Scarcity and the Human Condition Lecture 2 Scarcity and the Human Condition

Scarcity and the Human Condition Readings: Chapter 2 Familiarize yourself with myeconlab

Scarcity and the Human Condition In the last lecture, I argued that economists understand the forces shaping human social values and human social behaviour as originating from a response to the existential problem of scarcity. But is this true? Are there not other existential problems shaping human social life? Death Class Parent-Child Relationship While these are important, Scarcity is perhaps the least well understood existential problem.

Scarcity and the Human Condition Can scarcity be overcome? Since unlimited human wants (greed) is the cause of scarcity, no amount of economic growth solves this problem. Reducing poverty and inequality are good, but they will not eliminate scarcity. Even the richest person on earth cannot overcome scarcity. We have mostly failed to re-educate humans to be satisfied with a sustainable living. Increasing the pace of globalization or reversing it will not cure scarcity. Self sufficiency won’t do it either. This may not be such a bad thing.

Scarcity and the Human Condition What are the implications of scarcity on for human social life? Having more education means sacrificing consumption for a time. Having more economic growth may mean sacrificing security. Higher environmental quality usually requires the sacrifice of consumption. Implication: Choice is unavoidable when individual or social objectives are pursued. Choice involves tradeoffs.

Scarcity and the Human Condition How can we analyse these fundamental economic choice problems? Develop a simple economic model of the problem Call the model the parable of goat island

Scarcity and the Human Condition The Parable of Goat Island The people of Goat Island live communally in a tropical paradise. Their only decision is how many acres of land should be fenced and planted in yams, and how many acres of land should be used to free-range goats. There are 1000 acres of land on the island, 500 acres of which are rocky mountainside, with the remaining 500 acres being rich volcanic plain. One acre of mountainside can support 1 goat or produce 1 tonne of yams. One acre of plain can support 1 goat or produce 4 tonnes of yams. The alternatives facing the communal activity are described in the following table.

Scarcity and the Human Condition Acres in Yams, Acres in Goats Tonnes of Yams Tonnes of Goats 0, 1000 1000 100, 900 400 900 200, 800 800 300, 700 1200 700 400, 600 1600 600 500, 500 2000 500 600, 400 2100 700, 300 2200 300 800, 200 2300 200 900, 100 2400 100 1000, 0 2500

Scarcity and the Human Condition The choice society must make is how many yams and how many goats to produce. A production possibilities frontier (PPF) is one way to represent all the choices available. PPF of a Yam-Goat society Yams (tonnes) 2500 2000 1000 Goats 1000 500

Scarcity and the Human Condition What if there are more types of land? Yams Goats

Scarcity and the Human Condition Coke - Pizza Society Production Possibilities Frontier (PPF) for two goods: cola and pizza. Any point on the frontier such as E and any point inside the PPF such as Z are attainable. Points outside the PPF are unattainable. Your second challenge is to help the students begin to use the PPF model and to start thinking like economists. Thinking about everyday events in terms of graphs and tables of numbers is hard for most students. You can help them to appreciate economic modes in general and the PPF model in particular by using the model to describe the tradeoff between studying and a social life faced every day by each student. Why do some of the brightest students not get a 4.0 GPA? After sleeping, attending classes, and performing the mundane tasks of life, a student has 8 hours a day available for study and recreation. If the student spends all 8 hours studying, he/she will get a 4.0 GPA. But each hour of recreation lowers the GPA. The Economics of Campus Life 101. First, assume a constant opportunity cost of recreation equal to a 0.333 drop in the GPA for each hour spent not studying. The highest GPA possible is 4.0, the lowest is 1.333, and the negatively sloped PPF curve is a straight line. Ask the students to draw the graph based on your description. Help them to interpret the PPF graph: the intercept points reveal the maximum GPA and the maximum recreation hours possible, and the negative slope quantifies the tradeoff the student faces. Points on the curve represent production efficiency and points inside the curve represent a misallocation of the student’s time where opportunities for increases in recreation and/or GPA points are wasted. Then show that the opportunity cost of each additional hour of recreation (lost GPA points) is constant. Ask the students why.

Production Possibilities and Opportunity Cost Tradeoff Along the PPF Every choice along the PPF involves a tradeoff. On this PPF, we must give up some cola to get more pizzas or give up some pizzas to get cola.

Production Possibilities and Opportunity Cost As we move down along the PPF, we produce more pizzas, but the quantity of cola we can produce decreases. The opportunity cost of a pizza is the cola forgone.

Production Possibilities and Opportunity Cost In moving from E to F, the quantity of pizzas increases by 1 million. The quantity of cola decreases by 5 million cans. The opportunity cost of the fifth 1 million pizzas is 5 million cans of cola. One of these pizzas costs 5 cans of cola.

Production Possibilities and Opportunity Cost In moving from F to E, the quantity of cola produced increases by 5 million. The quantity of pizzas decreases by 1 million. The opportunity cost of the first 5 million cans of cola is 1 million pizzas. One of these cans of cola costs 1/5 of a pizza.

Production Possibilities and Opportunity Cost Note that the opportunity cost of a can of cola is the inverse of the opportunity cost of a pizza. One pizza costs 5 cans of cola. One can of cola costs 1/5 of a pizza.

Production Possibilities and Opportunity Cost Because resources are not equally productive in all activities, the PPF bows outward—is concave. The outward bow of the PPF means that as the quantity produced of each good increases, so does its opportunity cost.

Using Resources Efficiently All the points along the PPF are efficient. To determine which of the alternative efficient quantities to produce, we compare costs and benefits. The PPF and Marginal Cost The PPF determines opportunity cost. The marginal cost of a good or service is the opportunity cost of producing one more unit of it.

Using Resources Efficiently Figure 2.2 illustrates the marginal cost of pizza. As we move along the PPF in part (a), the opportunity cost of a pizza increases. The opportunity cost of producing one more pizza is the marginal cost of a pizza.

Using Resources Efficiently The bars illustrate the increasing opportunity cost of pizza. The black dots and the line MC show the marginal cost of pizza. The MC curve passes through the centre of each bar. Students always wonder why MC passes through the middle point of the bars. The height of each bar shows the cost of an average pizza in each of the 1 million pizza blocks. Focus on the 3rd 1 million pizzas. The opportunity cost of producing that 1 million pizzas is 3 million cans of cola. So in this range, the cost of an average pizza is 3 cans of cola. The dot indicates that 3 cans of cola is the cost of the average pizza, which over this range is the 2.5 millionth pizza.

Scarcity and the Human Condition What else does the PPF model tell us about economic choice? We can use it to examine the impact of racism, sexism, and recession. Each of these causes resources to be under-employed. This moves us to the interior of the PPF. This is grossly inefficient because more of everything could be produced and consumed.

Scarcity and the Human Condition We achieve production efficiency if we cannot produce more of one good without producing less of some other good. Points on the frontier are efficient.

Production Possibilities and Opportunity Cost Any point inside the frontier, such as Z, is inefficient. At such a point, it is possible to produce more of one good without producing less of the other good. At Z, resources are either unemployed or misallocated.

Scarcity and the Human Condition What else does our PPF model help us understand? Technological Progress and Capital Accumulation War and Natural Disaster

Economic Growth The expansion of production possibilities—and increase in the standard of living—is called economic growth. Two key factors influence economic growth: Technological change is the development of new goods and of better ways of producing goods and services. Capital accumulation is the growth of capital resources, which includes human capital. You can have some fun and generate some discussion by getting the students to think about what life might be like after another 200 years of economic growth. Provide some numbers: In 2006, income per person in the United States was about $100 a day. In 1806 it was about 70¢ a day, and if the past growth rate prevails for another 200 years, in 2206 it will be $14,000 a day. Emphasize the magic of compound growth. If they think that $14,000 a day is a big income, get them to do a ballpark estimate of the daily income of Bill Gates (about $20 million!) Encourage a discussion of why scarcity is still present even at these large incomes. Be sure to cover the “Standard of Living Tradeoff” idea that the students met in Chapter 1 and that they can now think about with the more powerful tool of the PPF. If you wish, connect the discussion of efficiency with that of growth. Ask the students to explain what determines the efficient growth rate (not in text).

Economic Growth The Cost of Economic Growth To use resources in research and development and to produce new capital, we must decrease our production of consumption goods and services. So economic growth is not free. The opportunity cost of economic growth is less current consumption.

Economic Growth Figure 2.5 illustrates the tradeoff we face. We can produce pizzas or pizza ovens along PPF0. By using some resources to produce pizza ovens today, the PPF shifts outward in the future.

Scarcity and the Human Condition What about war and natural disaster? War and natural disaster destroys capital and kills the labour force. This must push the PPF in until peace and good weather are re-established. Some Implications: The tsunami in Japan pushed the PPF in The Arab spring had a much higher cost in Libya and Syria than in Egypt or Tunisia. With a new government, Libya will likely attract new investment and may recover quickly. Syria is in trouble. Global warming is a real threat to long term economic prosperity.

Scarcity and the Human Condition What does this model fail to tell us about economic choice? Where on the PPF society should choose to locate. How society should organize production. How the product of society should be distributed. How much of society’s resources should be devoted to investment and research (to expand the PPF).

Scarcity and the Human Condition How will these economic choices be made? Depends on how the economy is organized. Much depends on the relative importance of government and markets in making these decisions. In Canada’s mixed economy both markets and government influence where society locates on the PPF. Both markets and governments influence how this social product is distributed. Finally, both markets and governments influence how much is invested. This raises two related questions: Why should markets be involved? Why not let democratic government make all the crucial decisions on how scarce resources should be allocated and distributed?

Scarcity and the Human Condition Markets have a number of advantages that most societies exploit. The market mechanism is decentralized and automatic, making possible rapid and virtually costless social decisions. Governments are centralized, slow and costly. (Example: Hurricane Katrina -2005). The market mechanism rewards innovation with profits. Governments are less effective at rewarding innovation. Democratic governments tend to respond to the demands of their narrow constituency in making decisions. The market responds to all consumers - consumer sovereignty.

Scarcity and the Human Condition Mixed economies tend to rely on markets to make most of the allocation and distribution decisions. In mixed economies, democratic decision-making is aimed at fine tuning policy instruments that bend market outcomes to better suit the interests of the ruling party and their constituency. Government use tax and subsidy instruments to alter market prices and so bend market outcomes. For instance, governments heavily subsidize university education, which increases enrolment at universities.

Scarcity and the Human Condition Government also buys goods and services in the marketplace, and then uses market and non-market channels to distribute these goods and services to members of the public. For example, governments buy health services from health care providers and then distribute these services through government run insurance schemes. Most government services (education, defence, etc) are largely purchased in markets and then distributed by government.

Scarcity and the Human Condition Markets play the key organizing function in mixed economies. Attempting to understand how the market system organizes our vast and complicated modern economy is where micro-economics begins, and this is where we turn next.

Scarcity and the Human Condition Next Day: Lecture 3 – The Market Mechanism Readings – Chapter 3, Demand and Supply