1. The Fundamental Economic Problem: Scarcity and Choice
Chapter 3
The Fundamental Economic Problem: Scarcity and Choice
Our necessities are few but our wants are endless.
INSCRIPTION ON A FORTUNE COOKIE

2. Scarcity, Choice, & Opportunity Cost
Resources are scarce
People have less resources than they would like
Choices
Must be made among limited set of possibilities
Have more one thing means have less something else (trade-off) 2

3. Scarcity, Choice, & Opportunity Cost
Labor – scarce
Time limitations
Number of skilled workers – limited
Economics – study
Use limited means to pursue unlimited ends
Opportunity cost of any decision
Value of next best alternative - forgone 3

4. How much does it really cost?
Principle of opportunity cost economics
Options available
Households & businesses
Governments & entire societies
Given - limited resources
Study logic of
How people can make optimal decisions
From among competing alternatives 4

5. How much does it really cost?
With limited resources
Decision - have more of one thing
Have less of something else
Relevant cost of any decision
Opportunity cost
Value of next best alternative - given up
Optimal decision making
Based on opportunity-cost calculations 5

6. Opportunity Cost and Money Cost
Market - functions well
Goods with high opportunity costs have high money costs
Goods with low opportunity costs have low money costs
Might not be identical: Forgone wage of college education
Optimal decision
Best serves objectives of decision maker
Selected by explicit or implicit comparison with possible alternative choices 6

7. Scarcity and Choice for a Single Firm
Outputs – produced by firm or economy
Goods & services it produces
Inputs - used by firm or economy
Labor, raw materials, electricity, other resources
To produce outputs 7

8. Scarcity and Choice for a Single Firm
Example: One business firm – Farmer
Fixed supply of inputs
Given technology
Produce two outputs
Produce more of one output
Produce less of the other 8

9. Table 1 Production possibilities open to a farmer Bushels of Soybeans
Bushels of Wheat
Label in Figure 1
40,000
30,000
20,000
10,000
38,000
52,000
60,000
65,000 A B C D E 9

10. Scarcity and Choice for a Single Firm
Production possibilities frontier (PPF)
Different combinations of various goods
Given
Available resources
Existing technology
Slopes downward to right (Why?)
Points: on or inside
Attainable
Points: outside
Cannot be achieved 10

11. Figure 1
Production possibilities frontier for production by a single farmer 10 20
Soybeans 30 40 A
Unattainable
region B 38
Attainable
region C 52 D E 10 20 30
Wheat 60 65 11

12. Scarcity and Choice for a Single Firm
Production possibilities frontier
Bowed outward
Resources (inputs) – specialized
Slope of production possibilities frontier
Opportunity cost
Principle of increasing costs
As production of a good expands
Opportunity cost of producing another unit
Generally increases 12

13. Figure 2
Production possibilities frontier with no specialized resources 10 20
Black shoes 30 40 50 A B C D 10 20 30
Brown shoes 40 50 13

14. Scarcity and Choice for a Single Firm
Concentrate more of productive capacity
On one commodity
Employ inputs
Better suited to making another commodity
Vary proportions of inputs
Limited quantities of some inputs
Bowed outward
Production possibilities frontier 14

15. Scarcity and Choice for Entire Society
Economy – constrained by
Resources
Technology
Production possibilities frontier – society
Position & shape
Determined by economy’s
Physical resources, skills, technology
Willingness to work
Past: construction of factories, research, & innovation 15

16. Scarcity and Choice for Entire Society
Production possibilities frontier
Civilian consumption (automobiles)
Military strength (missiles)
Downward slope - Choices
Increase civilian consumption
Decreasing military expenditure
Bowed outward
As defense spending increases
More expensive - “buy missiles”
Sacrifice civilian consumption 16

17. Figure 3 Production possibilities frontier for the entire economy 100
200
Thousands of Automobiles per Year
300
400
500
600
700 B D E G F C
100
200
300
Missiles per Year
400
500 17

18. The Concept of Efficiency
Efficiently produced output
Given current technology
Cannot increase output production
Without increasing amount of inputs
Or giving up a quantity of other output
Efficiency = absence of waste
Efficient economy
Wastes none of available resources
Produces maximum amount of output
Given technology 18

19. Three Coordination Tasks - Any Economy
Allocation of resources
Society’s decisions
Divide scarce input resources
Among different outputs produced
Among different firms / organizations
Produce outputs 19

20. Three Coordination Tasks - Any Economy
How to utilize resources efficiently
Reach production possibilities frontier
What
Which combination of goods to produce
Select one point on production possibilities frontier
To whom?
Total output - distributed to each person 20

21. 1. Market - Efficient Resource Allocation
Division of labor
Break up a task
Smaller, more specialized tasks
Each worker – more adept at a particular job
Example: Adam Smith’s pin factory
Law of comparative advantage
One country - production of particular good
Relative to other goods
If it produces that good less inefficiently
Than it produces other goods
Compared with other country 21

22. Adam Smith’s Pin Factory
”One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head: to make the head requires two or three distinct operations: to put it on is a particular business, to whiten the pins is another ... and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which in some manufactories are all performed by distinct hands, though in others the same man will sometime perform two or three of them.”

23. Principle of comparative advantage
Determine most efficient
Patterns of production and trade
Comparative advantage – matters
Country - gain by importing a good
Even if - produced more efficiently at home
Enable country – specialize
Produce goods – more efficient
Less efficient country – specialize
Export goods – least inefficient 23

24. 2.Market Exchange& How Much to Produce
Comparative advantage & division of labor
Creates greater productivity
Need system of exchange to increase standards of living
Trade
Goods for other goods
Common item: money
Market decides
How much of each good to be produced
More pin produced than consumed, price down, firms produce less 24

25. 3. How to Distribute Economy’s Outputs
Market system
Form of economic organization
Resource allocation decisions
Made by Individual producers and consumers
Based on their own best interests
Without central direction
Example 1: Vegetarians would not spend money on beef in Safeway
Example 2: demand for Hawaiian pineapples in Vermont ↑ → more pineapples in Vermont supermarkets 25

26. Summary Opportunity cost PPF: single firm vs. society Three tasks
How (Production)
Which (Exchange)
To Whom (Distribution)