Ch02:the economic problem scarcity and choice

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Ch02:the economic problem scarcity and choice

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Ch02:the economic problem scarcity and choice

  1. 1. CHAPTERCHAPTER 2Prepared by: Fernando QuijanoPrepared by: Fernando Quijanoand Yvonn Quijanoand Yvonn Quijano© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Economic Problem:Scarcity and Choice
  2. 2. CHAPTERCHAPTER2 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairScarcity, Choice, and Opportunity Cost• Human wants are unlimited, butresources are not.• Three basic questions must beanswered in order to understand aneconomic system:• What gets produced?• How is it produced?• Who gets what is produced?
  3. 3. CHAPTERCHAPTER3 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairScarcity, Choice, and Opportunity Cost• Every society has some system or mechanismthat transforms that society’s scarce resourcesinto useful goods and services.
  4. 4. CHAPTERCHAPTER4 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairScarcity, Choice, and Opportunity Cost• Capital refers to the things that arethemselves produced and then used toproduce other goods and services.• The basic resources that are availableto a society are factors of production:• Land• Labor• Capital
  5. 5. CHAPTERCHAPTER5 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairScarcity, Choice, and Opportunity Cost• Production is the process thattransforms scarce resources intouseful goods and services.• Resources or factors of productionare the inputs into the process ofproduction; goods and services ofvalue to households are the outputsof the process of production.
  6. 6. CHAPTERCHAPTER6 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairScarcity and Choicein a One-Person Economy• Nearly all the basic decisionsthat characterize complexeconomies must also be madein a single-person economy.• Constrained choice andscarcity are the basic conceptsthat apply to every society.
  7. 7. CHAPTERCHAPTER7 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairScarcity and Choicein a One-Person Economy• Opportunity cost is thatwhich we give up orforgo, when we make adecision or a choice.
  8. 8. CHAPTERCHAPTER8 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairScarcity and Choicein an Economy of Two or More• A producer has an absoluteadvantage over another in theproduction of a good or serviceif it can produce that productusing fewer resources.
  9. 9. CHAPTERCHAPTER9 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairScarcity and Choicein an Economy of Two or More• A producer has a comparativeadvantage in the production ofa good or service over anotherif it can produce that product ata lower opportunity cost.
  10. 10. CHAPTERCHAPTER10© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairComparative Advantageand the Gains From Trade• Colleen has an absolute advantage in theproduction of both wood and food becauseshe can produce more of both goods usingfewer resources than Bill.Daily ProductionWood(logs)Food(bushels)Colleen 10 10Bill 4 8
  11. 11. CHAPTERCHAPTER11© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairComparative Advantageand the Gains From Trade• In terms of wood:• For Bill, the opportunity cost of 8 bushels of food is 4 logs.• For Colleen, the opportunity cost of 8 bushels of food is 8 logs.• In terms of food:• For Colleen, the opportunity cost of 10 logs is 10 bushels of food.• For Bill, the opportunity cost of 10 logs is 20 bushels of food.Daily ProductionWood(logs)Food(bushels)Colleen 10 10Bill 4 8
  12. 12. CHAPTERCHAPTER12© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairComparative Advantageand the Gains From Trade• Suppose that Colleen and Bill each wanted equalnumbers of logs and bushels of food. In a 30-daymonth they (each separately) could produce:Daily ProductionWood(logs)Food(bushels)Colleen 10 10Bill 4 8Monthly Productionwith No TradeWood(logs)Food(bushels)Colleen 150 150Bill 80 80Total 230 230A.B.
  13. 13. CHAPTERCHAPTER13© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairComparative Advantageand the Gains From Trade• By specializing on the basis of comparativeadvantage, Colleen and Bill can produce more ofboth goods.Monthly Productionafter SpecializationWood(logs)Food(bushels)Colleen 270 30Bill 0 240Total 270 270C.Monthly Productionwith No TradeWood(logs)Food(bushels)Colleen 150 150Bill 80 80Total 230 230B.
  14. 14. CHAPTERCHAPTER14© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairComparative Advantageand the Gains From Trade• To end up with equal amounts of wood and foodafter trade, Colleen could trade 100 logs for 140bushels of food. Then:Monthly Productionafter SpecializationWood(logs)Food(bushels)Colleen 270 30Bill 0 240Total 270 270D.Monthly Use AfterTradeWood(logs)Food(bushels)Colleen 170 170Bill 100 100Total 270 270C.
  15. 15. CHAPTERCHAPTER15© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairSpecialization, Exchangeand Comparative Advantage• According to the theory ofcompetitive advantage,specialization and freetrade will benefit alltrading parties, even thosethat may be absolutelymore efficient producers.
  16. 16. CHAPTERCHAPTER16© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairCapital Goods and Consumer Goods• Capital goods are goods usedto produce other goods andservices.• Consumer goods are goodsproduced for presentconsumption.
  17. 17. CHAPTERCHAPTER17© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairCapital Goods and Consumer Goods• Investment is the process ofusing resources to producenew capital. Capital is theaccumulation of previousinvestment.• The opportunity cost of everyinvestment in capital is forgonepresent consumption.
  18. 18. CHAPTERCHAPTER18© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Production Possibility Frontier• The production possibilityfrontier (ppf) is a graph thatshows all of the combinationsof goods and services that canbe produced if all of society’sresources are used efficiently.
  19. 19. CHAPTERCHAPTER19© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Production Possibility Frontier• The productionpossibility frontiercurve has a negativeslope, which indicatesa trade-off betweenproducing one good oranother.
  20. 20. CHAPTERCHAPTER20© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Production Possibility Frontier• Points inside of thecurve are inefficient.• At point H, resourcesare either unemployed,or are used inefficiently.
  21. 21. CHAPTERCHAPTER21© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Production Possibility Frontier• Point F is desirablebecause it yields moreof both goods, but it isnot attainable giventhe amount ofresources available inthe economy.
  22. 22. CHAPTERCHAPTER22© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Production Possibility Frontier• Point C is one of thepossible combinationsof goods producedwhen resources arefully and efficientlyemployed.
  23. 23. CHAPTERCHAPTER23© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Production Possibility Frontier• A move along the curveillustrates the conceptof opportunity cost.• From point D, anincrease the productionof capital goodsrequires a decrease inthe amount ofconsumer goods.
  24. 24. CHAPTERCHAPTER24© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Law of Increasing Opportunity Cost• The slope of the ppf curveis also called the marginalrate of transformation(MRT).• The negative slope of theppf curve reflects the law ofincreasing opportunity cost.As we increase theAs we increase theproduction of one good, weproduction of one good, wesacrifice progressively moresacrifice progressively moreof the other.of the other.
  25. 25. CHAPTERCHAPTER25© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairEconomic Growth• Economic growth is anincrease in the total output of theeconomy. It occurs when asociety acquires new resources,or when it learns to producemore using existing resources.• The main sources of economicgrowth are capital accumulationand technological advances.
  26. 26. CHAPTERCHAPTER26© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairEconomic Growth• An outward shift meansthat it is possible toincrease the productionof one good withoutdecreasing theproduction of the other.• Outward shifts of theOutward shifts of thecurve representcurve representeconomic growth.economic growth.
  27. 27. CHAPTERCHAPTER27© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairEconomic Growth• From point D, theFrom point D, theeconomy can chooseeconomy can chooseany combination ofany combination ofoutput between F andoutput between F andG.G.
  28. 28. CHAPTERCHAPTER28© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairEconomic Growth• Not every sector of theeconomy grows at thesame rate.• In this historicexample, productivityincreases were moredramatic for corn thanfor wheat over this timeperiod.
  29. 29. CHAPTERCHAPTER29© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairCapital Goods and Growthin Poor and Rich Countries• Rich countries devote moreresources to capitalproduction than poorcountries.• As more resources flow intocapital production, the rateof economic growth in richcountries increases, and sodoes the gap between richand poor countries.
  30. 30. CHAPTERCHAPTER30© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairEconomic Growthand the Gains From Trade• By specializing and engaging in trade,Colleen and Bill can move beyond theirown production possibilities.
  31. 31. CHAPTERCHAPTER31© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairEconomic Systems• The economic problem:Given scarce resources, how,exactly, do large, complexsocieties go about answeringthe three basic economicquestions?
  32. 32. CHAPTERCHAPTER32© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairEconomic Systems• Economic systems are thebasic arrangements made bysocieties to solve the economicproblem. They include:• Command economies• Laissez-faire economies• Mixed systems
  33. 33. CHAPTERCHAPTER33© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairEconomic Systems• In a command economy, a centralgovernment either directly orindirectly sets output targets,incomes, and prices.• In a laissez-faire economy,individuals and firms pursue theirown self-interests without any centraldirection or regulation.
  34. 34. CHAPTERCHAPTER34© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairEconomic Systems• The central institution of a laissez-faire economy is the free-marketsystem.• A market is the institution throughwhich buyers and sellers interact andengage in exchange.
  35. 35. CHAPTERCHAPTER35© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairEconomic Systems• Consumer sovereignty is theidea that consumers ultimatelydictate what will be produced(or not produced) by choosingwhat to purchase (and whatnot to purchase).
  36. 36. CHAPTERCHAPTER36© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairEconomic Systems• Free enterprise: under a freemarket system, individualproducers must figure out howto plan, organize, andcoordinate the production ofproducts and services.
  37. 37. CHAPTERCHAPTER37© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairEconomic Systems• In a laissez-faire economy, thedistribution of output is alsodetermined in a decentralizedway. The amount that any onehousehold gets depends on itsincome and wealth.
  38. 38. CHAPTERCHAPTER38© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairEconomic Systems• The basic coordinatingmechanism in a free marketsystem is price. Price is theamount that a product sells forper unit. It reflects whatsociety is willing to pay.
  39. 39. CHAPTERCHAPTER39© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairMixed Systems,Markets, and GovernmentsSince markets are not perfect, governmentsintervene and often play a major role in theeconomy. Some of the goals of government are to:• Minimize market inefficiencies• Provide public goods• Redistribute income• Stabilize the macroeconomy:• Promote low levels of unemployment• Promote low levels of inflation
  40. 40. CHAPTERCHAPTER40© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairReview Terms and Conceptsabsolute advantageabsolute advantagecapitalcapitalcommand economycommand economycomparative advantage, theory ofcomparative advantage, theory ofconsumer goodsconsumer goodsconsumer sovereigntyconsumer sovereigntyeconomic growtheconomic growtheconomic problemeconomic probleminvestmentinvestmentlaissez-faire economylaissez-faire economymarginal rate of transformation (mrt)marginal rate of transformation (mrt)marketmarketopportunity costopportunity costoutputsoutputspricepriceproductionproductionproduction possibility frontier (ppf)production possibility frontier (ppf)resources or inputsresources or inputsthree basic questionsthree basic questions

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