Unit 1. The Basic Economic Problem

The Basic Economic Problem World's resources are finite, technology is limited, skill of people is limited World's resources are finite, technology is limited, skill of people is limited Human needs are limited but human wants are infinite. Human needs are limited but human wants are infinite. Human needs Human needs The Basic Economic Problem: people have to decide how much resources devote to each need The Basic Economic Problem: people have to decide how much resources devote to each need Resources are scarce relative to human wants: Water was not scarce in Arizona before 1492 Resources are scarce relative to human wants: Water was not scarce in Arizona before 1492 Water was not scarce in Arizona before 1492 Water was not scarce in Arizona before 1492

Economic vs. Free Goods Taking one choice prevents you from taking others  opportunity cost Taking one choice prevents you from taking others  opportunity cost Economic Goods are scarce relative to wants and have opportunity cost implicit. Economic Goods are scarce relative to wants and have opportunity cost implicit. Free goods are not scarce and have no opportunity cost implicit: breathing, applying the Pitagora's theorem Free goods are not scarce and have no opportunity cost implicit: breathing, applying the Pitagora's theorem Examples: Examples: Air Air The Pitagora's theorem The Pitagora's theorem Fluent roads Fluent roads

Another classification Exclud.RivalryYesNo Yes Private Goods: Ice cream, clothing, toll busy roads Nat. Monopol.: Cable TV, water, toll fluent roads No Com. Resource: Fish, clean rivers, free busy roads Public Goods: National defense, street light, free fluent roads, air Public goods ≠ free goods Goods at zero price ≠ free goods Excludability: consumers can be excluded individuallyExcludability: consumers can be excluded individually Rivalry: amount I consume reduces yoursRivalry: amount I consume reduces yours

The Production Possibility Frontier The PPF shows the different combination of goods which an economy is able to produce using all resources in the economy at full- employment. The PPF shows the different combination of goods which an economy is able to produce using all resources in the economy at full- employment. Example: Tyrannia is a country with 100 workers. Example: Tyrannia is a country with 100 workers. Workers can be used for guns or butter Workers can be used for guns or butter The number of workers in each sector determines (maximal) production The number of workers in each sector determines (maximal) production

The PPF of Tyrannia BUTTERGUNS InputOutputInputOutput

Efficiency and growth The PPF boundary shows maximal production achieved using resources at its full-employement levels. The PPF boundary shows maximal production achieved using resources at its full-employement levels. If resources are not used efficiently, economy is within the boundary (point A) If resources are not used efficiently, economy is within the boundary (point A) Economy can never be outside boundary (point B) Economy can never be outside boundary (point B) The PPF moves north-east when there is economic growth (C to C'). The PPF moves north-east when there is economic growth (C to C'). Economic growth may respond to: Economic growth may respond to: increase in available resources increase in available resources increase in productivity increase in productivity

A B C C' C''

The PPF and Opportunity Cost Producing one more gun has a cost in terms of butter Producing one more gun has a cost in terms of butter In (120,0), producing 10 more guns reduces 5 units of butter. Opportunity cost is ½ In (120,0), producing 10 more guns reduces 5 units of butter. Opportunity cost is ½ In (40,45), cost is 40/5=8 units of butter In (40,45), cost is 40/5=8 units of butter Opportunity cost of guns increases as we produce more guns (concavity) Opportunity cost of guns increases as we produce more guns (concavity) PPF is concave because decreasing marginal productivity is assumed!! PPF is concave because decreasing marginal productivity is assumed!!