1. Scarcity, Choice, and Economic Systems
Chapter 2
Scarcity, Choice, and
Economic Systems
ECONOMICS: Principles and Applications, 4e
HALL & LIEBERMAN, © 2008 Thomson South-Western

2. The Concept of Opportunity Cost
Opportunity cost of any choice
What we must forego when we make that choice
Accurate and complete concept of cost
Used when making or analyzing decisions
Everything you actually sacrifice in making the choice

3. Opportunity Cost for Individuals
The opportunity cost of a choice includes
Explicit cost
The dollars sacrificed - and actually paid out for a choice
Implicit cost
The value of something sacrificed when no direct payment is made
Arises from the scarcity of time or money
Time is money

4. Opportunity Cost and Society
Arises from the scarcity of society’s resources
Our desire for goods is limitless
Limited resources to produce them
To produce more of one thing
Society must shift resources away from producing something else

5. Production Possibilities Frontiers
Production Possibilities Frontier (PPF)
A curve showing all combinations of two goods that can be produced with the resources and technology available
Points outside the PPF
Unattainable
Points on or inside the PPF
Attainable

6. Production Possibilities Frontiers
Figure 2 The Production Possibilities Frontier
Number of Tanks per Year
Bushels of Wheat
per Year
100,000
200,000
300,000
400,000
500,000
1,000,000
950,000
850,000
700,000
all resources are
used for wheat
Moving from point A to point B
requires shifting resources out
of wheat and into tanks A B C D W E
all resources are
used for tanks F

7. Increasing Opportunity Cost
The law of increasing opportunity cost
The more of something we produce, the greater the opportunity cost of producing even more of it
Explains
The concave (upside-down bowl) shape of the PPF
Why the PPF becomes steeper as we move rightward and downward

8. The Search for a Free Lunch
There is no such thing as a free lunch
Operating inside the PPF:
Productive inefficiency
Recession
All resources are being used, but not in the most productive way
Increase production of one good without decreasing production of the other good

9. Recessions A slowdown in overall economic activity
Many resources are idle
Widespread unemployment
Factories shut down
Land and capital are not being used
Ending a recession
Move the economy from a point inside its PPF to a point on its PPF

10. Recessions United States in early 1940s
Entered WW II still suffering from the Great Depression
Used massive amounts of resources to produce military goods and services
The standard of living in U.S. improved slightly
Joining the war effort helped end the Depression

11. Recessions Figure 3 Production and Unemployment
1. Before WWII the United States
operated inside its PPF
Civilian Goods per Period
Military Goods per Period
2. then moved to the PPF
during the war.
Both military and civilian
production increased B A

12. Economic Growth Produce more of everything
Increase the economy’s productive capacity
Factors contributing to economic growth
Increase in the quantities of available resources
Physical capital
Human capital
Technological change

13. Economic Growth Figure 4 Economic Growth and the PPF (a) Wheat
(bushels per year)
Additional resources or technological advance affect only the wheat production A’
1,200,000 H A
1,000,000 J
700,000 D F
3,000
5,000
Tanks
per Year

14. Economic Growth Figure 4 Economic Growth and the PPF (b) Wheat
(bushels per year)
1,200,000 A
1,000,000
Additional resources or technological advance affect only the tank production D
5,000
6,000
Tanks
per Year

15. Economic Growth Figure 4 Economic Growth and the PPF (c) Wheat
(bushels per year)
Additional resources or technological advance affect the production of both goods
1,200,000
1,000,000 D
5,000
6,000
Tanks
per Year

16. Consumption versus Growth
Capital is
a resource - produce goods and services
a good - needs resources to be produced
Technological change
Needs resources – used in (R&D)
The tradeoff: Resources
Used to produce capital (R&D) this year
not being used to produce consumer goods

17. Economic Growth
Figure 5 How Current Production Affects Economic Growth
(a) High Consumption, Low Growth
(b) Low Consumption, High Growth
Consumer Goods
(units per year)
Consumer Goods
(units per year)
This year’s PPF
This year’s PPF
Next year’s
PPF
Next year’s PPF A A’
Capital Goods
(units per year)
Capital Goods
(units per year)

18. Economic Systems Economic system Specialization Exchange
The way our economy is organized
Specialization
Each person specializes in a limited number of activities
Exchange
Trading with others to obtain what we want

19. Specialization and Exchange
Greater production
Higher standards of living
All economies - high degrees of specialization and exchange
Human capabilities
Time needed to switch from one activity to another
Individual differences
Comparative advantage

20. Further Gains to Specialization
Absolute Advantage
Produce a good or service using fewer resources
Comparative Advantage
Produce a good or service at a lower opportunity cost
Specialization
Individuals should specialize according to their comparative advantage

21. Resource Allocation
Which goods and services should be produced with society’s resources?
Where on the PPF should the economy operate
How should they be produced?
Combination of capital with labor
Who should get them?
Distribution of the goods and services produced

22. Methods of Resources Allocation
Traditional Economy
Long-lived practices from the past
Command Economy (Centrally-Planned)
Explicit instructions from a central authority
Market Economy
Individual decision making

23. The Nature of Markets Market Global markets Local markets
Buyers and sellers with the potential to trade
Global markets
Buyers and sellers - spread across the globe
Local markets
Buyers and sellers - within a narrowly defined area

24. The Importance of Prices
the amount of money that must be paid to a seller for a good, service, or resource
Markets
create a sensible allocation of resources

25. Resource Allocation in the US
Market economy – the traders determine
The goods that are traded
The way they are traded
The price at which they trade
Traditional economy - Families
Command economy - The government
Market economy
dominant method of resource allocation in United States
Not a pure market economy

26. Resource Ownership Communism Socialism Capitalism
Most resources are owned in common
Socialism
Most resources are owned by state
Capitalism
Most resources are owned privately

27. Types of Economic Systems
System of resource allocation and resource ownership
Resource allocation
Market
Command
Resource ownership
Private
State

28. Types of Economic Systems
Figure 6 Types of Economic Systems
Resource Allocation
Market
Command
Private
State
Resource Ownership
Market Capitalism
Centrally Planned Capitalism
Centrally Planned Socialism
Market Socialism

29. Understanding the Market
The market is
the most simple way to allocate resources
Individual buyers and sellers
the most complex way to allocate resources
Economists

30. Are We Saving Lives Efficiently?
Saving a life requires use of resources
Resources sell at a price
Some methods of lifesaving are highly cost effective
Productive inefficiency also exists in lifesaving
Allocating lifesaving resources efficiently
Benefits of lifesaving efforts - not fully captured by “life-years saved”
Uncertainty

31. Are We Saving Lives Efficiently?
Figure 7 Efficiency and Inefficiency in Saving Lives
Quantity of
All Other Goods
per Year
inefficient
efficient
Eliminating inefficiency:
save more lives; have more of other goods; or both B A
Number of Lives Saved
per Year