Chapter 2: The Economic Problem: Scarcity and Choice PDF

Chapter 2 The Economic Problem: Scarcity and Choice Prepared by:...

Chapter 2 The Economic Problem: Scarcity and Choice Prepared by: Fernando & Yvonn Quijano © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair  The Economic Problem: 2 CHAPTER 2: The Economic Problem: Scarcity and Choice Scarcity and Choice Chapter Outline Scarcity, Choice, and Opportunity Cost Scarcity and Choice in a One-Person Economy Scarcity and Choice in an Economy of Two or More The Production Possibility Frontier Comparative Advantage and the Gains from Trade The Economic Problem Economic Systems Command Economies Laissez-Faire Economies: The Free Market Mixed Systems, Markets, and Governments Looking Ahead © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 2 of 34  THE ECONOMIC PROBLEM: SCARCITY AND CHOICE CHAPTER 2: The Economic Problem: Scarcity and Choice FIGURE 2.1 The Three Basic Questions 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? © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 3 of 34  THE ECONOMIC PROBLEM: SCARCITY AND CHOICE CHAPTER 2: The Economic Problem: capital Things that are themselves Scarcity and Choice produced and that are then used in the production of other goods and services. factors of production (or factors) The inputs into the process of production. Another word for resources. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 4 of 34  THE ECONOMIC PROBLEM: SCARCITY AND CHOICE CHAPTER 2: The Economic Problem: production The process that Scarcity and Choice transforms scarce resources into useful goods and services. inputs or resources Anything provided by nature or previous generations that can be used directly or indirectly to satisfy human wants. outputs Usable products. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 5 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST SCARCITY AND CHOICE IN A CHAPTER 2: The Economic Problem: ONE-PERSON ECONOMY Scarcity and Choice Nearly all the same basic decisions that characterize complex economies must also be made in a simple economy. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 6 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST Opportunity Cost CHAPTER 2: The Economic Problem: Scarcity and Choice The concepts of constrained choice and scarcity are central to the discipline of economics. opportunity costs The best alternative that we give up, or forgo, when we make a choice or decision. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 7 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST SCARCITY AND CHOICE IN AN CHAPTER 2: The Economic Problem: ECONOMY OF TWO OR MORE Scarcity and Choice Education takes time. Time spent in the classroom has an opportunity cost. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 8 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST Specialization, Exchange, and Comparative CHAPTER 2: The Economic Problem: Advantage Scarcity and Choice theory of comparative advantage Ricardo’s theory that specialization and free trade will benefit all trading parties, even those that may be absolutely more efficient producers. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 9 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST CHAPTER 2: The Economic Problem: absolute advantage A producer has an Scarcity and Choice absolute advantage over another in the production of a good or service if it can produce that product using fewer resources. comparative advantage A producer has a comparative advantage over another in the production of a good or service if it can produce that product at a lower opportunity cost. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 10 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST CHAPTER 2: The Economic Problem: Scarcity and Choice FIGURE 2.2 Comparative Advantage and the Gains from Trade © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 11 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST Weighing Present and Expected Future Costs CHAPTER 2: The Economic Problem: and Benefits Scarcity and Choice We trade off present and future benefits in small ways all the time. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 12 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST Capital Goods and Consumer Goods CHAPTER 2: The Economic Problem: Scarcity and Choice consumer goods Goods produced for present consumption. investment The process of using resources to produce new capital. Because resources are scarce, the opportunity cost of every investment in capital is forgone present consumption. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 13 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST THE PRODUCTION POSSIBILITY FRONTIER CHAPTER 2: The Economic Problem: Scarcity and Choice production possibility frontier (ppf) A graph that shows all the combinations of goods and services that can be produced if all of society’s resources are used efficiently. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 14 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST CHAPTER 2: The Economic Problem: Scarcity and Choice FIGURE 2.3 Production Possibility Frontier © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 15 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST Unemployment CHAPTER 2: The Economic Problem: Scarcity and Choice During economic downturns or recessions, industrial plants run at less than their total capacity. When there is unemployment of labor and capital, we are not producing all that we can. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 16 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST Inefficiency CHAPTER 2: The Economic Problem: Scarcity and Choice Waste and mismanagement are the results of a firm’s operating below its potential. Sometimes, inefficiency results from mismanagement of the economy instead of mismanagement of individual private firms. The Efficient Mix of Output To be efficient, an economy must produce what people want. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 17 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST Negative Slope and Opportunity Cost CHAPTER 2: The Economic Problem: Scarcity and Choice marginal rate of transformation (MRT) The slope of the production possibility frontier (ppf). FIGURE 2.4 Inefficiency from Misallocation of Land in Farming © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 18 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST The Law of Increasing Opportunity Cost CHAPTER 2: The Economic Problem: Scarcity and Choice TABLE 2.1 Production Possibility Schedule for Total Corn and Wheat Production in Ohio and Kansas TOTAL TOTAL CORN WHEAT PRODUCTION PRODUCTION POINT (MILLIONS OF (MILLIONS OF ON BUSHELS PER BUSHELS PER PPF YEAR) YEAR) A 700 100 B 650 200 C 510 380 D 400 500 E 300 550 FIGURE 2.5 Corn and Wheat Production in Ohio and Kansas © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 19 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST Economic Growth CHAPTER 2: The Economic Problem: Scarcity and Choice economic growth An increase in the total output of an economy. It occurs when a society acquires new resources or when it learns to produce more using existing resources. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 20 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST CHAPTER 2: The Economic Problem: Scarcity and Choice TABLE 2.2 Increasing Productivity in Corn and Wheat Production in the United States, 1935–2006 CORN WHEAT Yield Per Acre Labor Hours Per Yield Per Acre Labor Hours (Bushels) 100 Bushels (Bushels) Per 100 Bushels 1935–1939 26.1 108 13.2 67 1945–1949 36.1 53 16.9 34 1955–1959 48.7 20 22.3 17 1965–1969 78.5 7 27.5 11 1975–1979 96.3 4 31.3 9 1981–1985 107.2 3 36.9 7 1985–1990 112.8 NAa 38.0 NAa 1990–1995 120.6 NAa 38.1 NAa 1998 134.4 NAa 43.2 NAa 2001 138.2 NAa 43.5 NAa 2006 145.6 NAa 42.3 NAa © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 21 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST CHAPTER 2: The Economic Problem: Scarcity and Choice FIGURE 2.6 Economic Growth Shifts the ppf Up and to the Right © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 22 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST Sources of Growth and the Dilemma of the CHAPTER 2: The Economic Problem: Poor Countries Scarcity and Choice FIGURE 2.7 Capital Goods and Growth in Poor and Rich Countries © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 23 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST COMPARATIVE ADVANTAGE AND THE CHAPTER 2: The Economic Problem: GAINS FROM TRADE Scarcity and Choice FIGURE 2.8 Production Possibility Frontiers with No Trade © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 24 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST CHAPTER 2: The Economic Problem: Scarcity and Choice FIGURE 2.9 Colleen and Bill Gain from Trade Although it exists only as an abstraction, the ppf illustrates a number of very important concepts that we shall use throughout the rest of this book: scarcity, unemployment, inefficiency, opportunity cost, the law of increasing opportunity cost, economic growth, and the gains from trade. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 25 of 34  SCARCITY, CHOICE, AND OPPORTUNITY COST THE ECONOMIC PROBLEM CHAPTER 2: The Economic Problem: Scarcity and Choice Recall the three basic questions facing all economic systems: (1) What gets produced? (2) How is it produced? (3) Who gets it? Given scarce resources, how exactly do large, complex societies go about answering the three basic economic questions? © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 26 of 34  ECONOMIC SYSTEMS COMMAND ECONOMIES CHAPTER 2: The Economic Problem: Scarcity and Choice command economy An economy in which a central government either directly or indirectly sets output targets, incomes, and prices. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 27 of 34  ECONOMIC SYSTEMS LAISSEZ-FAIRE ECONOMIES: THE FREE CHAPTER 2: The Economic Problem: MARKET Scarcity and Choice laissez-faire economy Literally from the French: “allow [them] to do.” An economy in which individual people and firms pursue their own self-interests without any central direction or regulation. market The institution through which buyers and sellers interact and engage in exchange. Some markets are simple and others are complex, but they all involve buyers and sellers engaging in exchange. The behavior of buyers and sellers in a laissez-faire economy determines what gets produced, how it is produced, and who gets it. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 28 of 34  ECONOMIC SYSTEMS Consumer Sovereignty CHAPTER 2: The Economic Problem: Scarcity and Choice consumer sovereignty The idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase). © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 29 of 34  ECONOMIC SYSTEMS Individual Production Decisions: Free CHAPTER 2: The Economic Problem: Enterprise Scarcity and Choice free enterprise The freedom of individuals to start and operate private businesses in search of profits. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 30 of 34  ECONOMIC SYSTEMS Distribution of Output CHAPTER 2: The Economic Problem: Scarcity and Choice The amount that any one household gets depends on its income and wealth. Income is the amount that a household earns each year. It comes in a number of forms: wages, salaries, interest, and the like. Wealth is the amount that households have accumulated out of past income through saving or inheritance. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 31 of 34  ECONOMIC SYSTEMS Price Theory CHAPTER 2: The Economic Problem: Scarcity and Choice New businesses arise each day and some go out of business in response to profit opportunities and losses. In a free market system, the basic economic questions are answered without the help of a central government plan or directives. This is what the “free” in free market means— the system is left to operate on its own, with no outside interference. Individuals pursuing their own self-interest will go into business and produce the products and services that people want. Others will decide whether to acquire skills; whether to work; and whether to buy, sell, invest, or save the income that they earn. The basic coordinating mechanism is price. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 32 of 34  ECONOMIC SYSTEMS MIXED SYSTEMS, MARKETS, AND CHAPTER 2: The Economic Problem: GOVERNMENTS Scarcity and Choice The differences between command economies and laissez-faire economies in their pure forms are enormous. In fact, these pure forms do not exist in the world; all real systems are in some sense “mixed.” Even staunch defenders of the free enterprise system recognize that market systems are not perfect. First, they do not always produce what people want at lowest cost—there are inefficiencies. Second, rewards (income) may be unfairly distributed, and some groups may be left out. Third, periods of unemployment and inflation recur with some regularity. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 33 of 34  REVIEW TERMS AND CONCEPTS CHAPTER 2: The Economic Problem: absolute advantage investments Scarcity and Choice capital laissez-faire economy command economy marginal rate of transformation comparative advantage (MRT) consumer goods market consumer sovereignty opportunity cost economic growth outputs factors of production (or production factors) production possibility frontier (ppf) free enterprise theory of comparative advantage inputs or resources © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 34 of 34