Copyright 2002, Pearson Education Canada1 The Economic Problem: Scarcity and Choice Chapter 2

Copyright 2002, Pearson Education Canada2 Resources (Inputs) Used in Production zCapital yThings that have already been produced that are used to produce other goods and services e.g. buildings, machinery, roads. zHuman Resources yLabour, Skills and Knowledge zNatural Resources

Copyright 2002, Pearson Education Canada3 Three Basic Economic Questions zWhat will be produced? zHow will it be produced? zWho will get what is produced?

Copyright 2002, Pearson Education Canada4 Opportunity Cost zThe opportunity cost is that which we give up or forgo, when we make a decision or choice.

Copyright 2002, Pearson Education Canada5 The Theory of Comparative Advantage zRicardo’s theory that specialization and free trade will benefit all trading parties, even those that may be absolutely more efficient producers. zA person or country is said to have a comparative advantage in producing a good if it is relatively more efficient than a trading partner at doing so. In other words they have a lower opportunity cost.

Copyright 2002, Pearson Education Canada6 Comparative Advantage Example Production values assume that each person is only producing that good, so for instance Colleen can produce 10 logs or 10 baskets of food.

Copyright 2002, Pearson Education Canada7 Calculate Opportunity Cost z10 logs cost Colleen 10 baskets of food z5 logs cost Ivan 8 baskets of food zFor Shelter: y1 log costs Colleen 1 basket of food y1 log cost Ivan 1.6 baskets of food zFor Food: y1 basket costs Colleen 1 log y1 basket costs Ivan.625 logs

Copyright 2002, Pearson Education Canada8 How should each specialize? zColleen can produce logs cheaper than Ivan and therefore should produce shelter. zIvan can produce food/baskets cheaper than Colleen and therefore should produce shelter.

Copyright 2002, Pearson Education Canada9 Consumer Goods, Capital Goods and Investment zA capital good can be considered as anything that is produced that will be used to produce other valuable goods or services over time. zInvestment is the process of using up resources for the production of capital or simply purchasing capital. zConsumer goods are those produced for present consumption

Copyright 2002, Pearson Education Canada10 Production Possibility Frontier (PPF) zThe PPF is a graph that shows all the combinations of goods and services that can be produced if all of society’s resources are used efficiently.

Copyright 2002, Pearson Education Canada11 Production Possibility Frontier Consumer goods Capital goods zThe curve has a negative slope. zThe curve is concave to the origin.

Copyright 2002, Pearson Education Canada12 PPF and Opportunity Cost (Figure 2.3) zProducing tomatoes at D instead of E, means producing beef at D instead of E. 250 million more tomatoes at a cost of 100 million kg of beef.

Copyright 2002, Pearson Education Canada13 Law of Increasing Opportunity Cost zThe opportunity cost of producing a good increases as more resources are shifted into its production. zThis is clearly shown in the Production Possibility Schedule for tomato and beef production.

Copyright 2002, Pearson Education Canada14 PPF and Production Possibilities Schedule for Beef and Tomatoes (Figure 2.3 and Table 2.1)

Copyright 2002, Pearson Education Canada15 Economic Growth zEconomic growth is an increase in the total output of an economy. zIt occurs when a society acquires new resources or when it learns to produce more using existing resources.

Copyright 2002, Pearson Education Canada16 Economic Growth and Shifts in the PPF (Figure 2.4) zNew resources or technology can shift the PPF outward. zThe shift may or may not be parallel depending on where the productivity increases are concentrated; in this case, tomatoes more than beef.

Copyright 2002, Pearson Education Canada17 The Economic Problem zGiven scarce resources how exactly, do large, complex societies go about answering the three basic economic questions? yWhat will be produced? yHow will it be produced? yWho will get what is produced?

Copyright 2002, Pearson Education Canada18 Economic Systems zCommand Economy zLaissez-Faire Economies: Free Market

Copyright 2002, Pearson Education Canada19 Command Economy zAn economy in which a central authority or agency draws up a plan that establishes what will be produced and when, sets production goals, and makes rules for distribution.

Copyright 2002, Pearson Education Canada20 Laissez-faire Economy zLiterally from the French: “allow (them) to do” zAn economy in which individuals and firms pursue their self-interests without any central direction or regulation. zThe central institution in these economies is called the market.

Copyright 2002, Pearson Education Canada21 Markets zThe institutions through which buyers and sellers interact and engage in exchange.

Copyright 2002, Pearson Education Canada22 Important aspects of Market Economies: zConsumer sovereignty yThe idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase). zIndividual Production Decisions zDistribution of output decentralized zPrice theory

Copyright 2002, Pearson Education Canada23 A Role for Government: Mixed Market Economies zMinimize market inefficiencies zProvision of public goods zRedistribution of income zStabilize the macroeconomy yPromote low levels of unemployment yPromote low levels of inflation

Copyright 2002, Pearson Education Canada24 Review Terms and Concepts z capital z command economy z comparative advantage z consumer goods z consumer sovereignty z economic growth z economic problem z investment z laissez-faire economy z market z opportunity cost z outputs z price z producers z production z PPF z resources or inputs z three basic questions