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PART I INTRODUCTION TO ECONOMICS
The Economic Problem: Scarcity and Choice
CHAPTER OUTLINE
Scarcity, Choice, and �Opportunity Cost
The Economic Problem
Scarcity and Choice in a One-Person Economy
Scarcity and Choice in an Economy of Two or More
The Production Possibility Frontier
Economic Systems
Command Economies
Laissez-Faire Economies
The Free Markets:
Mixed Systems, Markets, and Governments
Review
CHAPTER 2 The Economic Problem: Scarcity and Choice
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▼ FIGURE 2.1 The Three Basic Questions
Every society has some system or process that transforms its scarce resources into useful goods and services. In doing so, it must decide what gets produced, how it is produced, and to whom it is distributed. The primary resources that must be allocated are land, labor, and capital.
The Economic Problem : Scarcity and Choice
CHAPTER 2 The Economic Problem: Scarcity and Choice
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A centralized government controls all or most factors of production and makes all or most production and allocation decisions for the economy.
Individual producers and consumers control production and allocation by creating combinations of supply and demand.
A mechanism of exchange between buyers and sellers of a good or service.
Types of Economic Systems
Market
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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
Laissez-faire Economy The Free market
Distribution of Output
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Which of the following problems are typical of a market system?
a. The market system does not always produce what people want at the lowest possible cost.
b. The market system offers rewards (income) that may be unfairly distributed, and some groups may be left out.
c. Periods of unemployment and inflation recur with some regularity.
d. All of the above.
e. None of the above.
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Which of the following problems are typical of a market system?
a. The market system does not always produce what people want at the lowest possible cost.
b. The market system offers rewards (income) that may be unfairly distributed, and some groups may be left out.
c. Periods of unemployment and inflation recur with some regularity.
d. All of the above.
e. None of the above.
CHAPTER 2 The Economic Problem: Scarcity and Choice
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A system Karl Marx envisioned in which individuals would contribute according to their abilities and receive benefits according to their needs.
Planned Economic System
Communism
CHAPTER 2 The Economic Problem: Scarcity and Choice
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Capitalism
Mixed Market
Market Economic Systems
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The differences between command economies and laissez-faire economies in their pure forms are enormous. In fact, these pure forms do not exist in the world; all real systems are in some sense “mixed.”
Mixed Systems, Markets and Governments
Economic Systems
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Laissez-faire economy Literally from the French: “allow [them] to do.” An economy in which individual people and firms pursue their own self-interest without any central direction or regulation.
Market The institution through which buyers and sellers interact and engage in exchange.
Economic Systems
Laissez-Faire Economies: The Free Market
Some markets are simple and others are complex, but they all involve buyers and sellers engaging in exchange. The behavior of buyers and sellers in a laissez-faire economy determines what gets produced, how it is produced, and who gets it.
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Economic Systems
Laissez-faire Economy The Free market
Price Theory
In a free market system, the basic economic questions are answered without the help of a central government plan or directives. This is what the “free” in free market means—the system is left to operate on its own with no outside interference. Individuals pursuing their own self-interest will go into business and produce the products and services that people want. Other individuals will decide whether to acquire skills; whether to work; and whether to buy, sell, invest, or save the income that they earn. The basic coordinating mechanism is price.
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Economic Systems
Laissez-Faire Economies: The Free Market
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).
CHAPTER 2 The Economic Problem: Scarcity and Choice
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Factors of production The inputs into the process of production. Another term for resources.
The Economic Problem : Scarcity and Choice
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.
CHAPTER 2 The Economic Problem: Scarcity and Choice
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Nearly all the same basic decisions that characterize complex economies must also be made in a simple economy.
Scarcity Choice and Opportunity Cost
Scarcity and Choice in a One-Person Economy
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What is the difference between a single-person economy and a more complex economy?
c. In a single-person economy, the concept of opportunity cost does not apply.
d. In a single-person economy, the mechanics of decision making are simpler than those of a more complex economy.
e. All of the above.
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What is the difference between a single-person economy and a more complex economy?
c. In a single-person economy, the concept of opportunity cost does not apply.
d. In a single-person economy, the mechanics of decision making are simpler than those of a more complex economy.
e. All of the above.
CHAPTER 2 The Economic Problem: Scarcity and Choice
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The concepts of constrained choice and scarcity are central to the discipline of economics.
Opportunity cost The best alternative that we give up, or forgo, when we make a choice or decision.
Scarcity Choice and Opportunity Cost
Scarcity and Choice in a One-Person Economy
Opportunity Cost
CHAPTER 2 The Economic Problem: Scarcity and Choice
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Using a day at the beach as an example, what is the opportunity cost of leisure?
a. Leisure is free. For example, you don’t have to pay for the benefit of enjoying the sun or relaxing at the beach.
b. Leisure has an opportunity cost only if there is a cost associated with it. For example, entering the beach may require you to pay a fee.
c. The opportunity cost of leisure at the beach is the value of the things that you could have produced during the time you were at the beach. For example, you could have used the time to work and earn some money.
d. According to economists, leisure activities are the only activities that do not carry an opportunity cost.
CHAPTER 2 The Economic Problem: Scarcity and Choice
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Using a day at the beach as an example, what is the opportunity cost of leisure?
a. Leisure is free. For example, you don’t have to pay for the benefit of enjoying the sun or relaxing at the beach.
b. Leisure has an opportunity cost only if there is a cost associated with it. For example, entering the beach may require you to pay a fee.
c. The opportunity cost of leisure at the beach is the value of the things that you could have produced during the time you were at the beach. For example, you could have used the time to work and earn some money.
d. According to economists, leisure activities are the only activities that do not carry an opportunity cost.
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The growth of the frozen dinner entrée market in the last 50 years is a good example of the role of opportunity costs in our lives.
Frozen Foods and�Opportunity Costs
Scarcity Choice and Opportunity Cost
Scarcity and Choice in a One-Person Economy
Opportunity Cost
CHAPTER 2 The Economic Problem: Scarcity and Choice
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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.
Scarcity Choice and Opportunity Cost
Scarcity and Choice in an Economy of two or more
Specialization, Exchange and Comparative Advantage
CHAPTER 2 The Economic Problem: Scarcity and Choice
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▶ FIGURE 2.2 Comparative Advantage and the Gains from Trade
month, assuming they wanted an equal number of logs and bushels. Colleen would split her time 50/50, devoting 15 days to each task and achieving total output of 150 logs and 150 bushels of food. Bill would spend 20 days cutting wood and 10 days gathering food.
In this figure, (a) shows the number of logs and bushels of food that Colleen and Bill can produce for every day spent at the task and (b) shows how much output they could produce in a
As shown in (c) and (d), by specializing and trading, both Colleen and Bill will be better off. Going from (c) to (d), Colleen trades 100 logs to Bill in exchange for 140 bushels of food.
Scarcity Choice and Opportunity Cost
Scarcity and Choice in an Economy of two or more
CHAPTER 2 The Economic Problem: Scarcity and Choice
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Absolute advantage A producer has an absolute advantage over another in the production of a good or service if he or she can produce that product using fewer resources.
Comparative advantage A producer has a comparative advantage over another in the production of a good or service if he or she can produce that product at a lower opportunity cost.
Scarcity Choice and Opportunity Cost
Scarcity and Choice in an Economy of two or more
Specialization, Exchange and Comparative Advantage
CHAPTER 2 The Economic Problem: Scarcity and Choice
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production possibility frontier (ppf) A graph that shows all the combinations of goods and services that can be produced if all of society’s resources are used efficiently.
Scarcity Choice and Opportunity Cost
The Production Possibility Frontier
CHAPTER 2 The Economic Problem: Scarcity and Choice
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The figure in (a) shows all of the combinations of logs and bushels of food that Colleen can produce by herself. If she spends all 30 days each month on logs, she produces 300 logs and no food (point A).
If she spends all 30 days on food, she produces 300 bushels of food and no logs (point B).
If she spends 15 days on logs and 15 days on food, she produces 150 of each (point C).
Scarcity Choice and Opportunity Cost
Scarcity and Choice in an Economy of two or more
A Graphical Presentation of Comparative Advantage and Gains
▶ FIGURE 2.3a Production Possibilities with No Trade
CHAPTER 2 The Economic Problem: Scarcity and Choice
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The figure in (b) shows all of the combinations of logs and bushels of food that Bill can produce by himself. If he spends all 30 days each month on logs, he produces 120 logs and no food (point D).
If he spends all 30 days on food, he produces 240 bushels of food and no logs (point E).
If he spends 20 days on logs and 10 days on food, he produces 80 of each (point F).
Scarcity Choice and Opportunity Cost
Scarcity and Choice in an Economy of two or more
▶ FIGURE 2.3b Production Possibilities with No Trade
A Graphical Presentation of Comparative Advantage and Gains
CHAPTER 2 The Economic Problem: Scarcity and Choice
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By specializing and engaging in trade, Colleen and Bill can move beyond their own production possibilities. If Bill spends all his time producing food, he will produce 240 bushels of food and no logs. If he can trade 140 of his bushels of food to Colleen for 100 logs, he will end up with 100 logs and 100 bushels of food. The figure in (b) shows that he can move from point F to point F'.
If Colleen spends 27 days cutting logs and 3 days producing food, she will produce 270 logs and 30 bushels of food. If she can trade 100 of her logs to Bill for 140 bushels of food, she will end up with 170 logs and 170 bushels of food. The figure in (a) shows that she can move from point C to point C'.
Scarcity Choice and Opportunity Cost
Scarcity and Choice in an Economy of two or more
▶ FIGURE 2.4 Colleen and Bill gain from Trade
CHAPTER 2 The Economic Problem: Scarcity and Choice
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We trade off present and future benefits in small ways all the time.
Scarcity Choice and Opportunity Cost
Scarcity and Choice in an Economy of two or more
Weighing Present and Expected Future Costs and Benefits
CHAPTER 2 The Economic Problem: Scarcity and Choice
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Consumer goods- goods produced for present consumption.
investment -The process of using resources to produce new capital.
Scarcity Choice and Opportunity Cost
Scarcity and Choice in an Economy of two or more
Capital Goods and Consumer Goods
Capital goods- goods owned by individuals, organizations, or governments to be used in the production of other goods or commodities or consumed to manufacture other goods and services.
CHAPTER 2 The Economic Problem: Scarcity and Choice
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All points below and to the left of the curve (the shaded area) represent combinations of capital and consumer goods that are possible for the society given the resources available and existing technology.
Points above and to the right of the curve, such as point G, represent combinations that cannot be reached.
If an economy were to end up at point A on the graph, it would be producing no consumer goods at all; all resources would be used for the production of capital. If an economy were to end up at point B, it would produce only consumer goods.
Scarcity Choice and Opportunity Cost
The Production Possibility Frontier
CHAPTER 2 The Economic Problem: Scarcity and Choice
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Although an economy may be operating with full employment of its land, labor, and capital resources, it may still be operating inside its ppf, at a point such as D. The economy could be using those resources inefficiently.
Periods of unemployment also correspond to points inside the ppf, such as point D.
Moving onto the frontier from a point such as D means achieving full employment of resources.
The Production Possibility Frontier
Scarcity Choice and Opportunity Cost
CHAPTER 2 The Economic Problem: Scarcity and Choice
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The ppf illustrates a number of economic concepts. One of the most important is opportunity cost. The opportunity cost of producing more capital goods is fewer consumer goods.
Moving from E to F, the number of capital goods increases from 550 to 800, but the number of consumer goods decreases from 1,300 to 1,100.
The Production Possibility Frontier
Scarcity Choice and Opportunity Cost
▶ FIGURE 2.5 Production Possibility Frontier
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Consider the figure below. As this country moves from point D to point B along the production possibility frontier AE,
a. the opportunity cost of building more consumer goods rises.
b. the opportunity cost of building more capital goods rises.
c. the opportunity cost is not affected because the curve does not shift.
d. the opportunity cost of producing more of either consumer goods or capital goods rises.
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Consider the figure below. As this country moves from point D to point B along the production possibility frontier AE,
a. the opportunity cost of building more consumer goods rises.
b. the opportunity cost of building more capital goods rises.
c. the opportunity cost is not affected because the curve does not shift.
d. the opportunity cost of producing more of either consumer goods or capital goods rises.
CHAPTER 2 The Economic Problem: Scarcity and Choice
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During economic downturns or recessions, industrial plants run at less than their total capacity. When there is unemployment of labor and capital, we are not producing all that we can.
Scarcity Choice and Opportunity Cost
The Production Possibility Frontier
Unemployment
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Waste and mismanagement are the results of a firm’s operating below its potential.
Sometimes, inefficiency results from mismanagement of the economy instead of mismanagement of individual private firms.
Scarcity Choice and Opportunity Cost
The Production Possibility Frontier
Inefficiency
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Society can end up inside its ppf at a point such as A by using its resources inefficiently.
If, for example, Ohio’s climate and soil were best suited for corn production and those of Kansas were best suited for wheat production, a law forcing Kansas farmers to produce corn and Ohio farmers to produce wheat would result in less of both. In such a case, society might be at point A instead of point B.
▶ FIGURE 2.6 Inefficiency from Misallocation of Land in Farming
Scarcity Choice and Opportunity Cost
The Production Possibility Frontier
Inefficiency
CHAPTER 2 The Economic Problem: Scarcity and Choice
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To be efficient, an economy must produce what people want.
Marginal rate of transformation (MRT) The slope of the production possibility frontier (ppf).
The Production Possibility Frontier
Scarcity Choice and Opportunity Cost
The Efficient Mix of Output
Negative Slope and Opportunity Cost
CHAPTER 2 The Economic Problem: Scarcity and Choice
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TABLE 2.1 Production Possibility Schedule for Total Corn and Wheat Production in Ohio and Kansas | ||
��Point on ppf | Total� Corn Production�(Millions of Bushels Per Year) | Total Wheat Production (Millions of Bushels Per Year) |
A | 700 | 100 |
B | 650 | 200 |
C | 510 | 380 |
D | 400 | 500 |
E | 300 | 550 |
The ppf illustrates that the opportunity cost of corn production increases as we shift resources from wheat production to corn production. Moving from point E to D, we get an additional 100 million bushels of corn at a cost of 50 million bushels of wheat.
Moving from point B to A, we get only 50 million bushels of corn at a cost of 100 million bushels of wheat. The cost per bushel of corn— measured in lost wheat— has increased.
Scarcity Choice and Opportunity Cost
The Production Possibility Frontier
The Law of Increasing Opportunity Cost
▶ FIGURE 2.7 Corn and wheat production in Ohio and Kansas
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Refer to the figure. A 10-ton increase in the production of farm goods requires a sacrifice of manufactured goods that is:
a. greater between points b and c than between points e and f.
b. greater between points e and f than between points b and c.
c. proportionally the same between any two points.
d. less and less as you move downward along the curve.
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Refer to the figure. A 10-ton increase in the production of farm goods requires a sacrifice of manufactured goods that is:
a. greater between points b and c than between points e and f.
b. greater between points e and f than between points b and c.
c. proportionally the same between any two points.
d. less and less as you move downward along the curve.
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Economic growth 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.
Economic Growth
Scarcity Choice and Opportunity Cost
The Production Possibility Frontier
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Recall the three basic questions facing all economic systems:
(1) What and how much gets produced?
(2) How is it produced?
(3) Who gets it?
Given scarce resources, how do large, complex societies go about answering the three basic economic questions?
Scarcity Choice and Opportunity Cost
The Economic Problem
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A market exists primarily in what type of economic system?
a. A command economy.
b. A laissez-faire economy.
c. A democracy.
d. A dictatorship.
e. An economy in transition.
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A market exists primarily in what type of economic system?
a. A command economy.
b. A laissez-faire economy.
c. A democracy.
d. A dictatorship.
e. An economy in transition.
CHAPTER 2 The Economic Problem: Scarcity and Choice
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R E V I E W T E R M S A N D C O N C E P T S
absolute advantage
capital
command economy
comparative advantage
consumer goods
consumer sovereignty
economic growth
factors of production (or factors)
free enterprise
inputs or resources
investments
laissez-faire economy
marginal rate of transformation (MRT)
market
opportunity cost
outputs
production
production possibility frontier (ppf)
theory of comparative advantage
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