Scarcity Choice and Economic Systems Slides by John
Scarcity, Choice, and Economic Systems Slides by: John & Pamela Hall ECONOMICS / HALL & LIEBERMAN Hall &3 e. Leiberman; Economics: Principles SCARCITY, CHOICE, AND ECONOMIC SYSTEMS Applications, 2004 © 2005 And South-Western/Thomson Learning
The Concept of Opportunity Cost • Opportunity cost of any choice – What we forego when we make that choice • Most accurate and complete concept of cost • Direct money cost of a choice may only be a part of opportunity cost of that choice • Opportunity cost of a choice includes both explicit costs and implicit costs – Explicit cost—dollars actually paid out for a choice – Implicit cost—value of something sacrificed when no direct payment is made 2
Opportunity Cost and Society • All production carries an opportunity cost – To produce more of one thing • Must shift resources away from producing something else 3
Production Possibilities Frontiers (PPF) • Curve showing all combinations of two goods that can be produced with resources and technology available • Society’s choices are limited to points on or inside the PPF 4
Figure 1: The Production Possibilities Frontier Quantity of All Other Goods per Period 1, 000 950, 000 850, 000 A At point A, all resources are used for "other goods. " B C 700, 000 500, 000 400, 000 W Moving from point A to point B requires shifting resources out of other goods and into health care. D E At point F. all resources are used for health care. F 100, 000 200, 000 300, 000 400, 000 500, 000 Number of Lives Saved per Period 5
Increasing Opportunity Cost • According to law of increasing opportunity cost – The more of something we produce • The greater the opportunity cost of producing even more of it • This principle applies to all of society’s production choices 6
The Search for a Free Lunch • Productive Inefficiency – More of at least one good can be produced • Without pulling resources from the production of any other good • No industry, firm or economy is ever 100% productively efficient – However, cases of gross inefficiency are not as common as you might think 7
Recessions • A slowdown in overall economic activity when resources are idle – Widespread unemployment – Factories shut down • Land capital are not being used • An end to the recession would move the economy from a point inside its PPF to a point on its PPF – Using idle resources to produce more goods and services without sacrificing anything • Can help us understand an otherwise confusing episode in U. S. economic history 8
Recessions • During early 1940 s, standard of living in U. S. did not decline as we might have expected but actually improved slightly. Why? – U. S. entered World War II and began using massive amounts of resources to produce military goods and services • Instead of pitting “health care” against “all other goods, ” we look at society’s choice between military goods and civilian goods • U. S. was still suffering from the Great Depression when it entered WWII • Joining war effort helped end the Depression and moved economy from a point like A, inside the PPF, to a point like B, on the frontier – Military production increased, but so did the production of civilian goods – Although there were shortages of some consumer goods » Overall result was a rise in the material well-being of the average U. S. citizen – War is only one factor that can reverse a downturn – No rational nation would ever choose war as an economic policy designed to cure a recession » Alternative policies that virtually everyone would find preferable 9
Figure 2: Production and Unemployment Military Goods per Period 1. Before WWII the United States operated inside its PPF. . . B 2. then moved to the PPF during the war. Both military and civilian production increased. A Civilian Goods per Period 10
Economic Growth • If economy is already operating on its PPF – Cannot exploit opportunity to have more of everything by moving to it • But what if the PPF itself were to change? Couldn’t we then produce more of everything? – This happens when an economy’s productive capacity grows • Many factors contribute to economic growth, but they can be divided into two categories – Quantities of available resources—especially capital—can increase • An increase in physical capital enables economy to produce more of everything that uses these tools – More factories, office buildings, tractors, or high-tech medical equipment • Same is true for an increase in human capital – Skills of doctors, engineers, construction workers, software writers, etc. – Technological change enables us to produce more from a given quantity of resources 11
Economic Growth • Increases in capital and technological change often go hand in hand • For instance, PET body scanners will enable us to save even more lives than our current set of resources – Moving horizontal intercept of PPF rightward, from F to F‘ – Impact of PET scanners stretches PPF outward along horizontal axis • How can a technological change in lifesaving enable us to produce more goods in other areas of the economy? – Society can choose to use some of increased lifesaving potential to shift other resources out of medical care and into production of other things • Because of technological advance and new capital, we can shift resources without sacrificing lives 12
Economic Growth • If we can produce more of the things that we value, without having to produce less of anything else, have we escaped from paying an opportunity cost? – Yes. . . and no – Figure 3 tells only part of story • Leaves out steps needed to create this shift in the PPF • For example, technological innovation doesn’t just “happen”— resources must be used to create it – Mostly by research and development (R&D) departments of large corporations • In order to produce more goods and services in the future, we must shift resources toward R&D and capital production – Away from production of things we’d enjoy right now 13
Figure 3: The Effect of a New Medical Technology Quantity of All Other Goods per Period 1, 000 2. But not its vertical intercept. 4. or more lives saved and greater production of other goods. A J 700, 000 H D 1. A technological advance in saving lives increases this PPF's horizontal intercept. . . 300, 000 3. The economy can end up with more lives saved and unchanged production of other goods. . . F F' 500, 000 600, 000 Number of Lives Saved per Period 14
Specialization and Exchange • Specialization – Method of production in which each person concentrates on a limited number of activities • Exchange – Practice of trading with others to obtain what we want • Allows for – Greater production – Higher living standards than otherwise possible • All economics exhibit high degrees of specialization and exchange 15
Further Gains to Specialization • Absolute Advantage: A Detour – Ability to produce a good or service using fewer resources than other producers use • Comparative Advantage – If one can produce some good with a smaller opportunity cost than others can – Total production of every good or service will be greatest when individuals specialize according to their comparative advantage – Another reason why specialization and exchange lead to higher living standards than self-sufficiency 16
Specialization in Perspective • While specialization gives us material gains – There may be opportunity costs to be paid in the loss of other things we care about • The right amount of specialization can be found by balancing gains against costs 17
Resource Allocation • Problem of resource allocation – Which goods and services should be produced with society’s resources? • Where on the PPF should economy operate? – How should they be produced? • No capital at all • Small amount of capital • More capital – Who should get them? • How do we distribute these products among the different groups and individuals in our society? 18
The Three Methods of Resources Allocation • Traditional Economy – Resources are allocated according to long-lived practices from the past • Command Economy (Centrally-Planned) – Resources are allocated according to explicit instructions from a central authority • Market Economy – Resources are allocated through individual decision making 19
The Nature of Markets • A market is a group of buyers and sellers with the potential to trade with each other – Global markets • Buyers and sellers spread across the globe – Local markets • Buyers and sellers within a narrowly defined area 20
The Importance of Prices • A price is the amount of money that must be paid to a seller to obtain a good or service • When people pay for resources allocated by the market – They must consider opportunity cost to society of their individual actions • Markets can create a sensible allocation of resources 21
Resource Allocation in the United States • Numerous cases of resource allocation outside the market – Such as families • Various levels of government collect about onethird of our incomes as taxes – Enables government to allocate resources by command • Government uses regulations of various types to impose constraints on our individual choice • The market is the dominant method of resource allocation in United States – However, it is not a pure market 22
Resource Ownership • Communism – Most resources are owned in common • Socialism – Most resources are owned by state • Capitalism – Most resources are owned privately 23
Types of Economic Systems • An economic system is composed of two features – Mechanism for allocating resources • Market • Command – Mode of resource ownership • Private • State 24
Figure 4: Types of Economic Systems Resource Allocation Private Market Command Market Capitalism Centrally Planned Capitalism Market Socialism Centrally Planned Socialism Resource Ownership State 25
Economic Systems and This Book • This book will focus on market capitalist economies • About 400 million people have come under the sway of the market in past decade • More are being added as China changes to a market economy • Study of modern economies is study of market capitalism 26
Using Theory: Are We Saving Lives Efficiently? • Could be productive inefficiency in saving human lives • Some economists have argued that we waste significant amounts of resources in our lifesaving efforts – How have they come to such a conclusion? • Saving a life—no matter how it is done—requires use of resources – Any lifesaving action we might take requires certain quantities of resources • For example, putting another hundred police on the streets, building another emergency surgery center, or running an advertising campaign to encourage healthy living – In a market economy, resources sell at a price • Allows us to use the dollar cost of a lifesaving method to measure value of resources used up by that method • Can compare “cost per year of life saved” of different methods 27
Using Theory: Are We Saving Lives Efficiently? • Cost per life saved of various life-saving methods ranges widely – From $150 per year of life saved for a physician warning a patient to quit smoking, to over $66, 000 per year of life saved from the ban on asbestos in automatic transmissions • Some lifesaving methods are highly cost effective but some serious productive inefficiency exists in lifesaving • Allocating lifesaving resources is much more complicated than our discussion so far has implied – Benefits of lifesaving efforts are not fully captured by “life-years saved” • Or even by an alternative measure, which accounts for improvement in quality of life • Another difficulty in allocating our lifesaving resources efficiently is uncertainty – Trying to gauge and improve our productive efficiency in saving lives— which was never an exact science—has become even less exact in the post-9/11 era 28
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