3 3 The Fundamental Economic Problem: Scarcity and Choice Our necessities are few but are wants are...

3

The Fundamental Economic Problem: Scarcity and Choice

Our necessities are few but are wants are endless.INSCRIPTION ON A FORTUNE COOKIE

● Scarcity, Choice, and Opportunity Cost

● Scarcity and Choice for a Single Firm

● Scarcity and Choice for the Entire Society

● The Concept of Efficiency

● The Three Coordination Tasks of any Economy

● Scarcity, Choice, and Opportunity Cost

● Scarcity and Choice for a Single Firm

● Scarcity and Choice for the Entire Society

● The Concept of Efficiency

● The Three Coordination Tasks of any Economy

ContentsContents

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

● Specialization Fosters Efficient Resource Allocation

● Specialization Leads to Exchange

● Markets, Prices, and the Three Coordination Tasks

● A Last Word: Don’t Confuse Ends with Means

● Specialization Fosters Efficient Resource Allocation

● Specialization Leads to Exchange

● Markets, Prices, and the Three Coordination Tasks

● A Last Word: Don’t Confuse Ends with Means

Contents (continued)Contents (continued)


Copyright © 2006 South-Western/Thomson Learning. All rights reserved.

Scarcity, Choice and Opportunity CostScarcity, Choice and Opportunity Cost

● Scarcity of resources necessity of choices

● Opportunity cost = value of the best forgone alternative♦ True cost of a scarce resource

● Scarcity of resources necessity of choices

● Opportunity cost = value of the best forgone alternative♦ True cost of a scarce resource

● Opportunity cost: Closely related to money cost if markets are well functioning

● No explicit prices for some valuable resources, e.g., time

● Total cost = money cost + opportunity cost

● Opportunity cost: Closely related to money cost if markets are well functioning

● No explicit prices for some valuable resources, e.g., time

● Total cost = money cost + opportunity cost

Opportunity Cost and Money CostOpportunity Cost and Money Cost


● Example of opportunity cost: a firm that produces two outputs with a fixed supply of inputs

● More of one output less of the other output

● Example of opportunity cost: a firm that produces two outputs with a fixed supply of inputs

● More of one output less of the other output

Opportunity Cost and Money CostOpportunity Cost and Money Cost



Scarcity and Choice for a Single FirmScarcity and Choice for a Single Firm

● Production Possibilities Frontier♦ Production possibilities frontier = a graph

showing different combinations of output for a given amount of inputs

♦ More of one good less of another

♦ Illustrates opportunity costs in production

● Production Possibilities Frontier♦ Production possibilities frontier = a graph

showing different combinations of output for a given amount of inputs

♦ More of one good less of another

♦ Illustrates opportunity costs in production

TABLE 1 Production Possibilities Open to a Farmer

TABLE 1 Production Possibilities Open to a Farmer


● Negatively sloped

● Slope = opportunity cost

● Illustrates the trade-off in the production of one good (or class of goods) against another

● Negatively sloped

● Slope = opportunity cost

● Illustrates the trade-off in the production of one good (or class of goods) against another

The Production Possibilities FrontierThe Production Possibilities Frontier


FIGURE 1 PPF for Production by a Single Farmer

FIGURE 1 PPF for Production by a Single Farmer

Attainable region So

yb

ea

ns

Wheat

E

D

C

B

A Unattainable region

60 65 52 38 30 20 10 0

10

20

30

40


♦ Shape: concave

♦ Principle of increasing costs: production of one good opportunity cost of producing another unit

♦ Reason: Inputs tend to be specialized.

♦ Shape: concave

♦ Principle of increasing costs: production of one good opportunity cost of producing another unit

♦ Reason: Inputs tend to be specialized.

The Principle of Increasing CostsThe Principle of Increasing Costs


FIGURE 2 PPF with No Specialized Resources

FIGURE 2 PPF with No Specialized Resources

D

C

B

A

Brown Shoes

Bla

ck S

ho

es

50

40

30

20

10

0 50 40 30 20 10


● Productivity constant along a production possibilities frontier.

productivity shift of the frontier♦ Skills

♦ Technology

♦ Capital stock

● Productivity constant along a production possibilities frontier.

productivity shift of the frontier♦ Skills

♦ Technology

♦ Capital stock

The Principle of Increasing CostsThe Principle of Increasing Costs



● Resources are scarce for the entire society.

● Choices must be made: More of one good implies less of another.

● Production possibilities frontier applicable to the economy as a whole.

● Resources are scarce for the entire society.

● Choices must be made: More of one good implies less of another.

● Production possibilities frontier applicable to the economy as a whole.

Scarcity and Choice for the Entire SocietyScarcity and Choice for the Entire Society

FIGURE 3 PPF for Entire Economy

FIGURE 3 PPF for Entire Economy

Th

ou

san

ds

of

Au

tom

ob

iles

per

Yea

r

Missiles per Year

C

F

E

D

B

500 400 300 200 100

0

100

200

300

400

500

600

700

G



Scarcity and Choice for the Entire SocietyScarcity and Choice for the Entire Society

● Economic growth = increase in production of goods and services

● Trade-off between consumption goods and capital goods

● Investment in capital goods shifts out the production possibilities frontier.

● Economic growth = increase in production of goods and services

● Trade-off between consumption goods and capital goods

● Investment in capital goods shifts out the production possibilities frontier.

Growth in the United States and AsiaGrowth in the United States and Asia

F

F

G

G

Capital Goods

(a) United States

This year’s production possibilities

Next year’s production possibilities

g

g

f

f

Capital Goods

(b) Asia

Next year’s production possibilities

A

BCo

nsu

mp

tio

n G

oo

ds

Co

nsu

mp

tio

n G

oo

ds

N

This year’s production possibilities


● Problems of scarcity and choice are everywhere in the economy.

● Households, firms, and government must decide how to allocate their income.

● Problems of scarcity and choice are everywhere in the economy.

● Households, firms, and government must decide how to allocate their income.

Scarcity and Choice Elsewhere in the EconomyScarcity and Choice Elsewhere in the Economy



The Concept of EfficiencyThe Concept of Efficiency

● Efficiency = no waste

● All available resources are utilized.

● Sources of inefficiency♦ Assigning inputs to the wrong task

♦ Unemployment

♦ Discrimination

● Competition should eliminate inefficiency.

● Efficiency = no waste

● All available resources are utilized.

● Sources of inefficiency♦ Assigning inputs to the wrong task

♦ Unemployment

♦ Discrimination

● Competition should eliminate inefficiency.


The Concept of EfficiencyThe Concept of Efficiency

● Efficiency and the production possibilities frontier♦ Every point on a production possibilities

frontier is efficient.

♦ Efficiency does not tell us which point is best.

♦ Any point inside the frontier is inefficient.

● Efficiency and the production possibilities frontier♦ Every point on a production possibilities

frontier is efficient.

♦ Efficiency does not tell us which point is best.

♦ Any point inside the frontier is inefficient.


The Three Coordination Tasks of Any EconomyThe Three Coordination Tasks of Any Economy

● How to utilize its resources efficiently.

● What combination of goods and services to produce.

● How much of each good to distribute to each person.

● How to utilize its resources efficiently.

● What combination of goods and services to produce.

● How much of each good to distribute to each person.


● The Wonders of the Division of Labor ♦ Breaking a task into a set of smaller, more

specialized tasks

♦ Specialization productivity growth

● The Wonders of the Division of Labor ♦ Breaking a task into a set of smaller, more

specialized tasks

♦ Specialization productivity growth

Specialization Fosters Efficient Resource AllocationSpecialization Fosters Efficient Resource Allocation


Specialization Fosters Efficient Resource AllocationSpecialization Fosters Efficient Resource Allocation

● The Amazing Principle of Comparative Advantage♦ Principle of comparative advantage =

specialization in the production of the good with the lowest opportunity cost

♦ Comparative advantage specialization

● The Amazing Principle of Comparative Advantage♦ Principle of comparative advantage =

specialization in the production of the good with the lowest opportunity cost

♦ Comparative advantage specialization


Specialization Leads to ExchangeSpecialization Leads to Exchange

● Specialization requires exchange

● Trading production because it permits specialization

● Specialization requires exchange

● Trading production because it permits specialization


Markets, Prices, and the Three Coordination TasksMarkets, Prices, and the Three Coordination Tasks

● Markets solutions to the three coordination tasks

● Consumers are in control

● Sometimes the solutions are compatible with society’s goals, other times not.

● Markets solutions to the three coordination tasks

● Consumers are in control

● Sometimes the solutions are compatible with society’s goals, other times not.


Last Word: Don’t Confuse Ends with MeansLast Word: Don’t Confuse Ends with Means

● Economic analysis judgment of capitalism

● Values ends

● Pragmatism means

● Economic analysis concerns means, not ends.

● Economic analysis judgment of capitalism

● Values ends

● Pragmatism means

● Economic analysis concerns means, not ends.

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