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Principles of Microeconomics

C H A P T E R 1 Economics: The Study of Choice START UP: ECONOMICS IN THE NEWS 2008 seemed to be the year of economic news. From the worst financial crisis since the Great Depression to the

possibility of a global recession, to gyrating gasoline and food prices, and to plunging housing prices, economic

questions were the primary factors in the presidential campaign of 2008 and dominated the news generally.

What causes the prices of some good to rise while the prices of some other goods fall? Price determination is

one of the things that we will study in this book. We will also consider factors that lead an economy to fall into a re-

cession—and the attempts to limit it.

While the investigation of these problems surely falls within the province of economics, economics encom-

passes a far broader range of issues. Ultimately, economics is the study of choice. Because choices range over every

imaginable aspect of human experience, so does economics. Economists have investigated the nature of family life,

the arts, education, crime, sports, job creation—the list is virtually endless because so much of our lives involves

making choices.

How do individuals make choices: Would you like better grades? More time to relax? More time watching

movies? Getting better grades probably requires more time studying, and perhaps less relaxation and entertain-

ment. Not only must we make choices as individuals, we must make choices as a society. Do we want a cleaner en-

vironment? Faster economic growth? Both may be desirable, but efforts to clean up the environment may conflict

with faster economic growth. Society must make choices.

Economics is defined less by the subjects economists investigate than by the way in which economists invest-

igate them. Economists have a way of looking at the world that differs from the way scholars in other disciplines

look at the world. It is the economic way of thinking; this chapter introduces that way of thinking.

economics

A social science that examines how people choose among the alternatives available to them.

scarcity

The condition of having to choose among alternatives.

scarce good

A good for which the choice of one alternative requires that another be given up.

free good

A good for which the choice of one use does not require that another be given up.

1. DEFINING ECONOMICS

L E A R N I N G O B J E C T I V E S

1. Define economics. 2. Explain the concepts of scarcity and opportunity cost and how they relate to the definition of

economics. 3. Understand the three fundamental economic questions: What should be produced? How

should goods and services be produced? For whom should goods and services be produced?

Economics is a social science that examines how people choose among the alternatives available to them. It is social because it involves people and their behavior. It is a science because it uses, as much as possible, a scientific approach in its investigation of choices.

1.1 Scarcity, Choice, and Cost All choices mean that one alternative is selected over another. Selecting among alternatives involves three ideas central to economics: scarcity, choice, and opportunity cost.

Scarcity

Our resources are limited. At any one time, we have only so much land, so many factories, so much oil, so many people. But our wants, our desires for the things that we can produce with those resources, are unlimited. We would always like more and better housing, more and better education—more and bet- ter of practically everything.

If our resources were also unlimited, we could say yes to each of our wants—and there would be no economics. Because our resources are limited, we cannot say yes to everything. To say yes to one thing requires that we say no to another. Whether we like it or not, we must make choices.

Our unlimited wants are continually colliding with the limits of our resources, forcing us to pick some activities and to reject others. Scarcity is the condition of having to choose among alternatives. A scarce good is one for which the choice of one alternative requires that another be given up.

Consider a parcel of land. The parcel presents us with several alternative uses. We could build a house on it. We could put a gas station on it. We could create a small park on it. We could leave the land undeveloped in order to be able to make a decision later as to how it should be used.

Suppose we have decided the land should be used for housing. Should it be a large and expensive house or several modest ones? Suppose it is to be a large and expensive house. Who should live in the house? If the Lees live in it, the Nguyens cannot. There are alternative uses of the land both in the sense of the type of use and also in the sense of who gets to use it. The fact that land is scarce means that soci- ety must make choices concerning its use.

Virtually everything is scarce. Consider the air we breathe, which is available in huge quantity at no charge to us. Could it possibly be scarce?

The test of whether air is scarce is whether it has alternative uses. What uses can we make of the air? We breathe it. We pollute it when we drive our cars, heat our houses, or operate our factories. In effect, one use of the air is as a garbage dump. We certainly need the air to breathe. But just as certainly, we choose to dump garbage in it. Those two uses are clearly alternatives to each other. The more garbage we dump in the air, the less desirable—and healthy—it will be to breathe. If we decide we want to breathe cleaner air, we must limit the activities that generate pollution. Air is a scarce good because it has alternative uses.

Not all goods, however, confront us with such choices. A free good is one for which the choice of one use does not require that we give up another. One example of a free good is gravity. The fact that gravity is holding you to the earth does not mean that your neighbor is forced to drift up into space! One person’s use of gravity is not an alternative to another person’s use.

There are not many free goods. Outer space, for example, was a free good when the only use we made of it was to gaze at it. But now, our use of space has reached the point where one use can be an al- ternative to another. Conflicts have already arisen over the allocation of orbital slots for communica- tions satellites. Thus, even parts of outer space are scarce. Space will surely become more scarce as we find new ways to use it. Scarcity characterizes virtually everything. Consequently, the scope of econom- ics is wide indeed.

8 PRINCIPLES OF MICROECONOMICS

opportunity cost

The value of the best alternative forgone in making any choice.

Scarcity and the Fundamental Economic Questions

The choices we confront as a result of scarcity raise three sets of issues. Every economy must answer the following questions:

1. What should be produced? Using the economy’s scarce resources to produce one thing requires giving up another. Producing better education, for example, may require cutting back on other services, such as health care. A decision to preserve a wilderness area requires giving up other uses of the land. Every society must decide what it will produce with its scarce resources.

2. How should goods and services be produced? There are all sorts of choices to be made in determining how goods and services should be produced. Should a firm employ a few skilled or a lot of unskilled workers? Should it produce in its own country or should it use foreign plants? Should manufacturing firms use new or recycled raw materials to make their products?

3. For whom should goods and services be produced? If a good or service is produced, a decision must be made about who will get it. A decision to have one person or group receive a good or service usually means it will not be available to someone else. For example, representatives of the poorest nations on earth often complain that energy consumption per person in the United States is 17 times greater than energy consumption per person in the world’s 62 poorest countries. Critics argue that the world’s energy should be more evenly allocated. Should it? That is a “for whom” question.

Every economy must determine what should be produced, how it should be produced, and for whom it should be produced. We shall return to these questions again and again.

Opportunity Cost

It is within the context of scarcity that economists define what is perhaps the most important concept in all of economics, the concept of opportunity cost. Opportunity cost is the value of the best altern- ative forgone in making any choice.

The opportunity cost to you of reading the remainder of this chapter will be the value of the best other use to which you could have put your time. If you choose to spend $20 on a potted plant, you have simultaneously chosen to give up the benefits of spending the $20 on pizzas or a paperback book or a night at the movies. If the book is the most valuable of those alternatives, then the opportunity cost of the plant is the value of the enjoyment you otherwise expected to receive from the book.

The concept of opportunity cost must not be confused with the purchase price of an item. Con- sider the cost of a college or university education. That includes the value of the best alternative use of money spent for tuition, fees, and books. But the most important cost of a college education is the value of the forgone alternative uses of time spent studying and attending class instead of using the time in some other endeavor. Students sacrifice that time in hopes of even greater earnings in the future or be- cause they place a value on the opportunity to learn. Or consider the cost of going to the doctor. Part of that cost is the value of the best alternative use of the money required to see the doctor. But, the cost also includes the value of the best alternative use of the time required to see the doctor. The essential thing to see in the concept of opportunity cost is found in the name of the concept. Opportunity cost is the value of the best opportunity forgone in a particular choice. It is not simply the amount spent on that choice.

The concepts of scarcity, choice, and opportunity cost are at the heart of economics. A good is scarce if the choice of one alternative requires that another be given up. The existence of alternative uses forces us to make choices. The opportunity cost of any choice is the value of the best alternative forgone in making it.

K E Y T A K E A W A Y S

< Economics is a social science that examines how people choose among the alternatives available to them.

< Scarcity implies that we must give up one alternative in selecting another. A good that is not scarce is a free good.

< The three fundamental economic questions are: What should be produced? How should goods and services be produced? For whom should goods and services be produced?

< Every choice has an opportunity cost and opportunity costs affect the choices people make. The opportunity cost of any choice is the value of the best alternative that had to be forgone in making that choice.

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