2 The Economic Problem: 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 PPF The Economic Problem Economic Systems Command Economies Laissez-Faire Economies: The Free Market Mixed Systems, Markets, and Governments

Factors of production : The inputs into the process of production. Another term for resources. Factor 1: Land means all natural resources on or under the ground includes: water, forests, wildlife, mineral deposits. Factor 2: Labor is all the human time, effort, talent used to make products physical and mental effort used to make a good or provide a service. Factor 3: Capital is a producer’s physical resources includes tools, machines, offices, stores, roads, vehicles; sometimes called physical capital or real capital Factor 4: Entrepreneurship vision, skill, ingenuity, willingness to take risks. Entrepreneurs anticipate consumer wants, satisfy these in new ways develop new products, methods of production, marketing or distributing risk time, energy, creativity, money to make a profit.

Goods and services of value to households. production The process that 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 Goods and services of value to households.

Three Basic Economic Questions Every society must answer three basic economic questions because of scarcity. What will be produced? How will it be produced? Who will get what is produced? Societies answer these questions differently, leading to a variety of economic systems.

It exists because wants are unlimited and resources are limited. Scarcity is the economic problem of having seemingly unlimited human needs and wants, in a world of limited resources. Why does it exist? It exists because wants are unlimited and resources are limited. Wants — desires that can be met by consuming products. Needs — things necessary for survival.

is value of next-best alternative a person gives up The concepts of constrained choice and scarcity are central to the discipline of economics. Opportunity cost is that which we give up or forgo, when we make a decision or a choice. or is value of next-best alternative a person gives up -not the value of all possible alternatives-

Comparative advantage An idea closely related to opportunity cost is called comparative advantage. Comparative advantage the ability to produce a good at a lower opportunity cost than another producer. if you produce a good at a lower opportunity cost then you should specialize in it. 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.

Comparative Advantage and the Gains From Trade Daily Production Wood (logs) Food (bushels) Colleen 10 Bill 4 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.

The production possibility frontier (PPF) Capital goods are goods used to produce other goods and services. Consumer goods are goods produced for present consumption. 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. The production possibility frontier curve has a negative slope, which indicates a trade-off between producing one good or another.

Points inside of the curve are inefficient. At point H, resources are either unemployed, or are used inefficiently. 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.

Point C is one of the possible combinations of goods produced when resources are fully and efficiently employed. 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.

The Law of Increasing Opportunity Cost 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.

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. 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.

Economic Growth 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.

Economic Systems The economic problem: Given scarce resources, how, exactly, do large, complex societies go about answering the three basic economic questions? Economic systems are the basic arrangements made by societies to solve the economic problem. They include: Command economies Laissez-faire economies Mixed systems

Economic Systems Command economies In a command economy, a central government either directly or indirectly sets output targets, incomes, and prices.

Laissez-faire economies Economic Systems Laissez-faire economies In a laissez-faire economy, individuals and firms pursue their own self-interests without any central direction or regulation. The central institution of a laissez-faire economy is the free-market system. market is the institution through which buyers and sellers interact and engage in exchange.

is the idea that consumers ultimately dictate what will be produced 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).

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. 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.

The basic coordinating mechanism in a free market system is price. 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.

Economic Systems Mixed systems Most modern economies are a mixture of market systems and centralized decision- making. These are known as mixed economies.

Differences Between Command Economies, Free Market Economies, And Mixed Economies There are differences in terms of the ways they address the three basic economic questions: Market-type economic systems answer these questions in a decentralized manner.

Differences Between Command Economies, Free Market Economies, And Mixed Economies There are differences in terms of the ways they address the three basic economic questions: Command economies, on the other hand, address these questions via centralized decision-making, usually by a centralized governmental authority.

Differences Between Command Economies, Free Market Economies, And Mixed Economies There are differences in terms of the ways they address the three basic economic questions: Mixed economies combine market-type systems with some degree of governmental intervention.