1. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. Chapter 2 Scarcity and the World of Trade-Offs

2. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-2 Introduction Some economists suggest that adding an extra hour during daylight saving time of the year actually increases instead of saving energy expenses. In this chapter, you will learn that making a choice to obtain something, such as an extra hour of daylight, involves an opportunity cost.

3. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-3 Learning Objectives Evaluate whether even affluent people face the problem of scarcity Understand why economists consider wants but not needs Explain why the scarcity problem induces individuals to consider opportunity costs

4. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-4 Learning Objectives (cont'd) Discuss why obtaining increasing increments of any particular good entails giving up more and more units of other goods Explain why society faces a trade-off between consumption goods and capital goods Distinguish between absolute and comparative advantage

5. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-5 Chapter Outline Scarcity Wants and Needs Scarcity, Choice, and Opportunity Cost The World of Trade-Offs The Choices Society Faces Economic Growth and the Production Possibilities Curve

6. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-6 Chapter Outline (cont'd) The Trade-Off Between the Present and the Future Specialization and Greater Productivity Comparative Advantage and Trade Among Nations

7. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-7 Did You Know That … A study by the Institute of Medicine has found that reshuffling the schedules of medical residents in order to give them more rest breaks requires hospitals to hire more residents to cover the scheduling gaps? Time, like all other resources, is scarce.

8. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-8 Scarcity –Is the most basic concept in all of economics –Occurs when the ingredients for producing things that people desire are insufficient to satisfy all wants –Means we never have enough of everything, including time, to satisfy our every desire

9. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-9 Scarcity (cont'd) What scarcity is NOT –It is not a shortage –It is not the same thing as poverty

10. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-10 Scarcity (cont'd) 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

11. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-11 Scarcity (cont'd) Resources or Factors of Production –Land Natural resources or the gifts of nature –Labor The human resource

12. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-12 Scarcity (cont'd) Resources or Factors of Production –Physical Capital All manufactured resources –Human Capital Accumulated training and education of workers

13. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-13 Scarcity (cont'd) Resources or Factors of Production –Entrepreneurship Person who organizes, manages, and assembles the other resources Risk taker Maker of basic business policy decisions

14. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-14 Scarcity (cont'd) Goods versus Economic Goods –Goods are all things from which individuals derive satisfaction or happiness. –Economic goods are scarce goods, for which the quantity demanded exceeds the quantity supplied at zero price.

15. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-15 Scarcity (cont'd) Services –Tasks that are performed for someone else –Can be referred to as intangible goods

16. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-16 Scarcity (cont'd) Recall –Scarcity occurs when the ingredients (resources) for producing things that people desire are insufficient to satisfy all wants.

17. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-17 Wants and Needs Needs –To economists, the term need is not definable. Wants –Goods and services on which we place a positive value –People have unlimited wants.

18. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-18 Scarcity, Choice, and Opportunity Cost Opportunity Cost –The highest-valued, next-best alternative that must be sacrificed to obtain something or to satisfy a want –The next-highest-ranked alternative, not all alternatives

19. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-19 Scarcity, Choice, and Opportunity Cost (cont'd) Questions –What is the opportunity cost of attending this economics class? –What is the opportunity cost of attending a concert by your favorite band? –What is the opportunity cost of working out at the gym?

20. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-20 Scarcity, Choice, and Opportunity Cost (cont'd) In economics, cost is always a forgone opportunity.

21. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-21 Limited Resources & Unlimited Wants Scarcity Choices Opportunity Cost Choices Yield Opportunity Costs

22. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-22 Scarcity, Choice, and Opportunity Cost Opportunity Cost –The highest-valued, next-best alternative that must be sacrificed to obtain something or to satisfy a want –Another way to say it is the best benefit you gave up when you made an alternate choice

23. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-23 Questions –What is the opportunity cost of attending this economics class? –What is the opportunity cost of attending a concert by your favorite band? –What is the opportunity cost of increasing research for an AIDS vaccine? Scarcity, Choice, and Opportunity Cost (cont'd)

24. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-24 Scarcity, Choice, and Opportunity Cost (cont'd) In economics, cost is always a forgone opportunity (to receive a benefit).

25. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-25 The World of Trade-Offs Whenever you engage in any activity, using any resource, you are trading off the use of that resource for one or more alternative uses. The value of the trade-off is represented by the opportunity cost, (that which you give up to obtain something else).

26. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-26 International Example: France is the Sleeping Giant A study by the Organization of Economic Cooperation and Development (OECD) indicates that residents of France allocate about twice as much time to eating as U.S. residents. The French also sleep more than people in other countries, including the United States. So, French residents face a lower opportunity cost of time devoted to eating and sleeping than U.S. residents.

27. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-27 The World of Trade-Offs Whenever you engage in any activity, using any resource, you are trading off the use of that resource for one or more alternative uses The value of the trade-off is represented by the opportunity cost, (that which you give up to obtain something else)

28. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-28 The World of Trade-Offs (cont'd) Graphical analysis of opportunity cost –The production possibilities curve (PPC) represents all possible combinations of maximum outputs that could be produced assuming a fixed amount of productive resources of a given quality

29. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-29 Figure 2-1 Production Possibilities Curve for Grades in Mathematics and Economics (Trade-Offs)

30. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-30 The World of Trade-Offs (cont'd) The Production Possibilities Curve (PPC) –Trade-offs: What would happen if you are more interested in getting a higher grade in economics? –Holding constant total study time: What would happen to the PPC if you spent more time studying? –Straight-line PPC: Is it possible that the terms of the trade-off might not be constant?

31. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-31 Example: Airlines Confront the Opportunity Cost of Legroom on Planes Major U.S. airlines, such as American, Continental and Delta, have added at least 10 more seats on their planes by reducing 1 to 2 inches in the distance between a point on one seat to the same point on the seat in the next row. For these airlines, the thousands of dollars generated by selling more ticketed passengers onto each plane are an opportunity cost too high to justify the extra passenger legroom.

32. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-32 The Choices Society Faces PPC is used to demonstrate related concepts of scarcity, choice, and trade-offs –At the individual level –At the societal level

33. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-33 Figure 2-2 Society’s Trade-Off Between E- Readers and Netbooks, Panel (a)

34. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-34 Figure 2-2 Society’s Trade-Off Between E-Readers and Netbooks, Panel (b)

35. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-35 The Choices Society Faces (cont'd) Production possibilities assumptions –Resources are fully employed –Production takes place over a specific time period –Resources are fixed for the time period –Technology does not change over the time period

36. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-36 The Choices Society Faces (cont'd) Technology –Society’s pool of applied knowledge concerning how goods and services can be produced

37. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-37 Why Not … provide “free” health care to everyone in the United States? Additional health care provided through government programs is not really free. The new U.S. government health care program has a 10-year price tag over $1 trillion indicates that resources valued at this amount by society would be allocated to producing more health care instead of other items

38. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-38 The Choices Society Faces (cont'd) Efficiency –Productive efficiency is producing the maximum output with given technology and resources –Alternatively, the situation in which a given output is produced at minimum cost

39. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-39 The Choices Society Faces (cont'd) Inefficient Point –Any point below the production possibilities curve at which the use of resources is not generating the maximum possible output Law of Increasing Additional Cost –As society attempts to produce more of a good, the opportunity cost of additional units of that good generally increases –Accounts for bowed shape of the PPC

40. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-40 Figure 2-3 The Law of Increasing Additional Cost

41. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-41 The Choices Society Faces (cont'd) Resources are not perfectly adaptable for alternative uses In general, the more specialized the resources, the more bowed the production possibilities curve

42. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-42 Economic Growth and the Production Possibilities Curve Economic growth –Increases the production possibilities of e- readers and netbooks –Over time, it is possible to have more of everything –Illustrated by an outward shift of the production possibilities curve

43. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-43 Figure 2-4 Economic Growth Allows for More of Everything

44. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-44 The Trade-Off Between the Present and the Future 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

45. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-45 Figure 2-5 Capital Goods and Growth Consumer goods –Goods produced for personal satisfaction Capital goods –Goods used to produce other goods

46. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-46 Figure 2-5 Capital Goods and Growth, Panel (a)

47. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-47 Figure 2-5 Capital Goods and Growth, Panel (b)

48. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-48 The Trade-Off Between the Present and the Future (cont’d) Capital Goods and Growth: Observations –Forgo consumption goods to produce capital goods –Increase in capital goods stimulates economic growth

49. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-49 The Trade-Off Between the Present and the Future (cont’d) Observations –An increase in capital goods at present will lead to a higher rate of economic growth in the future –In the future, the economic system can produce more consumer goods

50. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-50 Specialization and Greater Productivity Specialization –Organization of economic activity among different individuals and regions –Leads to greater productivity

51. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-51 Specialization and Greater Productivity (cont'd) Comparative Advantage –The ability to produce a good or service at a lower opportunity cost –Is always a relative concept

52. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-52 Specialization and Greater Productivity (cont'd) Absolute Advantage –The ability to produce more units of a good or service using a given quantity of labor or resource inputs –Equivalently, the ability to produce the same quantity of a good or service using fewer units of labor or resource inputs

53. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-53 Specialization and Greater Productivity (cont'd) Rational individuals choose their comparative advantage and then specialize Specialization leads to division of labor Adam Smith, in The Wealth of Nations, illustrated division of labor in pin making

54. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-54 Specialization and Greater Productivity (cont'd) Division of Labor –The segregation of resources into different specific tasks –For example, in automobile production, one worker puts on bumpers, another work puts on doors, and so on

55. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-55 Comparative Advantage and Trade Among Nations Analysis of absolute advantage, comparative advantage, and specialization is applicable to individuals, groups of people, or nations As a result, interstate trade occurs in the United States and international trade occurs between nations

56. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-56 Comparative Advantage and Trade Among Nations (cont’d) When nations specialize where they have a comparative advantage and then trade with the rest of the world –Economic efficiency improves Output increases Average standard of living rises

57. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-57 International Example: Time As a Determinant of Comparative Advantage Technological improvements in production, shipping, and delivery have enabled firms to use “just-in-time inventory management” to move newly produced items quickly to consumers. Nations where firms have implemented just-in- time inventory management are more likely to develop a comparative advantage over nations where firms have not.

58. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-58 You Are There … Stopping Students’ Thursday Night Parties with Friday Classes A study suggests that students who consume alcoholic beverages on Thursday nights would choose not to do so if they had Friday classes to attend. So, the provost of the University of Iowa decided to raise students’ opportunity cost of attending parties on Thursday nights by offering academic departments an extra $20 for each student rescheduled into a course that included a Friday class.

59. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-59 Issues & Applications: Is Daylight Saving Time Efficient? In the 1970s, the U.S. Department of Transportation determined that, compared with standard time, daylight saving time trimmed national electricity usage by about 1 percent. A more recent study, however, found that greater use of air conditioners to maintain lower temperatures during longer summer evenings led to greater use of electricity during daylight saving time.

60. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-60 Summary Discussion of Learning Objectives The problem of scarcity, even for the affluent –Scarcity and poverty are not synonymous Why economists consider individuals’ wants but not their needs –Needs are not objectively definable –Wants are things on which we place a positive value

61. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-61 Summary Discussion of Learning Objectives (cont'd) Why the scarcity problem leads people to evaluate opportunity costs –Allocating resources to producing one good means losing the opportunity to have another one Why getting more units of one good requires giving up more and more of another –Resources are specialized

62. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-62 Summary Discussion of Learning Objectives (cont'd) There is a trade-off between consumption goods and capital goods. –As more resources are devoted to the production of capital goods, we can expect the rate of economic growth to increase

63. Copyright © 2012 Pearson Addison-Wesley. All rights reserved. 2-63 Summary Discussion of Learning Objectives (cont'd) Absolute versus comparative advantage –One finds one’s absolute advantage by producing more of a specific good than someone else who uses the same amount of resources –One finds one’s comparative advantage by looking at the activity that has the lowest opportunity cost