The Economic Problem: Scarcity and Choice

C

H A

P T

E

C H

A P

T E

RR

2

Prepared by: Fernando QuijanoPrepared by: Fernando Quijano and Yvonn Quijano and Yvonn Quijano

© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray Fair

The Economic Problem: Scarcity and Choice

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e

© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray Fair 2 of 40

Scarcity, Choice, and Opportunity Cost

• Human wants are unlimited, but resources are not.

• Three basic questions must be answered in order to understand an economic system:

• What is produced?

• How is it produced?

• Who gets what is produced?

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e



• The basic resources that are available to a society are factors of production:

• Land

• Labor

• Capital

• Capital refers to the things that are themselves produced and then used to produce other goods and services.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e



• Production is the process that transforms scarce resources into useful goods and services.

• Resources or factors of production are the inputs into the process of production; goods and services of value to households are the outputs of the process of production.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e


Capital Goods and Consumer Goods

• Capital goods are goods used to produce other goods and services.

• Consumer goods are goods produced for present consumption.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e


Scarcity and Choicein a One-Person Economy

• Constrained choice and scarcity are the basic concepts that apply to every society.

• Opportunity cost is the best alternative we give up or forgo, when we make a decision or a choice.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e


Scarcity and Choicein an Economy of Two or More

• A producer has an absolute advantage over another in the production of a good or service if he can produce that product using fewer resources.

• A producer has a comparative advantage in the production of a good or service over another if he can produce that product at a lower opportunity cost.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e


Comparative Advantageand the Gains From Trade

• Evren has an absolute advantage in the production of both wood and food because she can produce more of both goods using fewer resources than Bill.

Daily ProductionWood(logs)

Fruits

Evren 10 10

Onur 4 8

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e



• Onur has a comperative advantage in fruit production.

• For Onur, the opportunity cost of 8 fruits is 4 logs.

• For Evren, the opportunity cost of 8 fruits is 8 logs.

• Evren has a comperative advantage in wood production.

• For Evren, the opportunity cost of 10 logs is 10 fruits.

• For Onur, the opportunity cost of 10 logs is 20 fruits.

Daily ProductionWood(logs)

Fruits

Evren 10 10

Onur 4 8

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e



• Suppose that Evren and Onur each wanted equal numbers of logs and bushels of fruit. In a 30-day month they (each separately) could produce:

Daily Production

Wood(logs)

Fruits

Evren 10 10

Onur 4 8

Monthly Production with No Trade

Wood(logs)

Fruits

Evren 150 150

Onur 80 80

Total 230 230A.B.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e



• By specializing on the basis of comparative advantage, Evren and Onur can produce more of both goods.

Monthly Production after Specialization

Wood(logs)

Fruits

Evren 270 30

Onur 0 240

Total 270 270

C.

Monthly Production with No Trade

Wood(logs)

Fruits

Evren 150 150

Onur 80 80

Total 230 230

B.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e



• To end up with equal amounts of wood and food after trade, Evren could trade 100 logs for 140 fruits. Then:

Monthly Production after Specialization

Wood(logs)

Fruits

Evren 270 30

Onur 0 240

Total 270 270

D.

Monthly Use After Trade

Wood(logs)

Fruits

Evren 170 170

Onur 100 100

Total 270 270

C.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e


Specialization, Exchangeand Comparative Advantage

• According to the theory of comparative advantage, specialization and free trade will benefit all trading parties, even those that may be absolutely more efficient producers.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e


The Production Possibility Frontier

• The production possibility frontier (ppf) is a graph that shows all of the combinations of goods and services that can be produced if all of society’s resources are used efficiently.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e



• Points inside of the curve are inefficient.

• At point H, resources are either unemployed, or are used inefficiently.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e



• At point H, resources are either unemployed, or are used inefficiently.

• Point F can not be reached.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e



• Point C is one of the possible combinations of goods produced when resources are fully and efficiently employed.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e



• A move along the curve illustrates the concept of opportunity cost.

• From point D, an increase the production of capital goods requires a decrease in the amount of consumer goods.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e


The Law of Increasing Opportunity Cost

• The slope of the ppf curve is also called the marginal rate of transformation (MRT).

• The negative slope of the ppf curve reflects the law of increasing opportunity cost. As we increase the As we increase the production of one good, we production of one good, we sacrifice progressively more sacrifice progressively more of the other.of the other.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e


Economic Growth

• An outward shift means that it is possible to increase the production of one good without decreasing the production of the other.

• Outward shifts of the Outward shifts of the curve represent curve represent economic growth.economic growth.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e


Economic Growth

• From point D, the From point D, the economy can choose economy can choose any combination of any combination of output between F and output between F and G.G.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e


Economic Systems

• Economic systems are the basic arrangements made by societies to solve the economic problem. They include:

• Command economies

• Laissez-faire economies

• Mixed systems

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e


Economic Systems

• In a command economy, a central government either directly or indirectly sets output targets, incomes, and prices.

• In a laissez-faire economy, individuals and firms pursue their own self-interests without any central direction or regulation.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e


Economic Systems

• The central institution of a laissez-faire economy is the free-market system.

• A market is the institution through which buyers and sellers interact and engage in exchange.

C

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

eC

H A

P T

E R

2:

The E

conom

ic P

roble

m:

Sca

rcit

y a

nd C

hoic

e


Mixed Systems,Markets, and Governments

Since markets are not perfect, governments intervene and often play a major role in the economy. Some of the goals of government are to:

• Minimize market inefficiencies

• Provide public goods

• Redistribute income

• Stabilize the macroeconomy:

• Promote low levels of unemployment

• Promote low levels of inflation

Documents

The Economic Problem: Scarcity and Choice