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Chapter Introduction 4

Chapter ObjectivesSection 3: Economic Choices and

Decision Making

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• Analyze trade-offs and opportunity costs. • Explain decision-making strategies.

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Section 3-4

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Introduction• The process of making a choice is not

always easy. – Because resources are scarce, consumers

need to make wise choices. – To become a good decision maker, you need to

know how to identify the problem and then analyze your alternatives.

– Finally, you have to make your choice in a way that carefully considers the costs and benefits of each possibility.

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Section 3-5

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Trade-Offs and Opportunity Cost• There are alternatives and costs to

everything we do. • In a world where “there is no such thing as

a free lunch,” it pays to examine these concepts closely.

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Section 3-6

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Trade-Offs• People face trade-offs, or alternative

choices, whenever they make an economic decision.

•To help make the decision, constructing a grid is one way to approach the problem.

Figure 1.5

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Section 3-7

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Trade-Offs (cont.)

• Using a decision-making grid… – forces you to consider a number of relevant

alternatives. – requires you to identify the criteria used to

evaluate the alternatives. – forces you to evaluate each alternative based

on the criteria you selected.

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Section 3-8

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Opportunity Cost• To an economist cost often means more

than the price tag placed on a good or service.

• Instead, economists think broadly in terms of opportunity cost–the cost of the next best alternative use of money, time, or resources when one choice is made rather than another.

• Even time has an opportunity cost, although you cannot always put a monetary value on it.

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Section 3-9

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Production Possibilities• A popular model economists use to

illustrate the concept of opportunity cost is the production possibilities frontier.

• This is a diagram representing various combinations of goods and/or services an economy can produce when all productive resources are fully employed.

• A classic example is a mythical country called Alpha which produces two goods–guns and butter.

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Section 3-10

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Identifying Possible Alternatives• Even though Alpha only produces two

goods, the country has a number of alternatives available to it.

• This is why the figure is called a production “possibilities” frontier.

Figure 1.6The Production Possibilities Frontier

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Section 3-11

Identifying Possible Alternatives (cont.)

• Eventually though, Alpha will have to settle on a single combination because its resources are limited.

Figure 1.6The Production Possibilities Frontier

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Section 3-12

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Fully Employed Resources• All points on the curve represent maximum

combinations of output possible if all resources are fully employed.

• As long as all resources are fully employed, however, there are no extra resources to produce extra quantities of guns or butter.

Figure 1.6The Production Possibilities Frontier

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Section 3-13

Fully Employed Resources (cont.)

• The figure is called a production possibilities “frontier” to indicate the maximum combinations of goods and/or services that can be produced.

Figure 1.6The Production Possibilities Frontier

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Section 3-14

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Opportunity Cost• Opportunity cost is a general concept that

is expressed in terms of trade-offs, or in terms of things given up to get something else.

• Opportunity cost is not always measured in terms of dollars and cents.

Figure 1.6The Production Possibilities Frontier

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Section 3-15

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The Cost of Idle Resources• If some resources were not fully employed,

then it would be impossible for Alpha to reach its potential.

• If Alpha was operating at point E,opportunity cost of the unemployed resources would be the 100 units of lost butter production.

Figure 1.6The Production Possibilities Frontier

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Section 3-16

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The Cost of Idle Resources (cont.)

• Production at point E could be the result of other idle resources, such as factories or land that are available but are not being used.

• As long as some resources are idle, the country cannot produce on its frontier.

Figure 1.6The Production Possibilities Frontier

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Section 3-17

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Economic Growth• The production possibilities frontier

represents potential output at a given point in time.

• Eventually, however, population may grow, the capital stock may grow, and productivity may increase.

Figure 1.6The Production Possibilities Frontier

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Section 3-18

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Economic Growth (cont.)

• If this happens, then Alpha will be able to produce more in the future than it can today.

• Economic growthcauses the production possibilities frontier to move outward.

Figure 1.6The Production Possibilities Frontier

End of Section 3

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