Ch02 the Economic Problem Scarcity and Choice

7/25/2019 Ch02 the Economic Problem Scarcity and Choice

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2002 Prentice Hall Business Publishing 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ra !airKarl Case, Ra !air

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Prepared by: FernandoPrepared by: Fernando

Quijano and Yvonn QuijanoQuijano and Yvonn Quijano

The Economic Problem:The Economic Problem:

Scarcity and ChoiceScarcity and Choice


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"hat is Pro#uction$"hat is Pro#uction$

% ProductionProductionis the process b &hich resourcesis the process b &hich resources

are transforme# into useful forms'are transforme# into useful forms'

% ResourcesResources, or, or inputsinputs, refer to anthing, refer to anthingpro(i#e# b nature or pre(ious generationspro(i#e# b nature or pre(ious generations

that can be use# #irectl or in#irectl to satisfthat can be use# #irectl or in#irectl to satisf

human &ants'human &ants'

% Capital resourcesCapital resources

% Human resourcesHuman resources

% Natural resourcesNatural resources


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)hree Basic *uestions)hree Basic *uestions

% )he mechanics of #ecision ma+ing in a larger econom)he mechanics of #ecision ma+ing in a larger econom

are more comple, but the tpe of #ecisions that mustare more comple, but the tpe of #ecisions that must

be ma#e are nearl i#entical'be ma#e are nearl i#entical'

% -ll societies must #eci#e.-ll societies must #eci#e.

% WhatWhat&ill be pro#uce#$&ill be pro#uce#$

% HowHow&ill it be pro#uce#$&ill it be pro#uce#$

% WhoWho&ill get &hat is pro#uce#$&ill get &hat is pro#uce#$


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)hree Basic *uestions)hree Basic *uestions


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pecialiation, Echange an#pecialiation, Echange an#

Comparati(e -#(antageComparati(e -#(antage

% 1a(i# Ricar#o #e(elope# the1a(i# Ricar#o #e(elope# the theory oftheory of

comparative advantagecomparative advantageto eplain theto eplain the

benefits of specialiation an# free tra#e'benefits of specialiation an# free tra#e'

)he theor is base# on the concept of)he theor is base# on the concept ofopportunit cost.opportunit cost.

% Opportunity costOpportunity costis that &hich &e gi(eis that &hich &e gi(e

up or forgo, &hen &e ma+e a #ecision orup or forgo, &hen &e ma+e a #ecision or

a choice'a choice'


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pecialiation, Echange an#pecialiation, Echange an#

Comparati(e -#(antageComparati(e -#(antage

% -ccor#ing to the-ccor#ing to the theory oftheory of

competitive advantage,competitive advantage,

specialiation an# free tra#e &illspecialiation an# free tra#e &ill

benefit all tra#ing parties, e(enbenefit all tra#ing parties, e(enthose that ma be absolutel morethose that ma be absolutel more

efficient pro#ucers'efficient pro#ucers'


7/26 2002 Prentice Hall Business Publishing 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ra !airKarl Case, Ra !air

-bsolute ersus Comparati(e -#(antage-bsolute ersus Comparati(e -#(antage

% Countr - has anCountr - has an absolute advantageabsolute advantagebecause it canbecause it can

pro#uce more foo# an# more clothing in one #a thanpro#uce more foo# an# more clothing in one #a than

countr B'countr B'

% Countr - has aCountr - has a comparative advantagecomparative advantagein thein the

pro#uction of foo# because a &or+er in countr - canpro#uction of foo# because a &or+er in countr - can

pro#uce 6 times as man units of foo# as a &or+er inpro#uce 6 times as man units of foo# as a &or+er in

countr B, but onl 3'4 as man units of clothing'countr B, but onl 3'4 as man units of clothing'

5utput per 1a of "or+5utput per 1a of "or+

!oo#!oo# ClothingClothing

Countr -Countr - 66 33

Countr BCountr B

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% )he opportunit costs can be summarie# as follo&s.)he opportunit costs can be summarie# as follo&s.

% For food:For food:

% 3 unit of foo# costs countr - unit of clothing'3 unit of foo# costs countr - unit of clothing'

% 3 unit of foo# costs countr B 2 units of clothing'3 unit of foo# costs countr B 2 units of clothing'

% For clothing:For clothing:

% 3 unit of clothing costs countr - 2 units of foo#'3 unit of clothing costs countr - 2 units of foo#'

% 3 unit of clothing costs countr B unit of foo#'3 unit of clothing costs countr B unit of foo#'




Countr BCountr B

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% Conclusion.Conclusion.

% Countr - &ill specialie in pro#ucing foo#, an#Countr - &ill specialie in pro#ucing foo#, an#

countr B &ill specialie in the pro#uction of clothing'countr B &ill specialie in the pro#uction of clothing'

% pecialiation also &or+s to #e(elop s+ills an#pecialiation also &or+s to #e(elop s+ills an#

raise pro#ucti(it'raise pro#ucti(it'




Countr BCountr B

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"eighing Present an# Epecte# !uture"eighing Present an# Epecte# !uture

Costs an# BenefitsCosts an# Benefits

% InvestmentInvestmentis the process of usingis the process of using

resources to pro#uce ne& capital'resources to pro#uce ne& capital'

Capital is the accumulation of pre(iousCapital is the accumulation of pre(ious

in(estment'in(estment'

% Because resources are scarce, theBecause resources are scarce, the

opportunit cost of e(er in(estment inopportunit cost of e(er in(estment in

capital is forgone present consumption'capital is forgone present consumption'


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)he Pro#uction Possibilit !rontier)he Pro#uction Possibilit !rontier

% )he)heproduction possibilityproduction possibility

frontier ppf!frontier ppf!is ais agraph thatgraph that

sho&s all of the combinationssho&s all of the combinations

of goo#s an# ser(ices thatof goo#s an# ser(ices thatcan be pro#uce# if all ofcan be pro#uce# if all of

societ8s resources are use#societ8s resources are use#

efficientl'efficientl'




% )he pro#uction possibilit)he pro#uction possibilit

frontier cur(e has a negati(efrontier cur(e has a negati(e

slope that in#icates theslope that in#icates the

tra#e9off that a societ facestra#e9off that a societ facesbet&een t&o goo#s'bet&een t&o goo#s'

% )he slope of the ppf is also)he slope of the ppf is also

calle# thecalle# the marginal rate ofmarginal rate of

transformation (MRT).transformation (MRT).




% Points insi#e of the cur(ePoints insi#e of the cur(e

are inefficient'are inefficient'

% -t point-t point HH, resources are, resources are

either unemploe#, or areeither unemploe#, or areuse# inefficientl'use# inefficientl'




% PointPoint FFis #esirableis #esirable

because it iel#s more ofbecause it iel#s more of

both goo#s, but it is notboth goo#s, but it is not

attainable gi(en theattainable gi(en theamount of resourcesamount of resources

a(ailable in the econom'a(ailable in the econom'




% PointPoint CCis one of theis one of the

possible combinations ofpossible combinations of

goo#s pro#uce# &hengoo#s pro#uce# &hen

resources are full an#resources are full an#efficientl emploe#'efficientl emploe#'




% - mo(e along the cur(e- mo(e along the cur(eillustrates the concept ofillustrates the concept ofopportunit cost'opportunit cost'

% :n or#er to increase the:n or#er to increase thepro#uction of capital goo#s,pro#uction of capital goo#s,the amount of consumerthe amount of consumergoo#s &ill ha(e to #ecrease'goo#s &ill ha(e to #ecrease'



)he ;a& of :ncreasing 5pportunit Cost)he ;a& of :ncreasing 5pportunit Cost

% )he)he concaveconcaveshape of theshape of the

pro#uction possibilitpro#uction possibilit

frontier cur(e reflects thefrontier cur(e reflects the

law of increasinglaw of increasingopportunity cost"opportunity cost"

% -s &e increase the-s &e increase the

pro#uction of one goo#, &epro#uction of one goo#, &e

sacrifice progressi(el moresacrifice progressi(el moreof the other'of the other'



Economic 7ro&thEconomic 7ro&th

% #conomic growth#conomic growthis an increase inis an increase in

the total output of the econom' :tthe total output of the econom' :t

occurs &hen a societ ac


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% )o increase the pro#uction)o increase the pro#uctionof one goo# &ithoutof one goo# &ithout

#ecreasing the pro#uction of#ecreasing the pro#uction of

the other, the PP! cur(ethe other, the PP! cur(e

must shift out&ar#'must shift out&ar#'% !rom point 1, the!rom point 1, the

econom can choose aneconom can choose an

combination of outputcombination of output

bet&een ! an# 7'bet&een ! an# 7'

% 5ut&ar# shifts of the5ut&ar# shifts of the

cur(e representcur(e represent

economic growth"economic growth"


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% =ot e(er sector of the=ot e(er sector of the

econom gro&s at theeconom gro&s at the

same rate'same rate'

% :n this historic eample,:n this historic eample,pro#ucti(it increasespro#ucti(it increases

&ere more #ramatic for&ere more #ramatic for

corn than for &heat o(ercorn than for &heat o(er

the 409ear perio#'the 409ear perio#'


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)he Economic Problem)he Economic Problem

% The economic problem:The economic problem: 7i(en scarce resources,7i(en scarce resources,

ho&, eactl, #o large, comple societies go aboutho&, eactl, #o large, comple societies go about

ans&ering the three basic economic ie# sstems


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)he Economic Problem)he Economic Problem

% :n a:n a command economycommand economy, a central go(ernment either, a central go(ernment either

#irectl or in#irectl sets output targets, incomes, an##irectl or in#irectl sets output targets, incomes, an#

prices'prices'

% :n a:n a laisse$%faire economylaisse$%faire economy,,literall from the !rench.literall from the !rench.

?allo& @themA to #o, in#i(i#ual people an# firms?allo& @themA to #o, in#i(i#ual people an# firms

pursue their o&n self9interests &ithout an centralpursue their o&n self9interests &ithout an central

#irection or regulation' )he central institution of a#irection or regulation' )he central institution of a

laisse9faire econom is thelaisse9faire econom is the free%mar&et systemfree%mar&et system''

% -- marketmarketis the institution through &hich buers an#is the institution through &hich buers an#

sellers interact an# engage in echange'sellers interact an# engage in echange'


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;aisse9!aire Economies.;aisse9!aire Economies.

)he !ree >ar+et)he !ree >ar+et

% Consumer sovereigntyConsumer sovereignty is the i#ea thatis the i#ea that

consumers ultimatel #ictate &hat &ill beconsumers ultimatel #ictate &hat &ill be

pro#uce# @or not pro#uce#A b choosing &hatpro#uce# @or not pro#uce#A b choosing &hat

to purchase @an# &hat not to purchaseA'to purchase @an# &hat not to purchaseA'

% 'ree enterprise('ree enterprise( un#er a free mar+etun#er a free mar+et

sstem, in#i(i#ual pro#ucers must figure outsstem, in#i(i#ual pro#ucers must figure out

ho& to plan, organie, an# coor#inate theho& to plan, organie, an# coor#inate thepro#uction of pro#ucts an# ser(ices'pro#uction of pro#ucts an# ser(ices'


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;aisse9!aire Economies.;aisse9!aire Economies.

)he !ree >ar+et)he !ree >ar+et

% )he)he distribution of outputdistribution of outputis also #etermine#is also #etermine#

in a #ecentralie# &a' )he amount that anin a #ecentralie# &a' )he amount that an

one househol# gets #epen#s on its incomeone househol# gets #epen#s on its income

an# &ealth'an# &ealth'

% )he basic coor#inating mechanism in a free)he basic coor#inating mechanism in a free

mar+et sstem is price'mar+et sstem is price' PricePriceis the amountis the amount

that a pro#uct sells for per unit' :t reflects &hatthat a pro#uct sells for per unit' :t reflects &hat

societ is &illing to pa'societ is &illing to pa'


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>ie# stems, >ar+ets, an#>ie# stems, >ar+ets, an#

7o(ernments7o(ernments

>ar+ets are not perfect, an# go(ernments pla a>ar+ets are not perfect, an# go(ernments pla a

maor role in all economic sstems in or#er to.maor role in all economic sstems in or#er to.

%>inimie mar+et inefficiencies>inimie mar+et inefficiencies

%Pro(i#e public goo#sPro(i#e public goo#s

%Re#istribute incomeRe#istribute income

%tabilie the macroeconomtabilie the macroeconom% Promote lo& le(els of unemplomentPromote lo& le(els of unemploment

% Promote lo& le(els of inflationPromote lo& le(els of inflation

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Ch02 the Economic Problem Scarcity and Choice

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