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Published byClement McLaughlin Modified over 9 years ago
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The Fundamental Economic Problem: Scarcity and Choice
Chapter 3 The Fundamental Economic Problem: Scarcity and Choice Our necessities are few but our wants are endless. INSCRIPTION ON A FORTUNE COOKIE
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Scarcity, Choice, & Opportunity Cost
Resources are scarce People have less resources than they would like Choices Must be made among limited set of possibilities Have more one thing means have less something else (trade-off) 2
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Scarcity, Choice, & Opportunity Cost
Labor – scarce Time limitations Number of skilled workers – limited Economics – study Use limited means to pursue unlimited ends Opportunity cost of any decision Value of next best alternative - forgone 3
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How much does it really cost?
Principle of opportunity cost economics Options available Households & businesses Governments & entire societies Given - limited resources Study logic of How people can make optimal decisions From among competing alternatives 4
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How much does it really cost?
With limited resources Decision - have more of one thing Have less of something else Relevant cost of any decision Opportunity cost Value of next best alternative - given up Optimal decision making Based on opportunity-cost calculations 5
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Opportunity Cost and Money Cost
Market - functions well Goods with high opportunity costs have high money costs Goods with low opportunity costs have low money costs Might not be identical: Forgone wage of college education Optimal decision Best serves objectives of decision maker Selected by explicit or implicit comparison with possible alternative choices 6
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Scarcity and Choice for a Single Firm
Outputs – produced by firm or economy Goods & services it produces Inputs - used by firm or economy Labor, raw materials, electricity, other resources To produce outputs 7
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Scarcity and Choice for a Single Firm
Example: One business firm – Farmer Fixed supply of inputs Given technology Produce two outputs Produce more of one output Produce less of the other 8
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Table 1 Production possibilities open to a farmer Bushels of Soybeans
Bushels of Wheat Label in Figure 1 40,000 30,000 20,000 10,000 38,000 52,000 60,000 65,000 A B C D E 9
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Scarcity and Choice for a Single Firm
Production possibilities frontier (PPF) Different combinations of various goods Given Available resources Existing technology Slopes downward to right (Why?) Points: on or inside Attainable Points: outside Cannot be achieved 10
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Figure 1 Production possibilities frontier for production by a single farmer 10 20 Soybeans 30 40 A Unattainable region B 38 Attainable region C 52 D E 10 20 30 Wheat 60 65 11
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Scarcity and Choice for a Single Firm
Production possibilities frontier Bowed outward Resources (inputs) – specialized Slope of production possibilities frontier Opportunity cost Principle of increasing costs As production of a good expands Opportunity cost of producing another unit Generally increases 12
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Figure 2 Production possibilities frontier with no specialized resources 10 20 Black shoes 30 40 50 A B C D 10 20 30 Brown shoes 40 50 13
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Scarcity and Choice for a Single Firm
Concentrate more of productive capacity On one commodity Employ inputs Better suited to making another commodity Vary proportions of inputs Limited quantities of some inputs Bowed outward Production possibilities frontier 14
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Scarcity and Choice for Entire Society
Economy – constrained by Resources Technology Production possibilities frontier – society Position & shape Determined by economy’s Physical resources, skills, technology Willingness to work Past: construction of factories, research, & innovation 15
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Scarcity and Choice for Entire Society
Production possibilities frontier Civilian consumption (automobiles) Military strength (missiles) Downward slope - Choices Increase civilian consumption Decreasing military expenditure Bowed outward As defense spending increases More expensive - “buy missiles” Sacrifice civilian consumption 16
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Figure 3 Production possibilities frontier for the entire economy 100
200 Thousands of Automobiles per Year 300 400 500 600 700 B D E G F C 100 200 300 Missiles per Year 400 500 17
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The Concept of Efficiency
Efficiently produced output Given current technology Cannot increase output production Without increasing amount of inputs Or giving up a quantity of other output Efficiency = absence of waste Efficient economy Wastes none of available resources Produces maximum amount of output Given technology 18
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Three Coordination Tasks - Any Economy
Allocation of resources Society’s decisions Divide scarce input resources Among different outputs produced Among different firms / organizations Produce outputs 19
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Three Coordination Tasks - Any Economy
How to utilize resources efficiently Reach production possibilities frontier What Which combination of goods to produce Select one point on production possibilities frontier To whom? Total output - distributed to each person 20
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1. Market - Efficient Resource Allocation
Division of labor Break up a task Smaller, more specialized tasks Each worker – more adept at a particular job Example: Adam Smith’s pin factory Law of comparative advantage One country - production of particular good Relative to other goods If it produces that good less inefficiently Than it produces other goods Compared with other country 21
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Adam Smith’s Pin Factory
”One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head: to make the head requires two or three distinct operations: to put it on is a particular business, to whiten the pins is another ... and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which in some manufactories are all performed by distinct hands, though in others the same man will sometime perform two or three of them.”
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Principle of comparative advantage
Determine most efficient Patterns of production and trade Comparative advantage – matters Country - gain by importing a good Even if - produced more efficiently at home Enable country – specialize Produce goods – more efficient Less efficient country – specialize Export goods – least inefficient 23
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2.Market Exchange& How Much to Produce
Comparative advantage & division of labor Creates greater productivity Need system of exchange to increase standards of living Trade Goods for other goods Common item: money Market decides How much of each good to be produced More pin produced than consumed, price down, firms produce less 24
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3. How to Distribute Economy’s Outputs
Market system Form of economic organization Resource allocation decisions Made by Individual producers and consumers Based on their own best interests Without central direction Example 1: Vegetarians would not spend money on beef in Safeway Example 2: demand for Hawaiian pineapples in Vermont ↑ → more pineapples in Vermont supermarkets 25
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Summary Opportunity cost PPF: single firm vs. society Three tasks
How (Production) Which (Exchange) To Whom (Distribution)
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