-ventivemedicine.Theyincreasethequantityandqualityofpropertyresources,enlargethestockoftechnologicalin-formation,andimprovethequalityofhumanresources.Aswehavealreadyseen,goodsforthefuturesuchascapitalgoodsaretheingredientsofeconomicgrowth.Goodsforthepresentareconsumergoodssuchasfood,clothing,andentertainment. Nowsupposetherearetwohypotheticaleconomies,PresentvilleandFutureville,thatareinitiallyidenticalineveryrespectexceptone:Presentville’scurrentchoiceofpositionsonitsproductionpossibilitiescurvestronglyfavors present goods over future goods. Point P inFigure1.6aindicatesthatchoice.Itislocatedquitefardownthecurvetotheright, indicatingahighpriority
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CHAPTER 1 Limits, Alternatives, and Choices 19
19
you leap toyour feet to seeanoutstandingplayat a footballgame.Butifallthespectatorsleaptotheirfeetatthesametime,nobody—includingyou—willhaveabetterviewthanwhenallremainedseated. Here are two economic examples:An individual stock-holdercansellsharesof,say,Googlestockwithoutaffectingthepriceofthestock.Theindividual’ssalewillnotnoticeablyreducethesharepricebecausethesaleisanegligiblefractionofthetotalsharesofGooglebeingboughtandsold.ButifalltheGoogleshareholdersdecidetoselltheirsharesthesameday,themarketwillbefloodedwithsharesandthestockpricewill fallprecipitously.Similarly,asinglecattleranchcanin-creaseitsrevenuebyexpandingthesizeofitslivestockherd.Theextracattlewillnotaffectthepriceofcattlewhentheyarebroughttomarket.Butifallranchersasagroupexpandtheirherds,thetotaloutputofcattlewillincreasesomuchthatthepriceofcattlewilldeclinewhenthecattlearesold.Ifthepricereduction is relatively large, ranchers as agroupmight findthattheirincomehasfallendespitetheirhavingsoldagreaternumberofcattlebecausethefallinpriceoverwhelmsthein-creaseinquantity.
Post Hoc Fallacy Youmustthinkverycarefullybeforecon-cludingthatbecauseeventAprecedeseventB,AisthecauseofB.Thiskindof faulty reasoning isknownas thepost hoc, ergo propter hoc, or “after this, therefore because of this,” fallacy.Noneconomicexample:Aprofessionalfootballteamhiresanewcoach and the team’s record improves. Is the new coach thecause?Maybe.Perhapsthepresenceofmoreexperiencedandtalented players or an easier schedule is the true cause.Theroostercrowsbeforedawnbutdoesnotcausethesunrise.
Economic example: Many people blamed the GreatDepressionofthe1930sonthestockmarketcrashof1929.ButthecrashdidnotcausetheGreatDepression.Thesamesevereweaknesses in the economy that caused the crash caused theGreatDepression.Thedepressionwouldhaveoccurredevenwithouttheprecedingstockmarketcrash.
Correlation but Not Causation Donotconfusecorrela-tion,or connection,with causation.Correlationbetween twoeventsortwosetsofdataindicatesonlythattheyareassociatedinsomesystematicanddependableway.Forexample,wemayfindthatwhenvariableXincreases,Yalsoincreases.Butthiscor-relationdoesnotnecessarilymeanthatthereiscausation—thatincreases inXcauseincreases inY.Therelationshipcouldbepurelycoincidentalordependentonsomeotherfactor,Z,notincludedintheanalysis. Hereisanexample:Economistshavefoundapositivecor-relationbetweeneducationandincome.Ingeneral,peoplewithmoreeducationearnhigherincomesthanthosewithlesseduca-tion.Commonsensesuggestseducationisthecauseandhigherincomesaretheeffect;moreeducationimpliesamoreknowl-edgeableandproductiveworker,andsuchworkersreceivelargersalaries. Butmighttherelationshipbeexplainableinotherways?Areeducationandincomecorrelatedbecausethecharacteris-tics required for succeeding ineducation—abilityandmoti-vation—are the same ones required to be a productive andhighlypaidworker? If so, thenpeoplewith those traitswillprobably both obtain more education and earn higher in-comes.Butgreatereducationwillnotbethesolecauseofthehigherincome.
payoff fromthischoice forFutureville isgreater futureproductioncapacityandeconomicgrowth.Theopportu-nity cost is fewer consumer goods in the present forFuturevilletoenjoy. IsFutureville’s choice thusnecessarily“better” thanPresentville’s?That, we cannot say.The different out-comessimplyreflectdifferentpreferencesandprioritiesinthetwocountries.Buteachcountrywillhavetolivewiththeeconomicconsequencesofitschoice.
A Qualification: International TradeProductionpossibilitiesanalysisimpliesthatanindividualnationislimitedtothecombinationsofoutputindicatedbyitsproductionpossibilitiescurve.Butwemustmodifythisprinciplewheninternationalspecializationandtradeexist.
Youwill see in laterchapters thataneconomycancircumvent, through international specialization andtrade,theoutputlimitsimposedbyitsdomesticproduc-tionpossibilitiescurve.Underinternationalspecializa-tion and trade, each nation first specializes in theproductionof those items forwhich ithas the lowestopportunity costs (due to an abundanceof theneces-sary resources).Countriesthenengageininternationaltrade,with each country exchanging the items that itcan produce at the lowest opportunity costs for theitems that other countries can produce at the lowestopportunitycosts. Internationalspecializationandtradeallowanationtogetmoreofadesiredgoodatlesssacrificeofsomeothergood.Rather than sacrifice three units of domestically
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PART ONE Introduction to Economics and the Economy20
producedrobotstogetathirdunitofdomesticallypro-ducedpizza,asinTable1.1,anationthatengagesinin-ternationalspecializationandtrademightbeabletodomuch better. If it specializes in robots while anothercountryspecializesinpizza,thenitmaybeabletoobtainthe third unit of pizza by trading only two units ofdomesticallyproduced robots foroneunitof foreign-producedpizza.Specializationandtradehavethesameeffectashavingmoreandbetterresourcesordiscoveringimproved production techniques; both increase thequantitiesofcapitalandconsumergoodsavailabletoso-ciety.Expansionofdomesticproductionpossibilitiesandinternationaltradearetwoseparateroutesforobtaininggreateroutput.
SUMMARYwants exceed the available resourcesnecessary to fulfill them.Societythereforemustdecidewhattoproduceandwhattoforgo.
Graphically,abudgetline(orbudgetconstraint)illustratestheeconomizingproblemforindividuals.Thelineshowsthevarious combinations of two products that a consumer canpurchasewithaspecificmoneyincome,giventhepricesofthetwoproducts.
LO1.5 List the categories of scarce resources and delineate the nature of society’s economizing problem.
LO1.6 Apply production possibilities analysis, increasing opportunity costs, and economic growth.
Aneconomy that is fullyemployedand thusoperatingon itsproductionpossibilitiescurvemustsacrificetheoutputofsometypesofgoodsandservicestoincreasetheproductionofothers.Thegainofonetypeofgoodorserviceisalwaysaccompaniedbyanopportunitycost intheformofthe lossofsomeof theothertypeofgoodorservice.
Becauseresourcesarenotequallyproductiveinallpossibleuses,shiftingresourcesfromoneusetoanothercreatesincreasingopportunity costs.The production of additional units of oneproductrequiresthesacrificeofincreasingamountsoftheotherproduct.
LO1.1 Define economics and the features of the economic perspective.
LO1.4 Explain the individual’s economizing problem and how trade-offs, opportunity costs, and attainable combinations can be illustrated with budget lines.
Individualsfaceaneconomizingproblem.Becausetheirwantsex-ceedtheirincomes,theymustdecidewhattopurchaseandwhatto forgo.Society also faces aneconomizingproblem.Societal
QUICK REVIEW 1.4
• Unemployment causes an economy to operate at a point inside its production possibilities curve.
• Increases in resource supplies, improvements in resource quality, and technological advance cause economic growth, which is depicted as an outward shift of the production possibilities curve.
• An economy’s present choice of capital and consumer goods helps determine the future location of its production possibilities curve.
• International specialization and trade enable a nation to obtain more goods than its production possibilities curve indicates.
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CHAPTER 1 Limits, Alternatives, and Choices 21
allgoodsandservices,thatis,toexperienceeconomicgrowth.Society’s choice as to themixof consumergoods and capitalgoodsincurrentoutputisamajordeterminantofthefuturelo-cationoftheproductionpossibilitiescurveandthusoftheextentofeconomicgrowth.
TERMS AND CONCEPTSeconomicseconomicperspectivescarcityopportunitycostutilitymarginalanalysisscientificmethodeconomicprincipleother-things-equalassumptionmicroeconomics
7. What are economic resources?What categories do eco-nomistsusetoclassifythem?Whyareresourcesalsocalledfactorsofproduction?Whyaretheycalledinputs? LO1.5
9. Specifyandexplainthetypicalshapesofmarginal-benefitandmarginal-costcurves.Howarethesecurvesusedtode-terminetheoptimalallocationofresourcestoaparticularproduct? If currentoutput is such thatmarginal costex-ceedsmarginalbenefit,shouldmoreorfewerresourcesbeallocatedtothisproduct?Explain. LO1.6
11. last word Studiesindicatethatmarriedmenonaver-ageearnmoreincomethanunmarriedmenofthesameageandeducationlevel.Whymustwebecautiousincon-cludingthatmarriage is thecauseandhigher incomeistheeffect?
The following and additional problems can be found in
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PART ONE Introduction to Economics and the Economy22
R E V I E W Q U E S T I O N S
1. Matcheachtermwiththecorrectdefinition. LO1.1 economics opportunitycost marginalanalysis utility a. Thenext-best thing thatmustbe forgone inorder to
produceonemoreunitofagivenproduct. b. Thepleasure,happiness,orsatisfactionobtainedfrom
consumingagoodorservice. c. Thesocialscienceconcernedwithhowindividuals,insti-
a. Theunemployment rate in theUnitedStateswas8.1percentinAugust2012.
b. AU.S.softwarefirmdischarged15workerslastmonthandtransferredtheworktoIndia.
c. An unexpected freeze in central Florida reduced thecitruscropandcausedthepriceoforangestorise.
d. U.S.output,adjustedforinflation,decreasedby2.4percentin2009.
e. LastweekWellsFargoBanklowereditsinterestrateonbusinessloansbyone-halfof1percentagepoint.
f. The consumer price index rose by 3.8 percent fromAugust2011toAugust2012.
3. Supposethatyou initiallyhave$100tospendonbooksor movie tickets.The books start off costing $25 eachand themovieticketsstartoffcosting$10each.Foreachof the following situations, would the attainable setof combinations that you can afford increase ordecrease? LO1.4
a. Your budget increases from $100 to $150 while thepricesstaythesame.
b. Yourbudgetremains$100,thepriceofbooksremains$25,butthepriceofmovieticketsrisesto$20.
c. Yourbudgetremains$100,thepriceofmovieticketsre-mains$10,butthepriceofabookfallsto$15.
4. Supposethatyouaregivena$100budgetatworkthatcanbespentonlyontwo items: staplersandpens. If staplerscost$10eachandpenscost$2.50each,thentheopportu-nitycostofpurchasingonestapleris: LO1.4
a. 10pens. b. 5pens. c. zeropens. d. 4pens. 5. Foreachofthefollowingsituationsinvolvingmarginalcost
a. 3,000unitsatwhichMC5$10andMB5$13. b. 11unitsatwhichMC5$4andMB5$3. c. 43,277unitsatwhichMC5$99andMB5$99. d. 82unitsatwhichMC,MB. e. 5unitsatwhichMB,MC. 6. Explainhow(ifatall)eachofthefollowingeventsaffects the
locationofacountry’sproductionpossibilitiescurve: LO1.6 a. Thequalityofeducationincreases. b. Thenumberofunemployedworkersincreases. c. Anewtechnique improvestheefficiencyofextracting
copperfromore. d. Adevastatingearthquakedestroysnumerousproduction
andpushoutitsproductionpossibilitiescurve? LO1.7 a. Betterweatherandnicercars. b. Highertaxesandlowerspending. c. Increasesinresourcesuppliesandadvancesintechnology. d. Decreasesinscarcityandadvancesinauditing.
P R O B L E M S
1. PotatoescostJanice$1perpound,andshehas$5.00thatshecouldpossiblyspendonpotatoesorotheritems.Ifshefeelsthatthefirstpoundofpotatoesisworth$1.50,thesec-ondpoundisworth$1.14,thethirdpoundisworth$1.05,and all subsequent pounds are worth $0.30, how manypoundsofpotatoeswillshepurchase?Whatifsheonlyhad$2tospend? LO1.1
2. Phamcanworkasmanyorasfewhoursasshewantsatthecollegebookstore for$9perhour.Butduetoherhecticschedule,shehasjust15hoursperweekthatshecanspendworking at either thebookstoreor otherpotential jobs.Onepotentialjob,atacafé,willpayher$12perhourforupto6hoursperweek.Shehasanotherjobofferataga-ragethatwillpayher$10anhourforupto5hoursper
c. Doesthebudgetlinetellyouwhichoftheavailablecom-binationsofcandybarsandbagsofpeanutstobuy?
d. Suppose that you had won $30 on your ticket, not$15. Showthe$30budgetlineinyourdiagram.Hasthe number of available combinations increased ordecreased?
4. Supposethatyouareonadesertislandandpossessexactly20coconuts.Yourneighbor,Friday,isafisherman,andheiswillingtotrade2fishforevery1coconutthatyouarewilling togivehim.Anotherneighbor,Kwame, isalsoafisherman, and he is willing to trade 3 fish for every1coconut. LO1.5
a. Onasingle figure,drawbudget lines for tradingwithFridayandfortradingwithKwame. (Putcoconutsontheverticalaxis.)
b. WhatistheslopeofthebudgetlinefromtradingwithFriday?
c. WhatistheslopeofthebudgetlinefromtradingwithKwame?
d. Which budget line features a larger set of attainablecombinationsofcoconutsandfish?
e. Ifyouaregoingtotradecoconutsforfish,wouldyourathertradewithFridayorKwame?
a. Showthesedatagraphically.Uponwhatspecificassump-tionsisthisproductionpossibilitiescurvebased?
b. If the economy is at pointC,what is the cost of onemore automobile?Ofonemoreforklift?Whichcharac-teristicoftheproductionpossibilitiescurvereflectsthelawofincreasingopportunitycosts:itsshapeoritslength?
c. Iftheeconomycharacterizedbythisproductionpossi-bilities tableandcurvewereproducing3automobilesand20forklifts,whatcouldyouconcludeaboutitsuseofitsavailableresources?
d. Isproductionatapointoutsidetheproductionpossibili-tiescurvecurrentlypossible?Couldafutureadvanceintechnologyallowproductionbeyond thecurrentpro-ductionpossibilitiescurve?Couldinternationaltradeal-lowacountrytoconsumebeyonditscurrentproductionpossibilitiescurve?
FURTHER TEST YOUR KNOWLEDGE AT www.mheducation.asia/olc/mcconnellPractice quizzes, student PowerPoints, worked problems, Webbased questions, and additional materials are available at the text’s Online Learning Center (OLC), www.mheducation.asia/olc/mcconnell, or scan here. Need a barcode reader? Try ScanLife, available in your app store.
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CHAPTER ONE APPENDIX24
LO1.8 Understand graphs, curves, and slopes as they relate to economics.Ifyouglancequicklythroughthistext,youwillfindmanygraphs.Someseemsimple,whileothersseemmoreformi-dable.Allareincludedtohelpyouvisualizeandunderstandeconomicrelationships.Physicistsandchemistssometimesillustratetheirtheoriesbybuildingarrangementsofmulti-coloredwoodenballs,representingprotons,neutrons,andelectrons,thatareheldinproperrelationtooneanotherbywiresorsticks.Economistsmostoftenusegraphstoil-lustratetheirmodels.Byunderstandingthese“pictures,”youcanmorereadilycomprehendeconomicrelationships.
Construction of a GraphA graph is a visual representation of the relationshipbetweentwoeconomicquantities,orvariables.ThetableinFigure1isahypotheticalillustrationshowingtherela-tionshipbetweenincomeandconsumptionfortheecon-omyas awhole.Without even studyingeconomics,wewouldlogicallyexpectthatpeoplewouldbuymoregoodsandserviceswhentheirincomesgoup.Thus,itisnotsur-prisingtofindinthetablethattotalconsumptionintheeconomyincreasesastotalincomeincreases. TheinformationinthetableisexpressedgraphicallyinFigure1.Hereishowitisdone:Wewanttoshowvisu-ally how consumption changes as income changes.Wethereforerepresentincomeonthehorizontal axisofthegraphandconsumptiononthevertical axis. Nowwearrangetheverticalandhorizontalscalesofthegraphtoreflecttherangesofvaluesofconsumptionand
incomeandmarkthescalesinconvenientincrements.Asyoucansee,thevaluesmarkedonthescalescoverallthevaluesinthetable.Theincrementsonbothscalesare$100. Because the graph has two dimensions, each pointwithin it represents an income value and its associatedconsumptionvalue.Tofindapointthatrepresentsoneofthefiveincome-consumptioncombinationsinthetableinFigure1,wedrawstraightlinesfromtheappropriateval-uesontheverticalandhorizontalaxes.For example,toplotpointc(the$200income–$150consumptionpoint),wedrawstraight linesup fromthehorizontal (income)axisat$200andacrossfromthevertical (consumption)axisat$150.Theselinesintersectatpointc,whichrepre-sents this particular income-consumption combination.You should verify that the other income-consumptioncombinationsshowninthetableareproperlylocatedinthegraphinFigure1.Finally,byassumingthatthesamegeneral relationship between income and consumptionprevailsforallotherincomes,wedrawalineorsmoothcurvetoconnectthesepoints.Thatlineorcurverepre-sentstheincome-consumptionrelationship. Ifthecurveisastraightline,asinFigure1,wesaytherelationshipislinear.(Itispermissible,andevencustom-ary,torefertostraightlinesingraphsas“curves.”)
Direct and Inverse RelationshipsThelineinFigure1slopesupwardtotheright,soitde-pictsadirectrelationshipbetweenincomeandconsump-tion.Byadirect relationship(orpositiverelationship)wemeanthattwovariables—inthiscase,consumptionand
Graphs and Their Meaning
Income Consumption per Week per Week Point
$ 0 $ 50 a
100 100 b
200 150 c
300 200 d
400 250 e
0
Con
sum
ptio
n (C
)
100
$100 200 300 400
200
300
$400
Income (Y )
Consumption
a
b
c
d
eC = 50 + .5Y
FIGURE 1 Graphing the direct relationship between consumption and income. Two sets of data that are positively or directly related, such as consumption and income, graph as an upsloping line.
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25CHAPTER ONE APPENDIX
Ticket Attendance, Price Thousands Point
$50 0 a
40 4 b
30 8 c
20 12 d
10 16 e
0 20 f
0
Tic
ket
pric
e (P
)
10
4 8 12 16
20
30
40
Attendance in thousands (Q)
Ticketdemand
a
b
c
d
e
f
P = 50 – 2.5Q
20
$50
FIGURE 2 Graphing the inverse relationship between ticket prices and game attendance. Two sets of data that are negatively or inversely related, such as ticket price and the attendance at basketball games, graph as a downsloping line.
income—changeinthesamedirection.Anincreaseincon-sumptionisassociatedwithanincreaseinincome;ade-creaseinconsumptionaccompaniesadecreaseinincome.Whentwosetsofdataarepositivelyordirectlyrelated,theyalwaysgraphasanupslopingline,asinFigure1. Incontrast,twosetsofdatamaybeinverselyrelated.ConsiderthetableinFigure2,whichshowstherelation-shipbetweenthepriceofbasketballticketsandgameat-tendanceatGiganticStateUniversity (GSU).Herewehavean inverse relationship (ornegativerelationship)because the two variables change in opposite directions.Whenticketpricesdecrease,attendanceincreases.Whenticketpricesincrease,attendancedecreases.Thesixdatapoints inthetable inFigure2areplottedinthegraph.Observe thatan inverse relationshipalwaysgraphsasadownslopingline.
Dependent and Independent VariablesAlthoughitisnotalwayseasy,economistsseektodeter-minewhichvariableisthe“cause”andwhichisthe“ef-fect.” Or, more formally, they seek the independentvariable and thedependentvariable.The independent variable is the cause or source; it is the variable thatchanges first.Thedependent variable is the effect oroutcome; it is the variable that changes becauseof thechange in the independent variable.As inour income-consumptionexample,incomegenerallyistheindepen-dent variable and consumption thedependent variable.Incomecausesconsumptiontobewhatitisratherthantheotherwayaround.Similarly,ticketprices(setinad-vanceoftheseasonandprintedontheticket)determineattendanceatGSUbasketballgames;attendanceatgames
does not determine the printed ticket prices for thosegames.Ticketprice is the independentvariableandthequantityofticketspurchasedisthedependentvariable. Youmay recall from your high school courses thatmathematiciansputtheindependentvariable(cause)onthehorizontalaxisandthedependentvariable(effect)ontheverticalaxis.Economistsarelesstidy;theirgraphingofindependentanddependentvariablesismorearbitrary.Theirconventionalgraphingoftheincome-consumptionrelationshipisconsistentwithmathematicalconvention,buteconomistsputpriceandcostdataon theverticalaxis.Hence,economists’graphingofGSU’sticketprice–attendancedatadiffersfromnormalmathematicalproce-dure.Thisdoesnotpresentaproblem,butwewantyoutobeawareofthisfacttoavoidanypossibleconfusion.
Other Things EqualOur simple two-variablegraphspurposely ignoremanyotherfactorsthatmightaffecttheamountofconsumptionoccurringateachincomelevelorthenumberofpeoplewhoattendGSUbasketballgamesateachpossibleticketprice.Wheneconomistsplottherelationshipbetweenanytwovariables,theyemploytheceteris paribus(other-things-equal)assumption.Thus,inFigure1allfactorsotherthanincomethatmightaffecttheamountofconsumptionarepresumedtobeconstantorunchanged.Similarly,inFigure2allfactorsotherthanticketpricethatmightinfluenceat-tendanceatGSUbasketballgamesareassumedconstant.Inreality,“otherthings”arenotequal;theyoftenchange,andwhentheydo,therelationshiprepresentedinourtwotables andgraphswill change. Specifically, the lineswehaveplottedwouldshifttonewlocations.
Slopes and Measurement Units Theslopeofalinewillbeaffectedbythechoiceofunitsforeithervariable.If,inourticketpriceillustration,wehadchosentomeasureat-tendance in individual people, our horizontal changewouldhavebeen4,000andtheslopewouldhavebeen
Slopes and Marginal Analysis Recall that economics islargelyconcernedwithchangesfromthestatusquo.Theconceptofslopeisimportantineconomicsbecauseitreflectsmarginalchanges—thoseinvolving1more(or1fewer)unit.Forexample,inFigure1the.5slopeshowsthat$0.50ofextraormarginalconsumptionisassociatedwitheach$1changein income.Inthisexample,peoplecollectivelywillconsume$0.50ofany$1increaseintheirincomesandreducetheirconsumptionby$0.50foreach$1declineinincome.
Infinite and Zero Slopes Manyvariablesareunrelatedorindependentofoneanother.Forexample,thequantityofwristwatchespurchasedisnotrelatedtothepriceofbananas.InFigure3awerepresentthepriceofbananasontheverti-calaxisandthequantityofwatchesdemandedonthehori-zontalaxis.Thegraphoftheirrelationshipisthelineparalleltotheverticalaxis.Theline’sverticalslopeindicatesthatthesamequantityofwatchesispurchasednomatterwhatthepriceofbananas.Theslopeofverticallinesisinfinite. Similarly,aggregateconsumptioniscompletelyunre-latedtothenation’sdivorcerate.InFigure3bweputcon-sumptionontheverticalaxisandthedivorcerateonthehorizontalaxis.Thelineparalleltothehorizontalaxisrep-resentsthislackofrelatednessbecausetheamountofcon-sumptionremainsthesamenomatterwhathappenstothedivorcerate.Theslopeofhorizontallinesiszero.
Vertical InterceptA line can be positioned on a graph (without plottingpoints)ifweknowjusttwothings:itsslopeanditsverticalintercept.Wehavealreadydiscussedslope.Thevertical interceptofalineisthepointwherethelinemeetstheverticalaxis.InFigure1theinterceptis$50.Thisinterceptmeansthatifcurrentincomewerezero,consumerswouldstillspend$50.Theymightdothisthroughborrowingorbysellingsomeoftheirassets.Similarly,the$50verticalinterceptinFigure2showsthatata$50ticketprice,GSU’sbasketballteamwouldbeplayinginanemptyarena.
Considerastockmarket“crash.”Thedramaticdropinthevalueofstocksmightcausepeopletofeellesswealthyandthereforelesswillingtoconsumeateachlevelofin-come.Theresultmightbeadownwardshiftofthecon-sumption line. To see this, you should plot a newconsumptionlineinFigure1,assumingthatconsumptionis,say,$20lessateachincomelevel.Notethattherela-tionshipremainsdirect;thelinemerelyshiftsdownwardtoreflectlessconsumptionspendingateachincomelevel. Similarly,factorsotherthanticketpricesmightaffectGSUgameattendance.IfGSUlosesmostofitsgames,attendance atGSUgamesmight be less at each ticketprice.Tosee this, redrawFigure2assuming that2,000fewerfansattendGSUgamesateachticketprice.
Slope of a LineLinescanbedescribedintermsoftheirslopes.Theslope of a straight lineistheratiooftheverticalchange(theriseordrop)tothehorizontalchange(therun)betweenanytwopointsoftheline.
relationships(curvylines).Theslopeofastraightlineisthesameatallitspoints.Theslopeofalinerepresentinganon-linearrelationshipchangesfromonepointtoanother.Suchlinesarealwaysreferredtoascurves. ConsiderthedownslopingcurveinFigure4.Itsslopeisnegativethroughout,butthecurveflattensaswemovedown along it.Thus, its slope constantly changes; thecurvehasadifferentslopeateachpoint. Tomeasure the slopeat a specificpoint,wedrawastraightlinetangenttothecurveatthatpoint.Astraightlineistangentatapointifittouches,butdoesnotinter-sect,thecurveatthatpoint.ThuslineaaistangenttothecurveinFigure4atpointA.Theslopeofthecurveatthatpointisequaltotheslopeofthetangentline.Specifically,thetotalverticalchange(drop) inthetangentlineaa is220andthetotalhorizontalchange(run)is15.Becausethe slopeof the tangent lineaa is220y15,or24, theslopeofthecurveatpointAisalso24. LinebbinFigure4istangenttothecurveatpointB.Followingthesameprocedure,wefindtheslopeatBtobe25y115,or21
Equation of a Linear RelationshipIfweknowthevertical interceptandslope,wecande-scribea line succinctly inequation form. In itsgeneralform,theequationofastraightlineis
For our income-consumption example, if C representsconsumption(thedependentvariable)andYrepresentsin-come(theindependentvariable),wecanwriteC5a1bY.Bysubstitutingtheknownvaluesoftheinterceptandtheslope,weget
C5501.5Y
ThisequationalsoallowsustodeterminetheamountofconsumptionCatanyspecificlevelofincome.Youshoulduseittoconfirmthatatthe$250incomelevel,consump-tionis$175. Wheneconomistsreversemathematicalconventionbyputtingtheindependentvariableontheverticalaxisandthedependentvariableonthehorizontalaxis,thenystandsfor the independentvariable,ratherthanthe dependentvariableinthegeneralform.WenotedpreviouslythatthiscaseisrelevantforourGSUticketprice–attendancedata.IfPrepresentstheticketprice(independentvariable)andQrepresentsattendance(dependentvariable),theirrela-tionshipisgivenby
Slope of a Nonlinear CurveWenowmovefromthesimpleworldoflinearrelationships(straight lines) to themore complexworldof nonlinear
(a)
Pric
e of
ban
anas
Purchases of watches
Slope =in�nite
0
(b)
Divorce rate
Con
sum
ptio
n
Slope = zero
0
FIGURE 3 Infinite and zero slopes. (a) A line parallel to the vertical axis has an infinite slope. Here, purchases of watches remain the same no matter what happens to the price of bananas. (b) A line parallel to the horizontal axis has a slope of zero. In this case, consumption remains the same no matter what happens to the divorce rate. In both (a) and (b), the two variables are totally unrelated to one another.
FIGURE 4 Determining the slopes of curves. The slope of a nonlinear curve changes from point to point on the curve. The slope at any point (say, B) can be determined by drawing a straight line that is tangent to that point (line bb) and calculating the slope of that line.
20
15
10
5
0 1510
A
B
5 20
a
b
ba
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CHAPTER ONE APPENDIX28
APPENDIX SUMMARYThe slope of a straight line is the ratio of the vertical
2. Describe thegraphical relationshipbetween ticketpricesand the number of people choosing to visit amusementparks.Isthatrelationshipconsistentwiththefactthat,his-torically,parkattendanceandticketpriceshavebothrisen?Explain. LO1.8
B slope 3,000 dependentvariable 800 verticalintercept R independentvariable
A P P E N D I X P R O B L E M S
1. Graphandlabelaseitherdirectorindirecttherelationshipsyouwouldexpecttofindbetween(a)thenumberofinchesof rainfall permonth and the sale of umbrellas, (b) theamountoftuitionandthelevelofenrollmentatauniversity,and(c)thepopularityofanentertainerandthepriceofherconcerttickets. LO1.8
2. Indicatehoweachof the followingmightaffect thedatashown in the table and graph in Figure 2 of thisappendix: LO1.8
a. GSU’s athletic director schedules higher-qualityopponents.
b. AnNBAteamlocatesinthecitywhereGSUplays. c. GSUcontractstohaveallitshomegamestelevised. 3. Thefollowingtablecontainsdataontherelationshipbe-
tween saving and income. Rearrange these data into ameaningfulorderandgraphthemontheaccompanyinggrid.What is the slope of the line?The vertical inter-cept? Writetheequationthatrepresentsthisline.Whatwould you predict saving to be at the $12,500 level ofincome? LO1.8
5. Supposethatwhentheinterestrateonloansis16percent,businessesfinditunprofitabletoinvestinmachineryandequipment.However,whentheinterestrateis14percent,$5billionworthofinvestmentisprofitable.At12percentinterest,a totalof$10billionof investment isprofitable.Similarly,totalinvestmentincreasesby$5billionforeachsuccessive2-percentage-pointdeclineintheinterestrate.Describetherelevantrelationshipbetweentheinterestrateandinvestmentinatable,onagraph,andasanequation.Puttheinterestrateontheverticalaxisandinvestmentonthehorizontalaxis.Inyourequationusetheformi5a1bI,whereiistheinterestrate,aistheverticalintercept,bistheslopeof the line (which isnegative), and I is the levelofinvestment. LO1.8
6. Suppose that C 5 a 1 bY, where C 5 consumption,a 5 consumption at zero income, b 5 slope, and Y 5income. LO1.8
a. AreC andY positively related or are they negativelyrelated?
b. If graphed, would the curve for this equation slopeupwardorslopedownward?
c. ArethevariablesCandY inverselyrelatedordirectlyrelated?
d. WhatisthevalueofCifa510,b50.50,andY5200? e. WhatisthevalueofYifC5100,a510,andb50.25?
