Scarcity, Choice, and Opportunity Cost

Topic 1: Basic Economic Ideas and Resource Allocation

Scarcity, Choice, and Opportunity Cost

• Scarcity is the fundamental economic problem; wants are unlimited, yet resources are finite.
• Optimal distribution and use of resources are essential due to scarcity.
• Limited resources necessitate choices between alternatives.
• If you have £1, one must choose between buying a chocolate bar or crisps due to monetary scarcity.
• Opportunity cost arises when a decision is made; it is the value of the next best alternative that is foregone.
• Selecting crisps over a chocolate bar means the chocolate bar's value is the opportunity cost.
• If a car bought for £15,000 depreciates by £5,000 after 5 years, the opportunity cost of keeping it is £5,000.
• Economic agents like consumers, producers, and governments face opportunity costs.
• Producers must choose between new staff or new machines.
• Governments need to decide between NHS and education spending.
• Production considerations involve answering key questions.
• Producers need to consider What to produce: determined by consumer preference via 'spending votes'.
• How to produce it: influenced by producers aiming to minimize costs and maximize profits.
• For whom to produce it: dictated by the purchasing power within the economy.
• Other factors like consumer confidence affect savings rates.
• Ceteris paribus is a crucial assumption in economics, meaning all other factors are constant or equal during analysis.
• Estimating the impact of interest rate changes relies on the ceteris paribus assumption.

The Margin and Decision Making at the Margin

• "Thinking at the margin" involves weighing the implications of the next step or action for a consumer.
• Economic theory suggests that each additional unit of a good or service brings diminishing marginal returns.
• Every decision involves considering additional costs and benefits. The option with the highest marginal benefit is favored.
• Decisions "at the margin" involve small resource adjustments, like deciding how to spend an extra hour.
• Marginal analysis simplifies decisions and promotes optimal choices.

Short Run, Long Run, Very Long Run

• In the short run, at least one production factor is fixed, limiting the response to price fluctuations.
• In the long run, all production factors are variable, allowing firms to expand capacity.
• In the very long run, all production factors and external inputs like government rules and technology are variable.

Positive and Normative Statements

• Differentiating between facts and opinions is critical.
• Positive statements are objective, testable with factual evidence, and can be accepted or rejected.
• Keywords include "will" and "is".
• "Raising the tax on alcohol will lead to a fall in the demand of alcohol and a fall in the profits of pub landlords" is a positive statement.
• The testability of these statements allows for rejection/acceptance.
• Normative statements are subjective, based on value judgements rather than facts.
• Keywords include "should".
• "The free market is the best way to allocate resources" is a normative statement.
• Value judgements impact economic decisions and policies. Differing conclusions can arise from the same data.

Factors of Production

• Economic resources encompass land, labor, capital, and enterprise.
• Capital: Physical goods used in production (machines, buildings, etc.) generate interest.
• Entrepreneurship: Managerial skills involving risk and innovation yields profit.
• Land: Natural resources like oil and physical space generate rent.
• Labour: Human capital contributes wages.

Specialisation and Division of Labour

• Specialization is where workers execute tasks in a production process.
• Adam Smith articulated increased worker productivity via division of labor.
• Specialization leads to higher efficiency and cost reduction for firms.
• Smith noted dividing pin production into 18 tasks lead to massive increase output.
• Output increases as each worker specializes.
• Specialization occurs across individuals, businesses, regions, or countries.

Advantages of Specialization

• Output and potentially higher quality increases due to focused production.
• Wider variety of goods and services may be available.
• Increased opportunities for economies of scale expand the market size.
• Greater competition inspires firms to cut costs, thus lowering prices.

Disadvantages of Specialization

• Repetitive work may decrease worker motivation, impacting quality and productivity.
• Workers might become dissatisfied.
• Structural unemployment may rise due to limited skill transferability from focused tasks.
• Variety of goods may decrease.
• Employee dissatisfaction can lead to high worker turnover.

Resource Allocation in Different Economic Systems and Issues of Transition

Free Market Economies

• In laissez-faire economies, scarce resources are allocated by supply and demand, with minimal government intervention.
• Decisions are made by firms and private individuals, who own everything.
• Governments intervene with laws and public services.
• Adam Smith and Friedrich Hayek were proponents of free markets.
• Smith's "invisible hand" and the price mechanism reflect consumer and business spending votes.
• Hayek argued intervention worsens markets, citing the Fed's low rates after the 1930s crash causing 'malinvestments'.
• Producers seek profits on what consumers want.
• Greater purchasing power dictates the goods.
• Efficiency rises as firms meet demand and minimize costs.
• Output of the economy increases.
• Government bureaucracy is avoided.
• Possible increased personal freedom.

Disadvantages of Free Market Economies

• Inequality can increase due to wealth benefiting the wealthy.
• No social security for those with low incomes is available.
• Exploitative monopolies may arise.
• Overconsumption of harmful goods (ex: tobacco) with negative consequences can occur.
• Public goods and merit goods are underprovided.

Planned Economy

• Central planning involves government allocation of resources based on perceived needs.
• Karl Marx viewed free markets as unstable, citing exploitation.
• Marx supported common ownership of production.
• Government dictates production and employees.
• Advantages include coordination in crises.
• Government reallocation can address market failure and allocate basic resources.
• Potential reduced inequality and maximized welfare.
• Monopoly abuse prevention.

Disadvantages of Planned Economy

• Governments may lack sufficient knowledge.
• There may be a failure to satisfy meet consumer preferences.
• Democracy and freedom can be limited.

Mixed Economy

• Today it is the most common economic system, blending free and planned features.
• Despite variations, the UK leans central, the US is more free, and Cuba is centrally planned.
• Government and market forces regulate the market.
• Governments provide public and merit goods(roads, police, healthcare, etc).
• Production relies on consumer, government, and producer profits.
• A mix of government priorities and purchasing power determine access.

Role of the Factor Enterprise in a Modern Economy

• The role of the entrepreneur is in a market.
• Entrepreneurs stimulate innovation and are rewarded with profits for bearing risks.
• Governments encourage enterprise through firm incentives.
• Enterprise fosters wealth and jobs.

Production Possibility Curves

• Production Possibility Frontiers (PPFs) displays maximum productive potential using two goods/services, with full resource employment.
• Scare resources can be shown on PPF curves.
• A trade-off exits between milk and yogurt, or cheese.

Understanding the diagram

• Points A and B show efficient point on graph for the maximum cheese and yoghurt.

• More yoghurt than cheese at point B costs an opportunity for more cheese.

• The law of diminishing returns results for more yoghurt produced, since the opportunity costs means cheese production lowers.

• Points C or D shows that resources are poorly managed.

• Production gets closer to the curve.

• Unemployment of resources is at these points.

• Point E means that resources are not being attainable.

• Producing cheese at 100 results to yoghurt produced at 40 instead of 90

• 90-40 = 50 units of yoghurt for producing cheese.

Economic Growth and Decline

• Economic growth and decline can be depicted on the PPF.
• Production occurs within the PPF.
• The PPF is used at point A and point B.
• It is not efficient to produce below the PPF (point C).

Diagram curves and assumptions

• There must be a fixed use of resources.
• There is a constant state of technology.
• The PPF curve is shifted outwards if there is technology or a number in resources.
• This is achieved with the of supply side policies.
• Moving along PPF curve is to shift with numerous state resource and shifts production.
• This indicates it is costly, such that there are no higher resources.
• Reducing costs by producing capital resources.

Opportunity Costs

• The PPF is constant when straight due to the one good the other will not change.
• Resource cannot apply.
• The PPF must increase to show opportunity.
• Producing more of Good B leads to a higher loss of Good A.

Classification of Goods and Services

Public Goods

• Public goods are not supplied in the free market, yet benefit society (ex: street lights).
• They are non-excludable and non-rival.
• The "free-rider problem" arises from non-excludability, leading to under-provision by the private sector since profits are unassured.
• Valuation challenges also contribute to under-provision.

Private Goods

• Private goods are rival and excludable (ex: chocolate bar).
• Private property rights prevent others from consuming the good.
• Economic goods are scarce with opportunity costs. They possess value to consumers.

Free Goods

• With free goods, there is no scarcity.
• Free goods include air and water.
• These are not traded because they are readily available.

Merit and Demerit Goods

• Demerit goods, such as cigarettes and alcohol, relate to negative externalities that are caused by failure of the consumer to be aware.
• Demerit goods may be the overprovivded.
• Merit goods relate to positive externalities, with information failure being the cause, in the case consumers underestimate the long term benefits, such as education or healthcare. These goods may be underprovivded.