Scarcity, Choice, and Economic Systems Outline 1.The concept of opportunity cost 2.Production possibility frontiers 3.The law of increasing opportunity cost 4.Productive inefficiency 5.Gains from specialization: Comparative advantage

Opportunity cost Resources are scarce; therefore, individuals and societies must make choices. Choice entails foregone alternatives, or opportunity cost. Opportunity cost is defined as the value of the next best alternative foregone as the result of choosing.

If I go to the movies, I give up both time and money. Opportunity cost equals: The value of the goods or services that could have been purchased with the money used to pay for the movie ticket; plus The value of the time that could have been used for something else, like work or study.

Time is money! I can make $150 per hour as a consultant. So I am giving up a lot by sitting around a doctor’s office or an airport. Cell phones help to reduce my opportunity cost at times like these.

Assumptions: ñFixed endowment of economic resources ñFixed technology ñResources fully utilized The PPF illustrates what is possible in terms of production with given resources and technology

( Technology is “applied know how.” ( “A sharp knife is better than a dull knife.” ( Specialization is the inevitable consequence of technology.

A hypothetical economy

Nondefense goods Defense goods Attainable zone A F C B I Unattainable Zone

Nondefense goods Defense goods A F C B U Full employment unemployment Full Employment and Unemployment

1 MOC is defined as marginal opportunity cost. Why is the PPF bow-shaped?

Nondefense goods Defense goods A F D E Resources are specialized and hence not perfectly adaptable to alternative uses Law of increasing opportunity cost

I just got a free lunch! Economists say “there is no free lunch” from society’s point of view. Preparing the lunch took resources that could have been used to produce something else.

Nondefense goods Defense goods U R S T Moving from point U to an efficient point is like getting a free lunch.

Nondefense goods Defense goods R S T Moving from point S to point T involves a tradeoff—a sacrifice of defense goods for nondefense goods. Tradeoffs

Micro is from the Greek word mikros, meaning “small.” Microeconomics is the study of individual economic agents—households, firms, and government units; and their interaction in specific markets. Macro is from the Greek work macros, meaning “large.” Macroeconomics is the study of the economy as a whole—that is, the study of the forces that determine total output, total employment, or the general price level.

Nondefense goods Defense goods A F C B U Microeconomics attempts to explain why this society might end up at point C instead of point B. Macroeconomics attempts to explain why society could end up at a point like point U.