Chapter 3

1. Chapter 3 The Fundamental Economic Problem: Scarcity and Choice Our necessities are few but our wants are endless. INSCRIPTION ON A FORTUNE COOKIE

2. Scarcity, Choice, & Opportunity Cost • Resources; inputs; factors of production • Instruments provided by nature or people • Used - create goods & services • Land (Natural resources) • Minerals, soil, water, & air • Labor • Capital • Factories, machines • Made by people

3. Scarcity, Choice, & Opportunity Cost • Resources – scarce • People - have less resources • Than they would like • Choices • Must be made • Among - limited set of possibilities • Have more – one thing • Have less – something else

4. Scarcity, Choice, & Opportunity Cost • Labor – scarce • Time limitations • Number of skilled workers – limited • Economics – study • Use limited means • Pursue unlimited ends • Opportunity cost - any decision • Value of next best alternative - forgone

5. How much does it really cost? • Principle of opportunity cost economics • Options available • Households & businesses • Governments & entire societies • Given - limited resources • Logic of • How people can make optimal decisions • From among competing alternatives

6. 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

7. Scarcity, Choice, & Opportunity Cost • Market - functions well • Goods with high opportunity costs • Have high money costs • Goods with low opportunity costs • Have low money costs • Optimal decision • Best serves objectives of decision maker • Selected: explicit or implicit comparison • Possible alternative choices

8. 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

9. Scarcity and Choice for a Single Firm • One business firm • Fixed supply of inputs • Given technology • Produce two outputs • Produce more of one output • Produce less of the other

10. Table 1 Production possibilities open to a farmer

11. Scarcity and Choice for a Single Firm • Production possibilities frontier • Different combinations of various goods • Given • Available resources • Existing technology • Slopes downward to right • Points: on or inside • Attainable • Points: outside • Cannot be achieved

12. Figure 1 Production possibilities frontier for production by a single farmer Unattainable region Attainable region B E C D A 40 30 38 52 Soybeans 20 0 10 20 30 60 65 10 Wheat

13. Scarcity and Choice for a Single Firm • Production possibilities frontier • Bowed outward • Resources – 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

14. Figure 2 Production possibilities frontier with no specialized resources 50 40 B C D A 30 40 50 20 Black shoes 0 10 20 30 10 Brown shoes

15. 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

16. 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

17. Figure 3 Production possibilities frontier for the entire economy 500 700 600 Thousands of Automobiles per Year 400 C D E G F B 300 400 500 200 0 100 200 300 100 Missiles per Year

18. 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

19. 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

20. 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

21. 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

22. 1. Market - Efficient Resource Allocation • Division of labor • Break up a task • Smaller, more specialized tasks • Each worker – more adept at a particular job • 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

23. 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

24. 2.Market Exchange& How Much to Produce • Comparative advantage & division of labor • Greater productivity • Need system of exchange • Increased standards of living • Trade • Goods for other goods • Common item: money • Market • How much of each good to be produced

25. 3. How to Distribute Economy’s Outputs • Market system • Form of economic organization • Resource allocation decisions • Individual producers and consumers • Their own best interests • Without central direction • Society - many important goals • Produce goods and services • Maximum efficiency (minimum waste) • Markets - operate more or less freely