1. 2 Prepared by: Fernando Quijano and Yvonn Quijano © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair The Economic Problems: Scarcity and Choice

2. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair Topics to Discussed Scarcity, Choice, and Opportunity Cost Scarcity and Choice in an Economy Comparative Advantage and Trade Specialization and Comparative Advantage Capital Goods and Consumer Goods The Production Possibility Frontier Economic Growth & Economic Systems 2 of 44

3. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 3 of 44 Scarcity, Choice, and Opportunity Cost Human wants are unlimited, but resources are not. Three basic questions must be answered in order to understand an economic system: What gets produced? How is it produced? Who gets what is produced?

4. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 4 of 44 Scarcity, Choice, and Opportunity Cost Every society has some system or mechanism that transforms that society’s scarce resources into useful goods and services.

5. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 5 of 44 Scarcity, Choice, and Opportunity Cost Production is the process that transforms scarce resources into useful goods and services. Resources or factors of production are the inputs into the process of production; goods and services of value to households are the outputs of the process of production.

6. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 6 of 44 Scarcity, Choice, and Opportunity Cost The basic resources that are available to a society are factors of production: Land Labor Capital Capital refers to the things that are themselves produced and then used to produce other goods and services.

7. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 7 of 44 Scarcity and Choice in a One-Person Economy Nearly all the basic decisions that characterise complex economies must also be made in a single- person economy. Constrained choice and scarcity are the basic concepts that apply to every society.

8. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 8 of 44 Scarcity and Choice in a One-Person Economy Opportunity cost is that which we give up or forgo, when we make a decision or a choice.

9. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 9 of 44 Scarcity and Choice in an Economy of Two or More A producer has an absolute advantage over another in the production of a good or service if it can produce that product using fewer resources.

10. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 10 of 44 Scarcity and Choice in an Economy of Two or More A producer has a comparative advantage in the production of a good or service over another if it can produce that product at a lower opportunity cost.

11. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 11 of 44 Comparative Advantage and the Gains From Trade Colleen has an absolute advantage in the production of both wood and food because she can produce more of both goods using fewer resources than Bill. Daily Production Wood (logs) Food (bushels) Colleen10 Bill48

12. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 12 of 44 Comparative Advantage and the Gains From Trade In terms of wood: For Bill, the opportunity cost of 8 bushels of food is 4 logs. For Colleen, the opportunity cost of 8 bushels of food is 8 logs. In terms of food: For Colleen, the opportunity cost of 10 logs is 10 bushels of food. For Bill, the opportunity cost of 10 logs is 20 bushels of food. Daily Production Wood (logs) Food (bushels) Colleen10 Bill48

13. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 13 of 44 Specialization, Exchange and Comparative Advantage According to the theory of competitive advantage, specialization and free trade will benefit all trading parties, even those that may be absolutely more efficient producers.

14. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 14 of 44 Capital Goods and Consumer Goods Capital goods are goods used to produce other goods and services. Consumer goods are goods produced for present consumption.

15. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 15 of 44 Capital Goods and Consumer Goods Investment is the process of using resources to produce new capital. Capital is the accumulation of previous investment. The opportunity cost of every investment in capital is forgone present consumption.

16. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 16 of 44 The Production Possibility Frontier The production possibility frontier (ppf) is a graph that shows all of the combinations of goods and services that can be produced if all of society’s resources are used efficiently.

17. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 17 of 44 The Production Possibility Frontier The production possibility frontier curve has a negative slope, which indicates a trade-off between producing one good or another.

18. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 18 of 44 The Production Possibility Frontier Points inside of the curve are inefficient. At point H, resources are either unemployed, or are used inefficiently.

19. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 19 of 44 The Production Possibility Frontier Point F is desirable because it yields more of both goods, but it is not attainable given the amount of resources available in the economy.

20. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 20 of 44 The Production Possibility Frontier Point C is one of the possible combinations of goods produced when resources are fully and efficiently employed.

21. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 21 of 44 The Production Possibility Frontier A move along the curve illustrates the concept of opportunity cost. From point D, an increase the production of capital goods requires a decrease in the amount of consumer goods.

22. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 22 of 44 The Law of Increasing Opportunity Cost The slope of the ppf curve is also called the marginal rate of transformation (MRT). As we increase the production of one good, we sacrifice progressively more of the other.The negative slope of the ppf curve reflects the law of increasing opportunity cost. As we increase the production of one good, we sacrifice progressively more of the other.

23. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 23 of 44 Economic Growth Economic growth is an increase in the total output of the economy. It occurs when a society acquires new resources, or when it learns to produce more using existing resources. The main sources of economic growth are capital accumulation and technological advances.

24. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 24 of 44 Economic Growth An outward shift means that it is possible to increase the production of one good without decreasing the production of the other. Outward shifts of the curve represent economic growth.Outward shifts of the curve represent economic growth.

25. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 25 of 44 Economic Growth From point D, the economy can choose any combination of output between F and G.From point D, the economy can choose any combination of output between F and G.

26. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 26 of 44 Economic Growth Not every sector of the economy grows at the same rate. In this historic example, productivity increases were more dramatic for corn than for wheat over this time period.

27. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 27 of 44 Capital Goods and Growth in Poor and Rich Countries Rich countries devote more resources to capital production than poor countries. As more resources flow into capital production, the rate of economic growth in rich countries increases, and so does the gap between rich and poor countries.

28. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 28 of 44 Economic Growth and the Gains From Trade By specializing and engaging in trade, Colleen and Bill can move beyond their own production possibilities.

29. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 29 of 44 Economic Systems The economic problem: Given scarce resources, how, exactly, do large, complex societies go about answering the three basic economic questions?

30. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 30 of 44 Economic Systems Economic systems are the basic arrangements made by societies to solve the economic problem. They include: Command economies Laissez-faire economies Mixed systems

31. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 31 of 44 Economic Systems In a command economy, a central government either directly or indirectly sets output targets, incomes, and prices. In a laissez-faire economy, individuals and firms pursue their own self-interests without any central direction or regulation.

32. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 32 of 44 Economic Systems The central institution of a laissez- faire economy is the free-market system. A market is the institution through which buyers and sellers interact and engage in exchange.

33. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 33 of 44 Economic Systems Consumer sovereignty is the idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase).

34. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 34 of 44 Economic Systems Free enterprise: under a free market system, individual producers must figure out how to plan, organize, and coordinate the production of products and services.

35. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 35 of 44 Economic Systems In a laissez-faire economy, the distribution of output is also determined in a decentralized way. The amount that any one household gets depends on its income and wealth.

36. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 36 of 44 Economic Systems The basic coordinating mechanism in a free market system is price. Price is the amount that a product sells for per unit. It reflects what society is willing to pay.

37. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 37 of 44 Mixed Systems, Markets, and Governments Since markets are not perfect, governments intervene and often play a major role in the economy. Some of the goals of government are to: Minimize market inefficiencies Provide public goods Redistribute income Stabilize the macroeconomy: Promote low levels of unemployment Promote low levels of inflation

38. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 38 of 44 Review Terms and Concepts absolute advantage capital command economy comparative advantage, theory of consumer goods consumer sovereignty economic growth economic problem investment laissez-faire economy marginal rate of transformation (mrt) market opportunity cost outputs price production production possibility frontier (ppf) resources or inputs three basic questions

39. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair Assigment Week-2 Question # 1. Human wants are unlimited, but resources available to fulfill : a.but resources are not b.and neither does resources c.and so the respurces d.all are true e.all are false Question # 2. What gets produced? How is it produced? and Who gets what is produced? are : a.three un-important questions b.three fundamental questions c.three basic questions d.(b) and (c) are true e.All are false 39 of 44 Question # 3. The process that transforms scarce resources into useful goods and services, called : a.consumption b.production c.distribution d.transfortation e.transformation Question # 4. The basic resources that are available to a society are factors of production: a.Land b.Labor c.Capital d.All are true e.All are false

40. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair Assigment Week-2 Question # 5. Opportunity cost is best defined as : a.the money spent once a choice is made. b.the sum of all alternatives given up when a choice is made. c.the cost of a good, less profits. d.the highest valued alternative given up when a choice is made. e.the cost of capital resources used in the production of additional capital Question # 6. If a producer (country or region) can produce a product using fewer resources, it is call that the producer : a.has a comparative advantage b.has an absolut advantage c.competitive advantage d.has a resources advantage e.all are true 40 of 44 Question #7. If a producer (country or region) can produce a product using lower opportunity costs, it is call that the producer : a.has a comparative advantage b.has an absolut advantage c.competitive advantage d.has a resources advantage e.all are true Question # 8. Those goods that used to produce other goods and services, called : a.consumer goods and services b.capital goods and services c.productive goods and services d.investment goods and services e.all are true

41. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair Assigment Week-2 Question # 9. Those goods that produced for present consumption, called : a.consumer goods and services b.capital goods and services c.productive goods and services d.investment goods and services e.all are true Question # 10. A graph that shows all of the combinations of goods and services that can be produced if all of society’s resources are used efficiently, called : a.production possibility frontier b.consumption possibility frontier c.distribution possibility froniter d.transportation possibility frontier e.transformation possibility frontier 41 of 44 Question # 11. If a nation is operating at a point lying inside its production possibilities curve (at point H), that is a sign of which of the following conditions? a.The nation is not fully or efficiently utilizing its resources. b.The nation has likely just discovered a technological advance in one of its key industries. c.The nation is clarly utilizing its resources efficiently. d.The nation is producing the maximum output that can be produced with a limited quantity and quality of resources. e.The nation is producing the maximum output that can be produced with its unlimited quantity of resources.

42. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair Assigment Week-2 Question # 12. An economy that produces only bread and petroleum jelly, operating on a bowed-out PPC (or PPF), now discovers a new source of oil. Assume oil is an input only in the production of petroleum jelly. Which of the graphs in the figure below depicts the resulting shift of the PPC? a.Figure A b.Figure B c.Figure C d.Figures B and C are both possible e.None of these 42 of 44 Question # 13. Economic growth can be illustrated : a. by an inward shift of the production possibilities curve. b.by a downward movement along the production possibilities curve. c.by a movement toward the production possibilities curve. d.by an upward movement along the production possibilities curve. e.by an outward shift of the production possibilities curve. Question # 14. Marginal opportunity cost is defined to be : a.the declining ability of a country to correct its balance of trade deficit. b.always unchanging. c.always decreasing. d.less productive resources. e.the amount of one good or service that must be forgone to obtain an additional unit of another good.

43. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair Assigment Week-2 Question # 15. Given the differences in opportunity costs within individual countries, it makes sense for countries a.to force protectionism of the most important domestic industries, using tariffs and quotas. b.to devalue their currencies at least once a year. c.to specialize in activities in which opportunity costs are highest and then avoid trade in order to manage trade deficit. d.to insist upon protection against foreign competition through legislation. e.to specialize in activities in which opportunity costs are lowest and then trade. 43 of 44 Question # 16. When economists refer to the public sector, they refer to: a.the firms. b.the public universities. c.the political parties. d.the government. e.the households. Question # 17. In general, the purpose of markets is to a.provide a means for unrecorded payments. b.provide a forum for exchange of political benefits. c.provide a means for illegal transactions. d.facilitate the exchange of goods and services between buyers and sellers. e.facilitate the exchange of illegal commodities

44. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair Assigment Week-2 Question #18. Barter is trade : a.without the use of money. b.only with the use of money. c.within countries who are experiencing foreign currency exchange problems. d.only in underdeveloped countries. e.barter does not exist in modern economy 44 of 44 Question # 19. Consumer sovereignty refers to : a.the idea that the desires of both producers and the government ultimately decide what is produced. b.the idea that consumers try to maximize their expenditures. c.the idea that consumers ultimately determine what is produced. d.a situation in which the government decides what is produced. e.the fact that consumers' choices are limited to what the producers decide to produce. Question # 20. According to what we have learned, there are significant differences between the market system and the centrally planned system. All of the following are differences except : a.private individuals starting new businesses. b.private ownership of land. c.private ownership of businesses. d.the existence of a government. e.private choices and purchases of goods and services.