2 Scarcity and Choice The Economic Problem Our

2 Scarcity and Choice: The Economic Problem Our necessities are few but are wants are endless. FORTUNE COOKIE INSCRIPTION

Contents ● 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 Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Contents (continued) ● 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 Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Scarcity, Choice and Opportunity Cost ● Scarcity of resources necessity of choices ● Opportunity cost = value of the best forgone alternative ♦ True cost of a scarce resource Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Opportunity Cost and Money 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 Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Opportunity Cost and Money Cost ● 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 Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Scarcity 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 Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

2 -1 Production Possibilities Open to a Farmer TABLE Copyright© 2003 South-Western/Thomson Learning. All

The Production Possibilities Frontier ● Negatively sloped ● Slope = opportunity cost ● Illustrates the trade-off in the production of one good (or class of goods) against another Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

2 -1 PPF for Production by a Single Firm Soybeans FIGURE 40 30 20 A B Attainable region Unattainable region C D 10 0 10 20 30 38 Wheat E 52 60 65 Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

The Principle of Increasing Costs ♦ Shape: concave ♦ Principle of increasing costs: production of one good opportunity cost of producing another unit ♦ Reason: Inputs tend to be specialized. Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

2 -2 PPF with No Specialized Resources FIGURE 50 Black Shoes 40 A B

The Principle of Increasing Costs ● Productivity constant along a production possibilities frontier. ● productivity shift of the frontier ♦ Skills ♦ Technology ♦ Capital stock Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Scarcity and Choice for the Entire Society ● 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. Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

2 -3 PPF for Entire Economy FIGURE Thousands of Automobiles per Year 700 B 600 D 500 E 400 G 300 F 200 100 C 0 100 200 300 400 500 Missiles per Year Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Scarcity 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. Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Growth in the United States and Asia G N A Consumption Goods Next year’s production possibilities This year’s production possibilities F G Capital Goods (a) United States g Consumption Goods F Next year’s production possibilities This year’s production possibilities f B f g Capital Goods (b) Asia Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Scarcity and Choice Elsewhere in the Economy ● Problems of scarcity and choice are everywhere in the economy. ● Households, firms, and government must decide how to allocate their income. Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

The 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. Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

The 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. Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

The 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. Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Specialization Fosters Efficient Resource Allocation ● The Wonders of the Division of Labor ♦ Breaking a task into a set of smaller, more specialized tasks ♦ Specialization productivity growth Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Specialization 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 Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Specialization Leads to Exchange ● Specialization requires exchange ● Trading production because it permits

Markets, 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. Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Last Word: Don’t Confuse Ends with Means ● Economic analysis judgment of capitalism ● Values ends ● Pragmatism means ● Economic analysis concerns means, not ends. Copyright © 2003 South-Western/Thomson Learning. All rights reserved.