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Copyright 2002, Pearson Education Canada 1 The Economic Problem: Scarcity and Choice Chapter 2
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Copyright 2002, Pearson Education Canada1
The Economic Problem:Scarcity and Choice
Chapter 2
Copyright 2002, Pearson Education Canada2
Resources (Inputs) Used in Production
Capital Things that have already been produced that
are used to produce other goods and services e.g. buildings, machinery, roads.
Human Resources Labour, Skills and Knowledge
Natural Resources
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Three Basic Economic Questions
What will be produced?
How will it be produced?
Who will get what is produced?
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Opportunity Cost
The opportunity cost is that which we give up or forgo, when we make a decision or choice.
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The 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.
A person or country is said to have a comparative advantage in producing a good if it is relatively more efficient than a trading partner at doing so. In other words they have a lower opportunity cost.
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Comparative Advantage Example
Production perday
Shelter ( logs ) Food ( baskets )
Colleen 10 10
Ivan 5 8
Production values assume that each person is only producing that good, so for instance Colleen can produce 10 logs or 10 baskets of food.
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Calculate Opportunity Cost
10 logs cost Colleen 10 baskets of food5 logs cost Ivan 8 baskets of foodFor Shelter:
1 log costs Colleen 1 basket of food 1 log cost Ivan 1.6 baskets of food
For Food: 1 basket costs Colleen 1 log 1 basket costs Ivan .625 logs
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How should each specialize?
Colleen can produce logs cheaper than Ivan and therefore should produce shelter.
Ivan can produce food/baskets cheaper than Colleen and therefore should produce shelter.
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Consumer Goods, Capital Goods and Investment
A capital good can be considered as anything that is produced that will be used to produce other valuable goods or services over time.
Investment is the process of using up resources for the production of capital or simply purchasing capital.
Consumer goods are those produced for present consumption
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Production Possibility Frontier (PPF)
The PPF is a graph that shows all the combinations of goods and services that can be produced if all of society’s resources are used efficiently.
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Production Possibility Frontier
Consumer goods
Cap
ital g
ood
s
The curve has a negative slope.
The curve is concave to the origin.
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PPF and Opportunity Cost (Figure 2.3)
Producing tomatoes at D instead of E, means producing beef at D instead of E. 250 million more tomatoes at a cost of 100 million kg of beef.
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Law of Increasing Opportunity Cost
The opportunity cost of producing a good increases as more resources are shifted into its production.
This is clearly shown in the Production Possibility Schedule for tomato and beef production.
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PPF and Production Possibilities Schedule for Beef and Tomatoes (Figure 2.3 and Table 2.1)
Point onPPF
Total TomatoProduction(millions
of kg)
Total BeefProduction(millions of
kg)
A 1500 0
B 1400 400
C 1100 800
D 800 1100
E 550 1300
F 0 1400
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Economic Growth
Economic growth is an increase in the total output of an economy.
It occurs when a society acquires new resources or when it learns to produce more using existing resources.
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Economic Growth and Shifts in the PPF (Figure 2.4)
New resources or technology can shift the PPF outward.
The shift may or may not be parallel depending on where the productivity increases are concentrated; in this case, tomatoes more than beef.
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The Economic Problem
Given scarce resources how exactly, do large, complex societies go about answering the three basic economic questions?
What will be produced? How will it be produced? Who will get what is produced?
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Economic Systems
Command Economy
Laissez-Faire Economies: Free Market
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Command Economy
An economy in which a central authority or agency draws up a plan that establishes what will be produced and when, sets production goals, and makes rules for distribution.
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Laissez-faire Economy
Literally from the French: “allow (them) to do”
An economy in which individuals and firms pursue their self-interests without any central direction or regulation.
The central institution in these economies is called the market.
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Markets
The institutions through which buyers and sellers interact and engage in exchange.
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Important aspects of Market Economies:
Consumer sovereignty The idea that consumers ultimately dictate
what will be produced (or not produced) by choosing what to purchase (and what not to purchase).
Individual Production DecisionsDistribution of output decentralizedPrice theory
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A Role for Government:Mixed Market Economies
Minimize market inefficienciesProvision of public goodsRedistribution of incomeStabilize the macroeconomy
Promote low levels of unemployment Promote low levels of inflation
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Review Terms and Concepts
capital command economy comparative advantage consumer goods consumer sovereignty economic growth economic problem investment laissez-faire economy
market opportunity cost outputs price producers production PPF resources or inputs three basic questions
