Chapter 2: Scarcity and the World of Trade-offs ECON 151 – PRINCIPLES OF MACROECONOMICS Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.

2 Introduction Society always faces choices regarding use of its scarce resources. The need to devote more law enforcement resources to antiterrorism efforts means that crimes considered less threatening, such as bank robberies, are on the rise.

3 Scarcity  Occurs when the ingredients (resources) for producing things that people desire are insufficient to satisfy all wants Scarcity

4 What scarcity is NOT:  It is not a shortage.  It is not the same thing as poverty. Scarcity

5 Production  Any activity that results in the conversion of resources into products that can be used in consumption Resources or Factors of Production  Inputs that are used to produce things that people want Scarcity

6 Resources or Factors of Production  Land Natural resources or the gifts of nature  Labor The human resource Scarcity

7 Resources or Factors of Production  Physical Capital All manufactured resources  Human Capital Accumulated training and education of workers Scarcity

8 Resources or Factors of Production  Entrepreneurship Person who organizes, manages, and assembles the other resources Risk taker Maker of basic business policy decisions Scarcity

9 Goods versus Economic Goods  Goods are all things from which individuals derive satisfaction and are, thus, valued.  Economic goods are goods and services produced from scarce resources. Scarcity

10 Services  Tasks that are performed for someone else  Sometimes referred to as “intangible goods” Scarcity

11 Needs (from the economic perspective)  Are objectively undefinable  Could be a wish, want, or a life-saving necessity Wants  Desirable things that people wish to have  People have unlimited wants Wants and Needs

12 Opportunity Cost  The highest-valued, next-best alternative that must be sacrificed to attain something or satisfy a want Scarcity, Choice, and Opportunity Cost

13 In economics, cost is always a forgone opportunity. Scarcity, Choice, and Opportunity Cost

14 Limited Resources & Unlimited Wants Scarcity ChoicesOpportunity Cost Scarcity, Choice, and Opportunity Cost

15 Whenever resources are used for any activity, the user is sacrificing the opportunity to use those resources for other things. The World of Trade-Offs

16 Opportunity cost graphically:  The production possibilities curve (PPC) represents all possible maximum combinations of total output that could be produced.  Along the production possibilities curve, there is a fixed quantity of productive resources of a given quality being used efficiently. The World of Trade-Offs

17 Figure 2-1 Production Possibilities Curve (PPC)

18 Questions  What would happen to the production possibilities curve if you spent more time studying?  What would happen to the potential grades?  Is it possible that terms of the trade-off might not be constant? Production Possibilities Curve (PPC)

19 Production possibilities assumptions  Resources are fully employed  Production is for a specific time period  Resources are fixed for the time period  Technology does not change over the time period The Choices Society Faces

20 Technology  Society’s pool of applied knowledge concerning how goods and services can be produced The Choices Society Faces

21 Society’s Trade-Off Between Digital Cameras and Pocket PCs Figure 2-2, Panel (a)

22 Society’s Trade-Off Between Digital Cameras and Pocket PCs Figure 2-2, Panel (b)

23 The Law of Increasing Relative Costs Figure 2-3

24 Law of Increasing Relative Costs  As society attempts to produce more of a good, the opportunity cost of additional units of that good generally increases. The Choices Society Faces

25 Economic growth  Increases the production possibilities of digital cameras and pocket PCs  Occurs over a period of time  Is illustrated by an outward shift of the production possibilities curve Economic Growth and the Production Possibilities Curve

26 Economic Growth Allows for More of Everything Figure 2-4

27 The PPC can be used to illustrate the trade-off between present and future consumption. Consumption  The use of goods and services for personal satisfaction The Trade-Off Between the Present and the Future

28 Capital Goods per Year Consumer goods  Goods produced for personal satisfaction Capital goods  Goods used to produce other goods Consumption Goods per Year ($ trillions) 8 B Capital Goods and Growth A 7

29 Capital Goods per Year 8 B A 7 Consumption Goods per Year ($ trillions) Recreation per Year Food per Year Future growth as a result of A on the left-hand diagram Today Capital Goods and Growth Figure 2-5, Panel (a)

30 Capital Goods per Year Consumption Goods per Year ($ trillions) C Capital Goods and Growth B A Future growth as a result of C on the left-hand diagram Today Recreation per Year Food per Year Figure 2-5, Panel (b)

31 Observations  Forgo consumption goods to produce capital goods  Increase in capital goods stimulates economic growth Capital Goods and Growth

32 Specialization  Division of productive activities  Leads to greater productivity Specialization and Greater Productivity

33 Question  How does the specialization of resources influence the shape of the production possibilities curve? The Choices Society Faces

34 Absolute Advantage  The ability to produce more units of a good or using a given quantity of labor or service resource inputs Specialization and Greater Productivity

35 Comparative Advantage  The ability to produce a good or service at a lower opportunity cost  A relative concept  Specialize in the production for which we have a comparative advantage Specialization and Greater Productivity

36 Division of Labor  Assigning different workers different tasks to produce a good or service  Organizing a division of labor within a firm to increase output Examples  Automobile production  Hospital operating room Division of Labor

37 Question  Why trade? Answer  Both participating countries benefit  Comparative advantage and specialization increases output and income of both Comparative Advantage and Trade Among Nations

Chapter 2: Scarcity and the World of Trade-offs ECON 151 – PRINCIPLES OF MACROECONOMICS Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.