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neoclassical • Main principle: resource scarcity • Not absolute scarcity, relative scarcity • Scarcity relative to “unlimited human wants” • Opportunity cost – “the value of what could have been produced if resources were used in the best alternative way”
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Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Dec 18, 2015

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Gordon Peters
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Page 1: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

neoclassical

• Main principle: resource scarcity

• Not absolute scarcity, relative scarcity

• Scarcity relative to “unlimited human wants”

• Opportunity cost – “the value of what could have been produced if resources were used in the best alternative way”

Page 2: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Production Possibilities

• Two goods: guns and butter• Given (constant) amounts of resources of

land (T), labor (L) and capital (K), and given (constant) technology

• Time period is given—one year• Neoclassical goal— efficiently allocating

given T, L, and K among competing industries to maximize consumer satisfaction per time period.

Page 3: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Graphing

y

x0

Page 4: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Production Possibilities Schedule

Guns Butter

Page 5: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Production Possibilities Schedule

Guns Butter

80

Page 6: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Production Possibilities Schedule

Guns Butter

0 80

Page 7: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Production Possibilities Schedule

Guns Butter

0 80

50

Page 8: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Production Possibilities Schedule

Guns Butter

0 80

50 0

Page 9: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Production Possibilities

Guns

Butter 0

50

80(mil. Of tubs)

(mil.)

Page 10: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

PPC Constant Trade-off

Guns

Butter 0

50

80(mil. Of tubs)

(mil.)

Page 11: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

PPC

• Straight-line production possibility curve indicates constant returns and constant opportunity costs

• Such a relation implies that resources are perfectly suitable for both industries (cows just as good for guns as butter; machine tools just as good for butter as guns).

• Not the normal PPC between two industries

Page 12: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Production Possibilities Schedule

Guns Butter

0 80

10 75

20 65

30 50

40 30

50 0

Page 13: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Production Possibilities Schedule

0

10

20

30

40

50

60

0 20 40 60 80 10075655030

Guns (Millions)

Butter (Mil. of Tubs)

Page 14: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

PPC

• Normal PPC is “bowed out” from origin

• Indicates diminishing returns and increasing opportunity costs

• Law of increasing opportunity costs states that in order to get more of any good in a given time period, society must sacrifice ever-increasing amounts of other goods, ceteris paribus.

Page 15: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Production Possibilities Schedule

0

10

20

30

40

50

60

0 20 40 60 80 10075655030

Guns (Millions)

Butter (Mil. of Tubs)

Page 16: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Prod. Poss. Schedule

• Let’s add two additional points to our schedule:

• Guns Butter25 75

15 40

Page 17: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Production Possibilities Schedule

0

10

20

30

40

50

60

0 20 40 60 80 10075655030

Guns (Millions)

Butter (Mil. of Tubs)

25,75 .

Page 18: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Point outside the curve

• Measuring in physical terms (#s of guns, tubs of butter), given resources and technology, a point outside is physically impossible, unattainable

• If we were measuring in $ (monetary) terms ($ worth of guns, $ worth of butter), then a point outside would be possible: physical output cannot increase, but prices can—inflation

Page 19: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Production Possibilities Schedule

0

10

20

30

40

50

60

0 20 40 60 80 10075655030

Guns (Millions)

Butter (Mil. of Tubs)

(15, 40) .

Page 20: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Point inside the curve

• Point inside the curve is possible, but undesirable—society can produce these combinations, but it is producing below full potential—there is unemployment and excess capacity; resources are being left unused and underutilized; this is inefficient and wasteful.

Page 21: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Point on the curve

• Operating anywhere on the curve is efficient, the economy is operating at full employment and full productive capacity.

• Operating on the curve, resources are scarce (because full employed) and opportunity cost is in effect (cannot increase production of one good without decreasing production of the other)

Page 22: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

PPC

• What determines where the curve is?– technology, resources

• What happens if there is an increase of resources and/or technological advance?– The curve shifts out (more of both goods can

be produced)

• What is the economic meaning of a shift out?– Economic growth

Page 23: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Shift of Production Possibilities Curve

Guns

Butter0

Page 24: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Economic Growth

• What is the source of economic growth?

• Increased resources and technological advance

• Parallel shift out, additional resources apply to both industries; technological advance is universal (applies to both)

Page 25: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Economic Growth

• What if the additional resources only applies to butter (or gun) production, or the technology only applies to one or the other?

• Sector-specific technical advance (or sector-specific resource expansion)

Page 26: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Production Possibilities CurveGuns

Butter

A

B0

B’

Page 27: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Sector-specific growth (in butter sector)

• More butter can be produced, but if all resources were applied to gun production, gun output would remain the same—technology doesn’t apply to guns)

• More of both can be produced, because increased productivity in the butter sector allows some resources to be shifted to gun sector.

Page 28: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Shift-in of curve

• Shift in means economic decline—could be universal or sector-specific. Results from a decline in resources and/or technological decline.

• Don’t get mixed up between a shift out of the curve and a point outside the curve; or a shift in of the curve versus a point inside the curve.

Page 29: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Economic Growth:Increased Resources: Land

• New land may be brought into cultivation, discoveries of new deposits of natural resources, increased stock of stock renewable resources (also, for a given country, conquering another country).

Page 30: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Economic Growth:Increased resources: Labor

• Population growth

• New sectors of the population enter the workforce (e.g., women during WWII, subsistence workers in Third World)

• For one

country,

Immigration.

Page 31: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Economic Growth: Increased Resources: Capital

• Machine tools industries

• Capital goods

production

Page 32: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Growth: Technological advance

• Microelectronics Revolution

• Technological innovations

• Organizational innovations

Page 33: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Economic Decline:Decreased Resources

• War

• Natural disaster

• Population decline

• Emigration

Page 34: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Economic Decline: Technological Decline

• Outlawing technologies (or their use at certain times or places) for environmental or health reasons

Page 35: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Unemployment &underemployment

Page 36: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Unemployment and excess capacity

• When resources are unemployed, they are not scarce

• There is no opportunity cost to employing unemployed resources

• When resources are unemployed, more of any good can be produced without decreasing production of other goods; more of both goods can be produced.

Page 37: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

PPC (Unemployment)Guns (Millions)

Butter (Millions of Tubs)

A

B0

D

E

FG1

G2

B1 B2

Page 38: Neoclassical Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost –

Different theories describe different economic scenarios

• Neoclassical theory applies when the economy is on the curve (at full employment)—then scarcity and opportunity cost are in effect

• Keynesian theory applies when the economy is inside the curve (unemployment and excess capacity)—no scarcity (resources are available) and no opportunity cost to employing them.