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Scarcity, Trade-Offs and Economic Growth Chapter 3

3.1 Three Economic Questions Every Society Faces Because of scarcity, certain economic questions must be answered regardless of the level of affluence of the society or its political structure. Because of scarcity, certain economic questions must be answered regardless of the level of affluence of the society or its political structure.

Three fundamental questions that inevitably must be faced in a world of scarcity are: What is to be produced? What is to be produced? How are these goods to be produced? How are these goods to be produced? For whom are the goods produced? For whom are the goods produced?

In market-oriented economies, people “vote” on economic affairs with their dollars. In market-oriented economies, people “vote” on economic affairs with their dollars. Consumer sovereignty describes how individual consumers in market economies determine what is to be produced. Consumer sovereignty describes how individual consumers in market economies determine what is to be produced.

Command economies rely on central planning, where decisions about what is produced is largely determined by a government official or a committee associated with the central planning organization. Command economies rely on central planning, where decisions about what is produced is largely determined by a government official or a committee associated with the central planning organization. Economies are organized in different ways to answer the question of what is to be produced. Economies are organized in different ways to answer the question of what is to be produced.

Market economies, on the other hand, largely rely on a decentralized decision-making process, in which literally millions of individual producers and consumers of goods and services determine what goods will be produced. Market economies, on the other hand, largely rely on a decentralized decision-making process, in which literally millions of individual producers and consumers of goods and services determine what goods will be produced.

Most countries, including the United States, have mixed economies in which the government and private sector together determine the allocation of resources. Most countries, including the United States, have mixed economies in which the government and private sector together determine the allocation of resources.

All economies, regardless of political structure, must decide how, from several possible ways, to produce the goods and services that they want. All economies, regardless of political structure, must decide how, from several possible ways, to produce the goods and services that they want. For example, when digging a ditch, a contractor must decide between many workers using their hands, a few workers with shovels, or one person with a backhoe. For example, when digging a ditch, a contractor must decide between many workers using their hands, a few workers with shovels, or one person with a backhoe.

A decision must be made as to which method is appropriate. A decision must be made as to which method is appropriate. The best method is the least-cost method. The best method is the least-cost method.

The best or "optimal" form of production will vary from one economy to the next. The best or "optimal" form of production will vary from one economy to the next. Each nation tends to use the production processes that conserve its relatively scarce (and thus relatively more expensive) resources and use more of its relatively abundant resources. Each nation tends to use the production processes that conserve its relatively scarce (and thus relatively more expensive) resources and use more of its relatively abundant resources.

Labor intensive methods will be used where capital is relatively scarce. Labor intensive methods will be used where capital is relatively scarce. Capital intensive methods will be used where labor is relatively scarce. Capital intensive methods will be used where labor is relatively scarce.

In every society, some mechanism must exist to determine how goods and services are to be distributed among the population. In every society, some mechanism must exist to determine how goods and services are to be distributed among the population. Who gets what? Who gets what?

In a market economy, with private ownership and control of the means of production, the amount of output one is able to obtain depends on one's income, which in turn, depends on the quantity and quality of the scarce resources that the individual controls. In a market economy, with private ownership and control of the means of production, the amount of output one is able to obtain depends on one's income, which in turn, depends on the quantity and quality of the scarce resources that the individual controls.

For example, Serena Williams' income is very large because her skills are unique and marketable. For example, Serena Williams' income is very large because her skills are unique and marketable.

3.2 The Circular Flow Model Product markets are the markets for goods and services. Product markets are the markets for goods and services. In the product market, households are buyers and firms are sellers. In the product market, households are buyers and firms are sellers. Factor or input markets are where households sell the use of their inputs (capital, land, labor and entrepreneurship) to firms. Factor or input markets are where households sell the use of their inputs (capital, land, labor and entrepreneurship) to firms. In the factor markets, households are the sellers and firms are the buyers. In the factor markets, households are the sellers and firms are the buyers. Wages, rents, interest and profit are the payments for labor, land, capital and entrepreneurship. Wages, rents, interest and profit are the payments for labor, land, capital and entrepreneurship.

3.3 The Production Possibilities Curve The economic concepts of scarcity, choice and trade-offs can be illustrated by the use of a production possibilities curve, which represents the potential total output combinations of any two goods for an economy. The economic concepts of scarcity, choice and trade-offs can be illustrated by the use of a production possibilities curve, which represents the potential total output combinations of any two goods for an economy. That is, it illustrates an economy's potential for allocating its limited resources for producing various combinations of goods, in a given time period. That is, it illustrates an economy's potential for allocating its limited resources for producing various combinations of goods, in a given time period.

The production possibilities curve discussion begins with a straight-line production possibilities curve, with the goods being one's grade in economics and one's grade in history. The production possibilities curve discussion begins with a straight-line production possibilities curve, with the goods being one's grade in economics and one's grade in history.

On a production possibilities curve, we assume that the economy has a given quantity and quality of resources and technology available to use for production. On a production possibilities curve, we assume that the economy has a given quantity and quality of resources and technology available to use for production.

Using an example involving food and shelter we can see a concave (bowed) production possibilities curve. Using an example involving food and shelter we can see a concave (bowed) production possibilities curve. Each point represents the potential amounts of food and shelter that can be produced in a given time period, given the quantity and quality of resources available. Each point represents the potential amounts of food and shelter that can be produced in a given time period, given the quantity and quality of resources available.

The economy cannot produce beyond the levels indicated by the production possibilities curve during a given time period, because there are not enough resources to produce that output. The economy cannot produce beyond the levels indicated by the production possibilities curve during a given time period, because there are not enough resources to produce that output. However, it is possible to operate inside the production possibilities curve. However, it is possible to operate inside the production possibilities curve.

If an economy is operating inside its production possibilities curve, it is not at full capacity, and is operating inefficiently. If an economy is operating inside its production possibilities curve, it is not at full capacity, and is operating inefficiently. The economy is not getting the most it can from its scarce resources. The economy is not getting the most it can from its scarce resources. As a result, actual output is less than potential output. As a result, actual output is less than potential output.

Efficiency requires society to use its resources to the fullest extent— getting the most we can out of our scarce resources; that is, there are no wasted resources. Efficiency requires society to use its resources to the fullest extent— getting the most we can out of our scarce resources; that is, there are no wasted resources.

If resources are being used efficiently, at a point along a production possibilities curve, more of one good or service requires the sacrifice of another good or service as its cost. If resources are being used efficiently, at a point along a production possibilities curve, more of one good or service requires the sacrifice of another good or service as its cost.

Efficiency does not tell us which point along the production possibilities curve is best. Efficiency does not tell us which point along the production possibilities curve is best. But it does tell us that points inside the curve cannot be best because some resources are wasted. But it does tell us that points inside the curve cannot be best because some resources are wasted.

The production possibilities curve is not a straight line. The production possibilities curve is not a straight line. It is concave from below (that is, bowed outward from the origin), reflecting increasing opportunity costs of producing additional amounts of a good. It is concave from below (that is, bowed outward from the origin), reflecting increasing opportunity costs of producing additional amounts of a good.

The basic reason for increasing opportunity cost is that some resources and skills cannot be easily adapted from their current uses to alternative uses. The basic reason for increasing opportunity cost is that some resources and skills cannot be easily adapted from their current uses to alternative uses. Easily adaptable resources are soon exhausted and resources and workers that are less well suited or appropriate (those with a relatively greater opportunity cost) must then be employed to increase output further. Easily adaptable resources are soon exhausted and resources and workers that are less well suited or appropriate (those with a relatively greater opportunity cost) must then be employed to increase output further.

3.3 Economic Growth and the Production Possibilities Curve To generate economic growth, a society must produce fewer consumer goods and more capital goods in the present. To generate economic growth, a society must produce fewer consumer goods and more capital goods in the present. They must sacrifice some consumption of consumer goods in the present in order to experience growth in the future. They must sacrifice some consumption of consumer goods in the present in order to experience growth in the future.

Investing in capital goods will increase the future production capacity of the economy. Investing in capital goods will increase the future production capacity of the economy. So an economy that invests more and consumes less now will be able to produce and consume more in the future. So an economy that invests more and consumes less now will be able to produce and consume more in the future.

An economy can only grow with qualitative or quantitative changes in the factors of production–land, labor, capital and entrepreneurship. An economy can only grow with qualitative or quantitative changes in the factors of production–land, labor, capital and entrepreneurship. Advancements in technology, improvements in labor productivity or new natural resource finds could all lead to outward shifts of the production possibilities curve. Advancements in technology, improvements in labor productivity or new natural resource finds could all lead to outward shifts of the production possibilities curve.

Economic growth means an outward shift in the “menu” of possible bundles of output illustrated by the production possibilities curve. Economic growth means an outward shift in the “menu” of possible bundles of output illustrated by the production possibilities curve. With growth comes the possibility to have more of both goods than were previously available. With growth comes the possibility to have more of both goods than were previously available.

It is important to remember that increases in a society's output do not make scarcity disappear. It is important to remember that increases in a society's output do not make scarcity disappear. Even when output has grown more rapidly than population, so people are made better off, they still face trade-offs. Even when output has grown more rapidly than population, so people are made better off, they still face trade-offs. At any point along the production possibilities curve, in order to get more of one thing, you must give up something else. At any point along the production possibilities curve, in order to get more of one thing, you must give up something else.

An economy that invests more of its resources for the future devotes a larger share of its productive capacity to capital goods rather than consumption goods. An economy that invests more of its resources for the future devotes a larger share of its productive capacity to capital goods rather than consumption goods. Economies that choose to invest more of their resources for the future will grow faster than those that don't, other things equal. Economies that choose to invest more of their resources for the future will grow faster than those that don't, other things equal.

The production possibilities curve can be used to illustrate the economic concepts of scarcity, choice, opportunity costs, efficiency, and economic growth. The production possibilities curve can be used to illustrate the economic concepts of scarcity, choice, opportunity costs, efficiency, and economic growth. Scarcity is represented by the fact that resource combinations outside the production possibility curve are unattainable. Scarcity is represented by the fact that resource combinations outside the production possibility curve are unattainable.

Choice is the fact that one must choose among the alternative bundles available along the production possibilities curve. Choice is the fact that one must choose among the alternative bundles available along the production possibilities curve. Opportunity costs are how much of one good you give up to get another unit of the second good as you move along the production possibilities curve. Opportunity costs are how much of one good you give up to get another unit of the second good as you move along the production possibilities curve.

Efficiency would mean being on the production possibilities curve rather than inside it. Efficiency would mean being on the production possibilities curve rather than inside it. Economic growth is represented by shifting out the production possibilities curve. Economic growth is represented by shifting out the production possibilities curve.