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INSCRIPTION ON A FORTUNE COOKIE
3 The Fundamental Economic Problem: Scarcity and Choice Our necessities are few but are wants are endless. INSCRIPTION ON A FORTUNE COOKIE
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Contents Scarcity, Choice, and Opportunity Cost
Scarcity and Choice for a Single Firm Scarcity and Choice for the Entire Society The Concept of Efficiency The Three Coordination Tasks of any Economy Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
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Contents (continued) Specialization Fosters Efficient Resource Allocation Specialization Leads to Exchange Markets, Prices, and the Three Coordination Tasks A Last Word: Don’t Confuse Ends with Means Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
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Scarcity, Choice and Opportunity Cost
Scarcity of resources necessity of choices Opportunity cost = value of the best forgone alternative True cost of a scarce resource
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Opportunity Cost and Money Cost
Opportunity cost: Closely related to money cost if markets are well functioning No explicit prices for some valuable resources, e.g., time Total cost = money cost + opportunity cost Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
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Opportunity Cost and Money Cost
Example of opportunity cost: a firm that produces two outputs with a fixed supply of inputs More of one output less of the other output Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
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Scarcity and Choice for a Single Firm
Production Possibilities Frontier Production possibilities frontier = a graph showing different combinations of output for a given amount of inputs More of one good less of another Illustrates opportunity costs in production
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TABLE 1 Production Possibilities Open to a Farmer
Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
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The Production Possibilities Frontier
Negatively sloped Slope = opportunity cost Illustrates the trade-off in the production of one good (or class of goods) against another Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
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FIGURE 1 PPF for Production by a Single Farmer
Unattainable region 40 Soybeans B 30 Attainable region C 20 D 10 E 10 20 30 38 52 60 65 Wheat Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
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The Principle of Increasing Costs
Shape: concave Principle of increasing costs: production of one good opportunity cost of producing another unit Reason: Inputs tend to be specialized. Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
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FIGURE 2 PPF with No Specialized Resources
50 A 40 B 30 Black Shoes C 20 D 10 10 20 30 40 50 Brown Shoes Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
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The Principle of Increasing Costs
Productivity constant along a production possibilities frontier. productivity shift of the frontier Skills Technology Capital stock Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
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Scarcity and Choice for the Entire Society
Resources are scarce for the entire society. Choices must be made: More of one good implies less of another. Production possibilities frontier applicable to the economy as a whole.
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FIGURE 3 PPF for Entire Economy
700 B 600 D 500 E 400 Thousands of Automobiles per Year 300 G F 200 100 C 100 200 300 400 500 Missiles per Year Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
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Scarcity and Choice for the Entire Society
Economic growth = increase in production of goods and services Trade-off between consumption goods and capital goods Investment in capital goods shifts out the production possibilities frontier.
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Growth in the United States and Asia
F Next year’s production possibilities N Next year’s production possibilities A f This year’s production possibilities Consumption Goods Consumption Goods This year’s production possibilities B Capital Goods Capital Goods (a) United States (b) Asia Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
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Scarcity and Choice Elsewhere in the Economy
Problems of scarcity and choice are everywhere in the economy. Households, firms, and government must decide how to allocate their income. Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
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The Concept of Efficiency
Efficiency = no waste All available resources are utilized. Sources of inefficiency Assigning inputs to the wrong task Unemployment Discrimination Competition should eliminate inefficiency.
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The Concept of Efficiency
Efficiency and the production possibilities frontier Every point on a production possibilities frontier is efficient. Efficiency does not tell us which point is best. Any point inside the frontier is inefficient.
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The Three Coordination Tasks of Any Economy
How to utilize its resources efficiently. What combination of goods and services to produce. How much of each good to distribute to each person.
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Specialization Fosters Efficient Resource Allocation
The Wonders of the Division of Labor Breaking a task into a set of smaller, more specialized tasks Specialization productivity growth
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Specialization Fosters Efficient Resource Allocation
The Amazing Principle of Comparative Advantage Principle of comparative advantage = specialization in the production of the good with the lowest opportunity cost Comparative advantage specialization
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Specialization Leads to Exchange
Specialization requires exchange Trading production because it permits specialization
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Markets, Prices, and the Three Coordination Tasks
Markets solutions to the three coordination tasks Consumers are in control Sometimes the solutions are compatible with society’s goals, other times not.
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Last Word: Don’t Confuse Ends with Means
Economic analysis judgment of capitalism Values ends Pragmatism means Economic analysis concerns means, not ends.
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