Chapter 2 The economic problem: Scarcity and choice

Three basic questions What will be produced? How will it be produced? Who will get what is produced?

Opportunity cost Opportunity cost is that which we give up, or forgo, when we make a choice or a decision. For example…

Scarcity A single person (Bill) lives alone on an island. The first problem he is facing: Scarcity –Time (how do we spend our time?) Work Or leisure –What to produce? Food Or wood

Wood and food wood food If we spend all our time cutting wood, how much food and wood we will get? If we spend all our time growing food, how much food and wood we will get? Feasible area for Bill’s production Infeasible area

Theory of comparative advantage Specialization and free trade will benefit all parties if they specialize in producing goods in which they have comparative advantage, even those that may be absolutely more efficient producers. For example…

Consider and economy of 2 people, Bill and Colleen Colleen 8 Bill food log

Begin by calculating the opportunity cost of each good for each person 10 logs cost Colleen 10 bushels of food. 10 logs cost Bill 16 bushels of food. 8 bushels of food cost Colleen 8 logs. 8 bushels of food cost Bill 5 logs.

The opportunity cost can be summarized: Logs: –1 log costs Colleen 1 bushel of food. –1 log costs Bill 1.6 bushels of food. Food: –1 bushel of food costs Colleen 1 log. –1 bushel of food costs Bill 5/8, or logs.

So, how should Colleen and Bill specialize and trade? Colleen can produce logs cheaper than Bill. Colleen should produce fuel. Bill can produce food cheaper than Colleen. Bill should produce food.

Review questions 1. Graph a line and calculate it’s slope. –For example: Y=3x+5 2. Changing of the slope of a curve. 3. What is opportunity cost? (concise definition) 4. Decide what is the comparative advantage by calculating the opportunity cost.(example in class)