The Fundamental Economic Problem: Scarcity and Choice Our necessities are few but are wants are endless. INSCRIPTION ON A FORTUNE COOKIE
Sep 14, 2014
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
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● 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.
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
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● 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
Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
Copyright © 2006 South-Western/Thomson Learning. All rights reserved.
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
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● 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
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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
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♦ 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
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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
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● 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
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Copyright © 2006 South-Western/Thomson Learning. All rights reserved.
● 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
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Copyright © 2006 South-Western/Thomson Learning. All rights reserved.
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
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● 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
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Copyright © 2006 South-Western/Thomson Learning. All rights reserved.
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.
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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.
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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.
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● 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
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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
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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
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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.
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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.