©2005 McGraw-Hill Ryerson Ltd. Chapter 2 1 The Economic Problem: Scarcity, Wants, and Choices

©2005 McGraw-Hill Ryerson Ltd.©2005 McGraw-Hill Ryerson Ltd. Chapter 2Chapter 2 11

The Economic Problem:The Economic Problem:Scarcity, Wants, and ChoicesScarcity, Wants, and Choices


The Foundation of EconomicsThe Foundation of Economics

• Society has virtually unlimited wants…Society has virtually unlimited wants…

• But resources are limited or scarceBut resources are limited or scarce


Unlimited WantsUnlimited Wants

• Goods & services provide Goods & services provide utilityutility

• Desire for a particular good can be Desire for a particular good can be satisfied, but not desire for goods in satisfied, but not desire for goods in generalgeneral

• The objective of all economic activity is to The objective of all economic activity is to fulfill wantsfulfill wants


Resource CategoriesResource Categories

Property ResourcesProperty Resources• LandLand



Property ResourcesProperty Resources• LandLand• CapitalCapital


Notes....Notes....

INVESTMENTINVESTMENT

FINANCIAL FINANCIAL CAPITALCAPITALREAL REAL CAPITALCAPITAL






Human ResourcesHuman Resources• LabourLabour




Human ResourcesHuman Resources• LabourLabour• Entrepreneurial AbilityEntrepreneurial Ability

– takes initiativetakes initiative– makes policy decisionsmakes policy decisions– innovatesinnovates– bears riskbears risk


PROPERTY RESOURCESPROPERTY RESOURCES

HUMAN RESOURCESHUMAN RESOURCES

LandLand RentRent

WagesWagesLabourLabour

Resource PaymentsResource Payments

EntrepreneurEntrepreneur Profit & LossProfit & Loss

CapitalCapital InterestInterest


Relative ScarcityRelative Scarcity

• resources (inputs) are scarce or limited in resources (inputs) are scarce or limited in supplysupply

• ultimate constraints on productionultimate constraints on production


Definition of EconomicsDefinition of Economics

• Social science concerned with Social science concerned with efficient use of scarce resources to efficient use of scarce resources to attain maximum fulfillment of society’s attain maximum fulfillment of society’s unlimited wantsunlimited wants

• Doing the best with what we haveDoing the best with what we have


Getting the Most from Available Getting the Most from Available ResourcesResources

• Full employment: using available Full employment: using available resourcesresources

• Full production: using resources efficientlyFull production: using resources efficiently– productive efficiencyproductive efficiency

• producing goods & services in the least costly wayproducing goods & services in the least costly way

– allocative efficiencyallocative efficiency• producing goods & services most wanted by producing goods & services most wanted by

societysociety


Production PossibilitiesProduction Possibilities

Assumptions:Assumptions:• full employment & productive efficiencyfull employment & productive efficiency• fixed resourcesfixed resources• fixed technologyfixed technology• two goodstwo goods

– pizzas symbolize consumer goodspizzas symbolize consumer goods– industrial machines symbolize capital goodsindustrial machines symbolize capital goods



• What if we could produce onlyWhat if we could produce only– 10,000 machines10,000 machines



• What if we could produce onlyWhat if we could produce only– 10,000 machines10,000 machines

• oror– 400,000 pizzas400,000 pizzas

• using using ALLALL of our resources of our resources

to get some pizzasto get some pizzaswe have to give up we have to give up some machines!some machines!

to get some pizzasto get some pizzaswe have to give up we have to give up some machines!some machines!



Pizza (00,000s)Pizza (00,000s) 00 11 22 33 44

Machines (000s)Machines (000s) 1010 99 77 44 00

Production Possibilities

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productionproductionpossibilitiespossibilities

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attainableattainable

unattainableunattainableattainable butattainable but

inefficientinefficient

Figure 2-1Figure 2-1



Law of Increasing Opportunity CostLaw of Increasing Opportunity Cost

• opportunity cost increases with amount opportunity cost increases with amount producedproduced

• as we make more pizzas, the # of as we make more pizzas, the # of machines we have to give up (per pizza) machines we have to give up (per pizza) increasesincreases

illustrated...illustrated...



Pizza (00,000s)Pizza (00,000s) 00 11 22 33 44


• opportunity cost of 1opportunity cost of 1stst 100,000 pizzas 100,000 pizzas

= 1,000 machines1,000 machines



Pizza (00,000s)Pizza (00,000s) 00 11 22 33 44


• opportunity cost of 2opportunity cost of 2ndnd 100,000 pizzas 100,000 pizzas




Pizza (00,000s)Pizza (00,000s) 00 11 22 33 44


• opportunity cost of 3opportunity cost of 3rdrd 100,000 pizzas 100,000 pizzas




Pizza (00,000s)Pizza (00,000s) 00 11 22 33 44


• opportunity cost of 4opportunity cost of 4thth 100,000 pizzas 100,000 pizzas




Pizza (00,000s)Pizza (00,000s) 00 11 22 33 44


Opportunity Cost 1st Pizza Unit = 1 Robot UnitOpportunity Cost 1st Pizza Unit = 1 Robot Unit

Opportunity Cost 2nd Pizza Unit = 2 Robot UnitsOpportunity Cost 2nd Pizza Unit = 2 Robot Units

Opportunity Cost 3rd Pizza Unit = 3 Robot UnitsOpportunity Cost 3rd Pizza Unit = 3 Robot Units

Opportunity Cost 4th Pizza Unit = 4 Robot UnitsOpportunity Cost 4th Pizza Unit = 4 Robot Units

the more pizzas we make,the more pizzas we make, the more each one costs,the more each one costs,

in terms of machines foregonein terms of machines foregone

the more pizzas we make,the more pizzas we make, the more each one costs,the more each one costs,

in terms of machines foregonein terms of machines foregone



Law of Increasing Opportunity CostLaw of Increasing Opportunity Cost

• as we make more pizzas, the # of as we make more pizzas, the # of machines we have to give up (per pizza) machines we have to give up (per pizza) increasesincreases

• so production possibilities curve gets so production possibilities curve gets steeper and steepersteeper and steeper




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11stst pizza unit pizza unit costs 1 costs 1 machine machine unitunit




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22ndnd pizza unit pizza unit costs 2 costs 2 machine machine unitsunits




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33rdrd pizza unit pizza unit costs 3 costs 3 machine machine unitsunits




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44thth pizza unit pizza unit costs 4 costs 4 machine machine unitsunits




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the more the more pizza we pizza we make, the make, the more more machines machines we give upwe give up

the the steeper steeper the curvethe curve



Shape of the CurveShape of the Curve

• concave to the originconcave to the origin

Economic RationaleEconomic Rationale

• resources are not completely adaptable to resources are not completely adaptable to alternative usesalternative uses


Unemployment & Productive InefficiencyUnemployment & Productive Inefficiency


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UU

a point like U represents a point like U represents unemployment or unemployment or underemploymentunderemployment

a point like U represents a point like U represents unemployment or unemployment or underemploymentunderemployment




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more of either or both more of either or both products is possibleproducts is possible

more of either or both more of either or both products is possibleproducts is possible


A Growing EconomyA Growing Economy

• increases in factor suppliesincreases in factor supplies

• advances in technologyadvances in technology



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Present Choices & Future PossibilitiesPresent Choices & Future PossibilitiesFigure 2-5Figure 2-5

Goods for the PresentGoods for the Present

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FAVOURINGFAVOURINGPRESENT GOODSPRESENT GOODS

FutureFutureCurveCurve


Present Choices & Future PossibilitiesPresent Choices & Future PossibilitiesFigure 2-5Figure 2-5


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FAVOURINGFAVOURINGFUTURE GOODSFUTURE GOODS



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FAVOURINGFAVOURINGPRESENT GOODSPRESENT GOODS



A Qualification: International TradeA Qualification: International Trade

• an individual nation is limited by the an individual nation is limited by the production possibilities curveproduction possibilities curve

• but NOT when there is international but NOT when there is international specialization and trade!specialization and trade!– possible to consume ABOVE the production possible to consume ABOVE the production

possibilities curvepossibilities curve


Examples & ApplicationsExamples & Applications

• Unemployment & Productive Unemployment & Productive InefficiencyInefficiency– The Great DepressionThe Great Depression– discriminationdiscrimination

• trade-offs & Opportunity Coststrade-offs & Opportunity Costs– logging or wilderness?logging or wilderness?

• Shifts in Production Possibilities CurvesShifts in Production Possibilities Curves– cell phones, the Internetcell phones, the Internet


Economic SystemsEconomic Systems

• resource allocation methods differ resource allocation methods differ according to:according to:– resource ownershipresource ownership– co-ordination methodco-ordination method


The Market SystemThe Market System

• private ownership of capitalprivate ownership of capital

• prices & markets co-ordinate activityprices & markets co-ordinate activity

• independent actions of buyers & sellersindependent actions of buyers & sellers

• pure capitalismpure capitalismlimited role for governmentlimited role for government

• Canadian capitalismCanadian capitalismgovernment plays a substantial rolegovernment plays a substantial role


The Command SystemThe Command System

• socialism, communismsocialism, communism

• government owns most resourcesgovernment owns most resources

• central planningcentral planning

• North Korea & Cuba last remaining North Korea & Cuba last remaining examplesexamples


BUSINESSESBUSINESSES

The Circular Flow ModelThe Circular Flow ModelFigure 2-6Figure 2-6


HOUSEHOLDSHOUSEHOLDS


BUSINESSESBUSINESSES


RESOURCERESOURCEMARKETMARKET

FACTORSFACTORSOF PRODUCTIONOF PRODUCTION

INPUTSINPUTS


BUSINESSESBUSINESSES HOUSEHOLDSHOUSEHOLDS



INPUTSINPUTS



$ COSTS

$ COSTS

$ INCOMES

$ INCOMES



PRODUCTPRODUCTMARKETMARKET

GOODS &GOODS &SERVICESSERVICES






INPUTSINPUTS

$ COSTS

$ COSTS

$ INCOMES

$ INCOMES





$ CONSUM

PTION

$ CONSUM

PTION

$ REVENUE

$ REVENUE





INPUTSINPUTS

$ COSTS

$ COSTS

$ INCOMES

$ INCOMES


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©2005 McGraw-Hill Ryerson Ltd. Chapter 2 1 The Economic Problem: Scarcity, Wants, and Choices