The Economic Problem:

Scarcity and Choice

Scarcity, Choice, and

Opportunity Cost

Scarcity and Choice in a One-Person

EconomyScarcity and Choice in an Economy of

Two or MoreThe PPF

The Economic Problem

Economic Systems

Command Economies

Laissez-Faire Economies:

The Free MarketMixed Systems,

Markets, and Governments

2CHAPTER OUTLINE:

Factors of production :

The inputs into the process of production. Another term for resources.

Factor 1: Land

means all natural resources on or under the ground includes:

water, forests, wildlife, mineral deposits.

Factor 2: Labor is all the human time, effort, talent used to make products physical and mental effort used to make a good or provide

a service.

Factor 3: Capital is a producer’s physical resources includes tools, machines, offices, stores, roads, vehicles; sometimes called physical

capital or real capital

Factor 4: Entrepreneurshipvision, skill, ingenuity, willingness to take risks.

Entrepreneurs anticipate consumer wants, satisfy these in new ways develop new products, methods of production,

marketing or distributing risk time, energy, creativity, money to make a profit.

production The process that transforms scarce resources

into useful goods and services.

inputs or resources Anything provided by nature or previous generations that can be used directly or

indirectly to satisfy human wants.

outputs Goods and services of value to households.

Three Basic Economic QuestionsEvery society must answer three basic

economic questions because of scarcity.What will be produced? How will it be produced?

Who will get what is produced?

Societies answer these questions differently, leading to a variety of economic systems.

Scarcityis the economic problem of having

seemingly unlimited human needs and wants, in a world of

limited resources.

Why does it exist?It exists because wants are unlimited and

resources are limited.

Wants — desires that can be met by consuming products.Needs — things necessary for survival.

The concepts of constrained choice and scarcity are central to the discipline of

economics.

Opportunity cost is that which we give up or forgo, when

we make a decision or a choice.

orOpportunity cost

is value of next-best alternative a person gives up

-not the value of all possible alternatives-

An idea closely related to opportunity cost is called comparative advantage.

Comparative advantagethe ability to produce a good at a lower opportunity cost than another producer.

if you produce a good at a lower opportunity cost then you should

specialize in it.

Theory of comparative advantage Ricardo’s theory that specialization and free trade will benefit all trading parties,

even those that may be “absolutely” more efficient producers.

Daily ProductionWood(logs)

Food(bushels)

Colleen 10 10Bill 4 8

Comparative Advantage and the Gains From Trade

Colleen 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.

Capital goods are goods used to produce other goods and services.Consumer goods are goods produced for present consumption.

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.The production possibility frontier curve has a negative slope, which indicates a

trade-off between producing one good or another.

Points inside of the curve are inefficient.

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

Point F is desirable because it yields more of both goods, but it is not attainable given the amount of resources available in the economy.

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

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.

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 production of one good, we sacrifice progressively more of the other.

The Law of Increasing Opportunity Cost

Economic Growth Economic growth

is an increase in the total output of the economy. It occurs when a society

acquires new resources, or when it learns to produce more using existing resources.

The main sources of economic growth are capital accumulation and technological advances. Outward shifts of the curve

represent economic growth.

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

Not every sector of the economy grows at the same rate.

In this historic example, productivity increases were more dramatic for corn than for wheat over this time period.

Economic Growth

Economic SystemsThe economic problem:

Given scarce resources, how, exactly, do large, complex societies go about

answering the three basic economic questions?

Economic systems are the basic arrangements made by

societies to solve the economic problem. They include:

Command economies Laissez-faire economies Mixed systems

Economic SystemsCommand economies

In a command economy,

a central government either directly or indirectly sets output targets, incomes, and

prices.

Economic SystemsLaissez-faire economies

In a laissez-faire economy, individuals and firms pursue their own

self-interests without any central direction or regulation.

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

market is the institution through which buyers

and sellers interact and engage in exchange.

Economic Systems

Consumer sovereignty is the idea that consumers ultimately

dictate what will be produced (or not produced)

by choosing what to purchase (and what not to purchase).

Economic SystemsIn a laissez-faire economy, the distribution of output is

also determined in a decentralized way. The amount that any one household gets

depends on its income and wealth.Income

is the amount that a household earns each year. It comes in a number of forms: wages, salaries, interest, and the like.

Wealth is the amount that households have

accumulated out of past income through saving or inheritance.

Economic Systems

The basic coordinating mechanism in a free market system is price.

Price is the amount that a product sells for per unit. It reflects what society is

willing to pay.

Economic SystemsMixed systems

Most modern economies are a mixture of market systems and

centralized decision-making. These are known as mixed economies.

Differences Between Command Economies, Free Market

Economies, And Mixed EconomiesThere are differences in terms of the ways they

address the three basic economic questions: Market-type economic systems answer these

questions in a decentralized manner.

Differences Between Command Economies, Free Market

Economies, And Mixed EconomiesThere are differences in terms of the ways they

address the three basic economic questions:Command economies, on the other hand,

address these questions via centralized decision-making, usually by a centralized governmental authority.

Differences Between Command Economies, Free Market

Economies, And Mixed EconomiesThere are differences in terms of the ways they

address the three basic economic questions:Mixed economies combine market-type

systems with some degree of governmental intervention.