Economic Choices in a World of Scarcity

Ch 02 Taylor: Principles of Macroeconomics
3e
1
Textbook Media Press
Choosing What to Consume
The real world is one of scarcity
That is, a world in which people’s desires
exceed what is possible.
As a result, economic behavior involves trade-
offs in which individuals, firms, government,
and society must give up things that they
desire to obtain other things that they desire
more.
Ch 02 Taylor: Principles of Macroeconomics
3e
2
Textbook Media Press
Choosing What to Consume (2)
Individuals face three main categories of trade-
offs:
the consumption choice of what quantities of
goods to consume
the labor-leisure choice of what quantity of hours
to work,
and the intertemporal choices that involve costs
in the present and benefits in the future, or
benefits in the present and costs in the future.
Ch 02 Taylor: Principles of Macroeconomics
3e
3
Textbook Media Press
A Consumption Choice Budget Constraint
The 
budget constraint
, sometimes called the
opportunity set
, illustrates the range of choices
available.
The slope of the budget constraint is determined
by the relative price of the choices.
Choices beyond the budget constraint are
impossible. Choices inside the budget constraint
are wasteful.
Ch 02 Taylor: Principles of Macroeconomics
3e
4
Textbook Media Press
How Changes in Income and Prices Affect the Budget Constraint
Ch 02 Taylor: Principles of Macroeconomics
3e
5
Textbook Media Press
Personal Preferences Determine Specific Choices
Ch 02 Taylor: Principles of Macroeconomics
3e
6
Textbook Media Press
Making a Choice Along the Labor-Leisure
Budget Constraint
People will choose along their budget
constraints in a way that maximizes their
satisfaction or 
utility
, which is based on their
own distinctive personal preferences.
Ch 02 Taylor: Principles of Macroeconomics
3e
7
Textbook Media Press
Ch 02 Taylor: Principles of Macroeconomics
3e
8
Textbook Media Press
Making a Choice Along the Labor-Leisure
Budget Constraint
Ch 02 Taylor: Principles of Macroeconomics
3e
9
Textbook Media Press
Interest Rates: The Price of
Intertemporal Choice
An interest rate has three components:
the risk premium to cover the risk of not being
repaid
the rate of expected inflation,
and the time value of money, as
compensation for waiting to spend.
Ch 02 Taylor: Principles of Macroeconomics
3e
10
Textbook Media Press
The Power of Compound Interest
The formula for how 
compound interest
accumulates over time is:
(Present amount) × (1 + Interest rate)number of years
= Future amount.
Ch 02 Taylor: Principles of Macroeconomics
3e
11
Textbook Media Press
Opportunity Cost
Opportunity cost 
measures cost by what is
given up in exchange.
Sometimes opportunity cost can be measured
in money
But it is often useful to consider whether time
should be included as well,
Or to measure it in terms of the actual
resources that must be given up.
Ch 02 Taylor: Principles of Macroeconomics
3e
12
Textbook Media Press
Marginal Analysis
Most economic decisions and trade-offs
are not all-or-nothing.
Instead, they involve 
marginal analysis
Which means they are about decisions
on the margin, involving a little more or a
little less.
Ch 02 Taylor: Principles of Macroeconomics
3e
13
Textbook Media Press
Marginal Decision-Making and
Diminishing Marginal Utility
The law of 
diminishing marginal utility
points out that as a person receives more
of something—whether it is a specific
good or another resource—the
additional marginal gains tend to
become smaller.
Ch 02 Taylor: Principles of Macroeconomics
3e
14
Textbook Media Press
Sunk Costs  
Because 
sunk costs 
occurred in the past and
cannot be recovered, they should be
disregarded in making current decisions.
Ch 02 Taylor: Principles of Macroeconomics
3e
15
Textbook Media Press
The Production Possibilities Frontier and
Social Choices
A 
production possibilities frontier 
defines a
set of choices faced by society as a whole.
The shape of the PPF is typically curved
outward, rather than straight.
Choices outside the PPF are unattainable, and
choices inside the PPF are wasteful.
Over time, a growing economy will tend to
shift the PPF outwards.
Ch 02 Taylor: Principles of Macroeconomics
3e
16
Textbook Media Press
Ch 02 Taylor: Principles of Macroeconomics
3e
17
Textbook Media Press
Law of Diminishing Returns
The 
law of diminishing returns 
holds that as
increments of additional resources are
devoted to producing something, the marginal
increase in output will become smaller and
smaller.
Ch 02 Taylor: Principles of Macroeconomics
3e
18
Textbook Media Press
Productive Efficiency and Allocative
Efficiency
All choices along a production possibilities
frontier display 
productive efficiency
That is, it is impossible to use society’s resources
to produce more of one good without decreasing
production of the other good.
The specific choice along a production
possibilities frontier that reflects the mix of goods
that society prefers is the choice with 
allocative
efficiency
.
Ch 02 Taylor: Principles of Macroeconomics
3e
19
Textbook Media Press
Ch 02 Taylor: Principles of Macroeconomics
3e
20
Textbook Media Press
Why Society Must Choose
Positive statements 
describe the world as it is
Normative statements 
describe how the world should
be.
Even when economics analyzes the gains and losses
from various events or policies, and thus draws
normative conclusions about how the world should be,
the analysis of economics is rooted in a positive
analysis of how people, firms, and government actually
behave, not how they should behave
Ch 02 Taylor: Principles of Macroeconomics
3e
21
Textbook Media Press
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Economic behavior involves trade-offs as individuals, firms, government, and society make choices to satisfy desires considering scarcity. The concepts of consumption choice, budget constraints, and the impact of income and prices on choices are explored in this text. Personal preferences drive decision-making along with considerations of satisfaction and utility, guiding individuals to maximize their choices within constraints.


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  1. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 1

  2. Choosing What to Consume The real world is one of scarcity That is, a world in which people s desires exceed what is possible. As a result, economic behavior involves trade- offs in which individuals, firms, government, and society must give up things that they desire to obtain other things that they desire more. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 2

  3. Choosing What to Consume (2) Individuals face three main categories of trade- offs: the consumption choice of what quantities of goods to consume the labor-leisure choice of what quantity of hours to work, and the intertemporal choices that involve costs in the present and benefits in the future, or benefits in the present and costs in the future. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 3

  4. A Consumption Choice Budget Constraint The budget constraint, sometimes called the opportunity set, illustrates the range of choices available. The slope of the budget constraint is determined by the relative price of the choices. Choices beyond the budget constraint are impossible. Choices inside the budget constraint are wasteful. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 4

  5. How Changes in Income and Prices Affect the Budget Constraint Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 5

  6. Personal Preferences Determine Specific Choices Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 6

  7. Making a Choice Along the Labor-Leisure Budget Constraint People will choose along their budget constraints in a way that maximizes their satisfaction or utility, which is based on their own distinctive personal preferences. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 7

  8. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 8

  9. Making a Choice Along the Labor-Leisure Budget Constraint Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 9

  10. Interest Rates: The Price of Intertemporal Choice An interest rate has three components: the risk premium to cover the risk of not being repaid the rate of expected inflation, and the time value of money, as compensation for waiting to spend. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 10

  11. The Power of Compound Interest The formula for how compound interest accumulates over time is: (Present amount) (1 + Interest rate)number of years = Future amount. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 11

  12. Opportunity Cost Opportunity cost measures cost by what is given up in exchange. Sometimes opportunity cost can be measured in money But it is often useful to consider whether time should be included as well, Or to measure it in terms of the actual resources that must be given up. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 12

  13. Marginal Analysis Most economic decisions and trade-offs are not all-or-nothing. Instead, they involve marginal analysis Which means they are about decisions on the margin, involving a little more or a little less. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 13

  14. Marginal Decision-Making and Diminishing Marginal Utility The law of diminishing marginal utility points out that as a person receives more of something whether it is a specific good or another resource the additional marginal gains tend to become smaller. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 14

  15. Sunk Costs Because sunk costs occurred in the past and cannot be recovered, they should be disregarded in making current decisions. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 15

  16. The Production Possibilities Frontier and Social Choices A production possibilities frontier defines a set of choices faced by society as a whole. The shape of the PPF is typically curved outward, rather than straight. Choices outside the PPF are unattainable, and choices inside the PPF are wasteful. Over time, a growing economy will tend to shift the PPF outwards. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 16

  17. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 17

  18. Law of Diminishing Returns The law of diminishing returns holds that as increments of additional resources are devoted to producing something, the marginal increase in output will become smaller and smaller. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 18

  19. Productive Efficiency and Allocative Efficiency All choices along a production possibilities frontier display productive efficiency That is, it is impossible to use society s resources to produce more of one good without decreasing production of the other good. The specific choice along a production possibilities frontier that reflects the mix of goods that society prefers is the choice with allocative efficiency. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 19

  20. Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 20

  21. Why Society Must Choose Positive statements describe the world as it is Normative statements describe how the world should be. Even when economics analyzes the gains and losses from various events or policies, and thus draws normative conclusions about how the world should be, the analysis of economics is rooted in a positive analysis of how people, firms, and government actually behave, not how they should behave Ch 02 Taylor: Principles of Macroeconomics 3e Textbook Media Press 21

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