Chapter 2 Confronting Scarcity Choices in Production Review

Chapter 2 Confronting Scarcity: Choices in Production

Review § What is the economic way of thinking? – Scarcity forces us to choose and economists analyze opportunity costs when analyzing choices – People are motivated to maximize their self interest – Individuals maximize choices by engaging in marginal decision making

Factors of Production § Definition: resources available to an economy for the production of goods and services § Factors of production (FOP) create utility. § Utility is the value or satisfaction that people derive from the goods or services they consume

Factors of Production § Land (natural resources)-resources of nature that can be used in the production of goods and services – Must be found in nature – Expansion occurs through: § Discovery of more § Discovery of new use § New ways of extraction

Factors of Production § Labor-human factor in production – Natural ability – Human capital – Increase labor through § Increasing number of people available § Increasing human capital

Factors of Production § Capital-resources produced for use in the production of goods and services – Resource must have been produced – Resource can be used to produce other goods and services – THIS DOES NOT MEAN FINANCIAL CAPITAL (money)

Factors of Production § Entrepreneurs change the way that the factors of production are used by putting new technologies to work § Entrepreneur person who seeks to earn profits by finding new ways to organize the factors of production (sometimes classified as the fourth factor of production) § Technology knowledge that can be applied to production of goods and services

Case in Point: Technology Cuts Costs, Boosts Productivity and Profits § Read p. 41 § Who are the winners and losers from technology? – Consumers – Producers – Workers

Land, labor or capital? § § § § An unemployed factory worker A college professor The SMCHS library Yellowstone National Park An untapped deposit of natural gas The White House A power plant

Production Possibilities Curve § § § CSU Monterey Bay built on site of Fort Ord Shift from military use to civilian use Definition: Model that shows goods and services that an economy is capable of producing given the factors of production and technology it has available

Production Possibilities Curve § Assumes that only two goods can be produced § Any increase in one good means you can produce less of the other § Assumes that factors of production are fixed

Production Possibilities Curve § The PPC is downward sloping – Reflects scarcity § The PPC is bowed out – Curve gets steeper as we move from left to right – “Producing an additional good on horizontal axis requires a greater sacrifice of the good on the vertical axis than did previous units produced” (Tregarthen & Rittenberg, 2000, p. 57)

Production Possibilities Curve § The PPC is bowed out – The absolute value of the slope of any production possibilities curve (PPC) = the opportunity cost of an additional unit of a good on the horizontal axis – Steeper the slope, the greater the opportunity cost of producing that good – Illustrates the law of increasing opportunity cost

Calculating Opportunity Cost § Opportunity cost = what is given up/what is obtained § Economy can produce either 40 houses or 20 office buildings § OC of houses = 20 office buildings/40 houses=. 5 office buildings § OC of office buildings = 40 houses/20 office buildings = 2 houses § Try “Try It Yourself” 2 -2 on p. 49

Production Possibilities Curve § Law of increasing opportunity cost – As an economy moves along its PPC in the direction of increased production of one good, the opportunity cost of additional units of that good increase – Law applies because as one moves closer to one end of the curve, resources transferred from one use to the other had greater and greater comparative advantage

Production Possibilities Curve § Comparative advantage is when the opportunity cost of producing that good or service is lower for a particular economy than any other – International trade theory is based on comparative advantage

Production Possibilities Curve § Specialization implies that an economy is producing goods and services in which it has a comparative advantage – People work and use the income they earn to buy goods and services from people who have a comparative advantage in doing other things – What would life be like without specialization? Hong Kong vs. United States

Production Possibilities Curve § Movement along the PPC means that all factors of production are being maximized (point A) § Production within the curve means that factors of production are being used inefficiently (point B) – Idle factors of production – Inefficient production – Could increase production of both goods

Production Possibilities Curve § Production outside of the PPC is impossible without economic growth – Increased educational levels – Change in technology – Increased quality or quantity of labor and capital

Applications of the PPC Model § In order to allocate resources efficiently, then each nation should specialize in producing products for which they have a comparative advantage § Nations should trade in order to get the goods and services they need – Trade results in more production § Failure to specialize means that the world economy would be producing inside the global PPC

Production Possibilities and Economic Growth § An outward shift of the PPC indicates economic growth. § Economic growth raises standards of living, even in the continuing face of scarcity. § Economic growth is a sustained increase in a nation’s production of goods and services.

Production Possibilities and Economic Growth § The history of world economic growth raises important questions about the ability of nations to deal with the ever-present problem of scarcity. – Rich versus poor nations – Conditions that favor growth – How can growth be promoted? – How can poverty be reduced?

Production Possibilities and Economic Growth § Economic growth occurs through – Increases in educational levels – Changes in technology – Increases in quantity or quality of labor and capital – Innovation

Institutions Matter for Economic Growth