Transcript Chapter 2: The Economic Problem: Scarcity and Choice

CHAPTER
2
The Economic Problems:
Scarcity and Choice
Prepared by: Fernando Quijano
and Yvonn Quijano
© 2004 Prentice Hall Business Publishing
Principles of Economics, 7/e
Karl Case, Ray Fair
C H A P T E R 2: The Economic Problem: Scarcity and Choice
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
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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?
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
Scarcity, Choice, and Opportunity Cost
• Every society has some system or mechanism
that transforms that society’s scarce resources
into useful goods and services.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
Scarcity and Choice
in a One-Person Economy
• Nearly all the basic decisions that
characterise complex economies
must also be made in a singleperson economy.
• Constrained choice and
scarcity are the basic concepts
that apply to every society.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
Comparative Advantage
and the Gains From Trade
Daily Production
Colleen
Bill
Wood
(logs)
Food
(bushels)
10
4
10
8
• 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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
Comparative Advantage
and the Gains From Trade
Daily Production
Colleen
Bill
Wood
(logs)
Food
(bushels)
10
4
10
8
• 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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
Capital Goods and Consumer Goods
• Capital goods are goods used to
produce other goods and
services.
• Consumer goods are goods
produced for present
consumption.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
The Production Possibility Frontier
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• The production
possibility frontier
curve has a negative
slope, which indicates
a trade-off between
producing one good or
another.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
The Production Possibility Frontier
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• Points inside of the
curve are inefficient.
• At point H, resources
are either unemployed,
or are used inefficiently.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
The Production Possibility Frontier
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• 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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
The Production Possibility Frontier
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• Point C is one of the
possible combinations
of goods produced
when resources are
fully and efficiently
employed.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
The Production Possibility Frontier
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• 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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
The Law of Increasing Opportunity Cost
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• The slope of the ppf curve
is also called the marginal
rate of transformation
(MRT).
• 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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
Economic Growth
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• Outward shifts of the
curve represent
economic growth.
• An outward shift
means that it is
possible to increase
the production of one
good without
decreasing the
production of the other.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
Economic Growth
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• From point D, the
economy can
choose any
combination of
output between F
and G.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
Economic Growth
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• 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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
Capital Goods and Growth
in Poor and Rich Countries
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•
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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
Economic Growth
and the Gains From Trade
• By specializing and engaging in trade,
Colleen and Bill can move beyond their
own production possibilities.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
Economic Systems
• The economic problem:
Given scarce resources,
how, exactly, do large,
complex societies go about
answering the three basic
economic questions?
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
Economic Systems
• The central institution of a laissezfaire economy is the free-market
system.
• A market is the institution through
which buyers and sellers interact
and engage in exchange.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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).
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
Review Terms and Concepts
absolute advantage
laissez-faire economy
capital
marginal rate of transformation (mrt)
command economy
market
comparative advantage,
theory of
opportunity cost
consumer goods
consumer sovereignty
economic growth
economic problem
investment
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outputs
price
production
production possibility frontier (ppf)
resources or inputs
three basic questions
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
Assigment Week-2
Question # 1. Human wants are unlimited, but
resources available to fulfill :
a.
but resources are not
Question # 3. The process that transforms scarce
resources into useful goods and services,
called :
b.
and neither does resources
a.
consumption
c.
and so the respurces
b.
production
d.
all are true
c.
distribution
e.
all are false
d.
transfortation
e.
transformation
Question # 2. What gets produced? How is it
produced? and Who gets what is produced?
are :
a.
three un-important questions
Question # 4. The basic resources that are
available to a society are factors of
production:
b.
three fundamental questions
a.
Land
c.
three basic questions
b.
Labor
d.
(b) and (c) are true
c.
Capital
e.
All are false
d.
All are true
e.
All are false
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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
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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.
b.
c.
d.
e.
consumer goods and services
capital goods and services
productive goods and services
investment goods and services
all are true
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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
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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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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
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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.
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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.
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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
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C H A P T E R 2: The Economic Problem: Scarcity and Choice
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
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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.
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