1. Chapter 2 Scarcity and the World of Trade-Offs

2. Introduction
Suppose that you are a passenger on an airline flight, and the captain announces an early arrival at your destination. Immediately, you begin to contemplate how you might use that extra hour.
But soon enough, you hear the bad news: There are no empty gates, and you will have to wait at least an hour to exit the plane. As you abandon your plans for that extra hour, you realize that you have incurred an opportunity cost.
In this chapter, you will learn how opportunity costs affect economic decisions.

3. Learning Objectives
Evaluate whether even affluent people face the problem of scarcity
Understand why economists consider wants but not needs
Explain why the scarcity problem induces individuals to consider opportunity costs 3

4. Learning Objectives (cont'd)
Discuss why obtaining increasing increments of any particular good entails giving up more and more units of other goods
Explain why society faces a trade-off between consumption goods and capital goods
Distinguish between absolute and comparative advantage 4

5. Chapter Outline Scarcity Wants and Needs
Scarcity, Choice, and Opportunity Cost
The World of Trade-Offs
The Choices Society Faces
Economic Growth and the Production Possibilities Curve 6

6. Chapter Outline (cont'd)
The Trade-Off Between the Present and the Future
Specialization and Greater Productivity
Comparative Advantage and Trade Among Nations 7

7. Did You Know That …
A recent report by the U.S. Department of Commerce indicates that 11 percent of consumer spending is devoted to “non- essential items”?
Some commentators responded by arguing that Americans are wasting money on items they don’t really need.
Economists would say that individual economic choices are based on wants rather than needs. 9

8. Scarcity Scarcity Is the most basic concept in all of economics
Occurs when the ingredients for producing things that people desire are insufficient to satisfy all wants
Means we never have enough of everything, including time, to satisfy our every desire
This is the central concept in economics. All economic analysis derives from this condition. Stress that scarcity arises because at any given time people want more than their resources will allow them to consume. The classic way to define scarcity is that wants are unlimited while resources are limited. Resources or inputs are anything that can be used to produce things people want. It is important to stress that scarcity is a relative concept. Even though not everyone has “unlimited” wants, they usually want more than they can have at the moment. As income rises, so do wants. Studies by Simon Kuznets and Milton Friedman provide evidence of this fact. Kuznets found that between 1869–1929, real national income rose by a factor of 4, but the APC remained constant. Friedman reported in The Theory of the Consumption Function that the APC remains constant even cross-sectionally as income goes from lower levels to higher levels out of permanent income. Also, poverty in the United States is defined at levels that would be considered affluent by people in most countries. 10

9. Scarcity (cont'd) What scarcity is NOT It is not a shortage
It is not the same thing as poverty 11

10. Scarcity (cont'd) Production Resources or Factors of Production
Any activity that results in the conversion of resources into products that can be used in consumption
Resources or Factors of Production
Inputs that are used to produce things that people want
Resources or inputs are things that produce goods and services. At any given time, resources are fixed. Generally, students will agree that this is so. Thus, at any given time, the amount of goods and services that can be produced is limited. Over time, resources have increased. Indeed, 150 years ago petroleum was not even a resource. Today, it is one of the most important resources. Advances in technology allow society to use things that were previously not resources. Over time, an increase in resources does not allow society to eliminate scarcity because, at any given time, resources are fixed while wants are not. 12

11. Scarcity (cont'd) Resources or Factors of Production Land Labor
Natural resources or the gifts of nature
Labor
The human resource 14

12. The new office norm is now 82 degrees during summer months.
International Policy Example: A Lower Productive Contribution of Sweltering Japanese Labor
In order to reduce carbon dioxide emissions, offices in Japan are using far less air conditioning than they have in the past.
The new office norm is now 82 degrees during summer months.
As a result, the productivity of Japanese workers now declines in the summer. 14

13. Scarcity (cont'd) Resources or Factors of Production Physical Capital
All manufactured resources
Human Capital
Accumulated training and education of workers 15

14. Scarcity (cont'd) Resources or Factors of Production Entrepreneurship
Person who organizes, manages, and assembles the other resources
Risk taker
Maker of basic business policy decisions 16

15. Scarcity (cont'd) Goods versus Economic Goods
Goods are all things from which individuals derive satisfaction or happiness.
Economic goods are scarce goods, for which the quantity demanded exceeds the quantity supplied at zero price. 17

16. Scarcity (cont'd) Services Tasks that are performed for someone else
Can be referred to as intangible goods 18

17. Scarcity (cont'd) Recall
Scarcity occurs when the ingredients (resources) for producing things that people desire are insufficient to satisfy all wants. 19

18. Wants and Needs Needs Wants
To economists, the term need is not definable.
Wants
Goods and services on which we place a positive value
People have unlimited wants. 20

19. Scarcity, Choice, and Opportunity Cost
The highest-valued, next-best alternative that must be sacrificed to obtain something or to satisfy a want
The next-highest-ranked alternative, not all alternatives 21

20. Scarcity, Choice, and Opportunity Cost (cont'd)
Questions
What is the opportunity cost of attending this economics class?
What is the opportunity cost of attending a concert by your favorite band?
What is the opportunity cost of working out at the gym? 22

21. Scarcity, Choice, and Opportunity Cost (cont'd)
In economics, cost is always a forgone opportunity. 23

22. Example: The Opportunity Cost of 17 Minutes of Labor in the U.S.
During the economic downturn between 2007 and 2009, the length of the average workday decreased by 17 minutes.
The U.S. Labor Department determined that the average amount of time spent in watching TV rose by 12 minutes; the average amount of time spent sleeping rose by 5 minutes.
We can conclude that those additional 17 minutes of work in earlier years had imposed an opportunity cost of time spent TV viewing and sleeping. 23

23. The World of Trade-Offs
Whenever you engage in any activity, using any resource, you are trading off the use of that resource for one or more alternative uses
The value of the trade-off is represented by the opportunity cost, (that which you give up to obtain something else)
After the scarcity problem is analyzed, the problem of choice should be presented. Because of scarcity, that is wants are greater than the means to satisfy these wants (resources), people are forced to choose means of satisfying these wants. The concepts of opportunity cost, trade-offs, and the production possibilities curve are introduced. These concepts are often difficult for students to grasp. The production possibilities curve can be especially troublesome if actual numbers are not presented along with the graph. A successful method of presenting this model is to use a table of combinations of two goods and fully develop the model before introducing the graph. 26

24. The World of Trade-Offs (cont'd)
Graphical analysis of opportunity cost
The production possibilities curve (PPC) represents all possible combinations of maximum outputs that could be produced assuming a fixed amount of productive resources of a given quality 27

25. Figure 2-1 Production Possibilities Curve for Grades in Mathematics and Economics (Trade-Offs)

26. The World of Trade-Offs (cont'd)
The Production Possibilities Curve (PPC)
Trade-offs: What would happen if you are more interested in getting a higher grade in economics?
Holding constant total study time: What would happen to the PPC if you spent more time studying?
Straight-line PPC: Is it possible that the terms of the trade-off might not be constant? 29

27. The Choices Society Faces
PPC is used to demonstrate related concepts of scarcity, choice, and trade-offs
At the individual level
At the societal level

28. Figure 2-2: Society’s Trade-Off Between Tablet Devices and Smartphones, Panel (a)

29. Figure 2-2: Society’s Trade-Off Between Tablet Devices and Smartphones, Panel (b)

30. International Example: In China, More Factories Mean Fewer Roads – And More Traffic
Recently, a 62-mile section of highway in China became ensnarled in a traffic jam that took public safety officers nearly two weeks to break up.
Traffic experts agree that this stretch of highway is overburdened with more traffic than it was designed to handle.
China has allocated resources away from road construction in favor of building new manufacturing facilities.
So, China is producing more manufacturing output at the opportunity cost of better roads.

31. The Choices Society Faces (cont'd)
Production possibilities assumptions
Resources are fully employed
Production takes place over a specific time period
Resources are fixed for the time period
Technology does not change over the time period 30

32. The Choices Society Faces (cont'd)
Technology
Society’s pool of applied knowledge concerning how goods and services can be produced 31

33. What If … we try to increase output by diverting resources to “green” products?
Some government officials suggest that, if more resources are used to produce environmentally- safe products, overall production will increase.
But, with a fixed amount of resources and a given level of technology, production of other goods and services can only decrease if the output of “green” products is expanded.

34. The Choices Society Faces (cont'd)
Efficiency
Productive efficiency is producing the maximum output with given technology and resources
Alternatively, the situation in which a given output is produced at minimum cost 35

35. The Choices Society Faces (cont'd)
Inefficient Point
Any point below the production possibilities curve at which the use of resources is not generating the maximum possible output
Law of Increasing Additional Cost
As society attempts to produce more of a good, the opportunity cost of additional units of that good generally increases
Accounts for bowed shape of the PPC

36. Figure 2-3 The Law of Increasing Additional Cost

37. The Choices Society Faces (cont'd)
Resources are not perfectly adaptable for alternative uses
In general, the more specialized the resources, the more bowed the production possibilities curve 36

38. Economic Growth and the Production Possibilities Curve
Increases the production possibilities of smart phones and tablet devices
Over time, it is possible to have more of everything
Illustrated by an outward shift of the production possibilities curve 37

39. Figure 2-4: Economic Growth Allows for More of Everything

40. The Trade-Off Between the Present and the Future
The PPC can be used to illustrate the trade-off between present and future consumption
Consumption
The use of goods and services for personal satisfaction 39

41. Consumption Goods and Capital Goods: A Trade-Off
Consumer goods
Goods produced for personal satisfaction
Capital goods
Goods used to produce other goods

42. Figure 2-5 Capital Goods and Growth, Panel (a)

43. Figure 2-5 Capital Goods and Growth, Panel (b)

44. The Trade-Off Between the Present and the Future (cont’d)
Capital Goods and Growth: Observations
Forgo consumption goods to produce capital goods
Increase in capital goods stimulates economic growth 43

45. The Trade-Off Between the Present and the Future (cont’d)
Observations
An increase in capital goods at present will lead to a higher rate of economic growth in the future
In the future, the economic system can produce more consumer goods 44

46. Specialization and Greater Productivity
Organization of economic activity among different individuals and regions
Leads to greater productivity
After the tools for analyzing choice are developed, the chapter discusses specialization based on comparative advantage. The relationship between these two is essential to develop because it is the basis for exchange. A convincing case can be made on an intuitive level that if each person, region, and country specializes in producing those things that they can produce relatively most efficiently, then it is possible to increase output without increasing the total amount of resources. Then a more formal demonstration can be given. A result of specialization is that trade occurs because each economic unit ends up producing more of something than they want. In some cases, they produce something that they do not consume at all. Higher incomes and living standards result from specialization and trade based on comparative advantage. 45

47. Specialization and Greater Productivity (cont'd)
Comparative Advantage
The ability to produce a good or service at a lower opportunity cost
Is always a relative concept 47

48. Example: A Comparative Advantage in Watching Gift-Card Balances
Some individuals pay others to keep track of their gift-card balances.
A firm called Tango Card uses software to monitor gift-card balances and provide periodic reports to consumers.
Tango Card customers can save the time they would otherwise have devoted to this activity. 47

49. Specialization and Greater Productivity (cont'd)
Absolute Advantage
The ability to produce more units of a good or service using a given quantity of labor or resource inputs
Equivalently, the ability to produce the same quantity of a good or service using fewer units of labor or resource inputs 46

50. Specialization and Greater Productivity (cont'd)
Rational individuals choose their comparative advantage and then specialize
Specialization leads to division of labor
Adam Smith, in The Wealth of Nations, illustrated division of labor in pin making 46 50

51. Specialization and Greater Productivity (cont'd)
Division of Labor
The segregation of resources into different specific tasks
For example, in automobile production, one worker puts on bumpers, another work puts on doors, and so on

52. Comparative Advantage and Trade Among Nations
Analysis of absolute advantage, comparative advantage, and specialization is applicable to individuals, groups of people, or nations
As a result, interstate trade occurs in the United States and international trade occurs between nations

53. Comparative Advantage and Trade Among Nations (cont’d)
When nations specialize where they have a comparative advantage and then trade with the rest of the world
As economic efficiency improves
Output increases
Average standard of living rises

54. You Are There …The Opportunity Cost of Vacation Time in South Korea
The Korea Tourist Organization (KTO) serves to develop and promote vacation tours within the country.
Employees of the KTO allocate fewer days to vacations each year than does the average South Korean.
This can be explained by the fact that employees are rewarded with extra pay for unused vacation days.

55. Issues & Applications: The Rising Opportunity Cost of Airlines’ Block Times
Airlines are lengthening the block times published on their flight schedules.
Additional buffer times have been added, especially for longer flights.

56. Figure 2-6: Block-Time Buffers During One Month of U. S
Figure 2-6: Block-Time Buffers During One Month of U. S. Commercial Air Flights

57. Issues & Applications: The Rising Opportunity Cost of Airlines’ Block Times (cont’d)
Airlines have included additional minutes of block time as a means of having more flights classified as “on time”.
If flight times have actually increased, then there is an opportunity cost for all travelers.
This opportunity cost is the time that could have been devoted to other activities.

58. Summary Discussion of Learning Objectives
The problem of scarcity, even for the affluent
Scarcity and poverty are not synonymous
Why economists consider individuals’ wants but not their needs
Needs are not objectively definable
Wants are things on which we place a positive value

59. Summary Discussion of Learning Objectives (cont'd)
Why the scarcity problem leads people to evaluate opportunity costs
Allocating resources to producing one good means losing the opportunity to have another one
Why getting more units of one good requires giving up more and more of another
Resources are specialized

60. Summary Discussion of Learning Objectives (cont'd)
There is a trade-off between consumption goods and capital goods.
As more resources are devoted to the production of capital goods, we can expect the rate of economic growth to increase

61. Summary Discussion of Learning Objectives (cont'd)
Absolute versus comparative advantage
One finds one’s absolute advantage by producing more of a specific good than someone else who uses the same amount of resources
One finds one’s comparative advantage by looking at the activity that has the lowest opportunity cost