Chapter 2-the-economic-problems

CHAPTERCHAPTER 2
Prepared by: Fernando QuijanoPrepared by: Fernando Quijano
and 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 Fair
The Economic Problems:
Scarcity and Choice

CHAPTERCHAPTER
Topics to Discussed
• Scarcity, Choice, and Opportunity Cost
• Scarcity and Choice in an Economy
• Comparative Advantage and Trade
• Specialization and Comparative Advantage
• Capital Goods and Consumer Goods
• The Production Possibility Frontier
• Economic Growth & Economic Systems
2 of 44

CHAPTERCHAPTER
© 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 Fair 3 of 44
Scarcity, Choice, and Opportunity Cost
• Human wants are unlimited, but resources
are not.
• Three basic questions must be answered in
order to understand an economic system:
• What gets produced?
• How is it produced?
• Who gets what is produced?

CHAPTERCHAPTER
• Every society has some system or mechanism
that transforms that society’s scarce resources
into useful goods and services.

CHAPTERCHAPTER
• Production is the process that
transforms scarce resources into
useful goods and services.
• Resources or factors of production
are the inputs into the process of
production; goods and services of
value to households are the outputs
of the process of production.

CHAPTERCHAPTER
• The basic resources that are available
to a society are factors of production:
• Land
• Labor
• Capital
• Capital refers to the things that are
themselves produced and then used to
produce other goods and services.

CHAPTERCHAPTER
Scarcity and Choice
in a One-Person Economy
• Nearly all the basic decisions that
characterise complex economies
must also be made in a single-
person economy.
• Constrained choice and
scarcity are the basic concepts
that apply to every society.

CHAPTERCHAPTER
Scarcity and Choice
in a One-Person Economy
• Opportunity cost is that
which we give up or forgo,
when we make a decision
or a choice.

CHAPTERCHAPTER
Scarcity and Choice
in an Economy of Two or More
• A producer has an absolute
advantage over another in
the production of a good or
service if it can produce that
product using fewer
resources.

CHAPTERCHAPTER
Scarcity and Choice
in an Economy of Two or More
• A producer has a
comparative advantage in
the production of a good or
service over another if it can
produce that product at a
lower opportunity cost.

CHAPTERCHAPTER
Comparative Advantage
and the Gains From Trade
• 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.
Daily Production
Wood
(logs)
Food
(bushels)
Colleen 10 10
Bill 4 8

CHAPTERCHAPTER
Comparative Advantage
• 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 Production
Wood
(logs)
Food
(bushels)
Colleen 10 10
Bill 4 8

CHAPTERCHAPTER
Specialization, Exchange
and Comparative Advantage
• According to the theory of
competitive advantage,
specialization and free trade will
benefit all trading parties, even
those that may be absolutely more
efficient producers.

CHAPTERCHAPTER
Capital Goods and Consumer Goods
• Capital goods are goods used to
produce other goods and
services.
• Consumer goods are goods
produced for present
consumption.

CHAPTERCHAPTER
Capital Goods and Consumer Goods
• Investment is the process of using
resources to produce new capital.
Capital is the accumulation of
previous investment.
• The opportunity cost of every
investment in capital is forgone
present consumption.

CHAPTERCHAPTER
The Production Possibility Frontier
• 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.

CHAPTERCHAPTER
• The production
possibility frontier
curve has a negative
slope, which indicates
a trade-off between
producing one good or
another.

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

CHAPTERCHAPTER
• 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.

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

CHAPTERCHAPTER
• 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.

CHAPTERCHAPTER
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 theAs we increase the
production of one good, weproduction of one good, we
sacrifice progressively moresacrifice progressively more
of the other.of the other.

CHAPTERCHAPTER
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.

CHAPTERCHAPTER
Economic Growth
• An outward shift
means that it is
possible to increase
the production of one
good without
decreasing the
production of the other.
• Outward shifts of theOutward shifts of the
curve representcurve represent
economic growth.economic growth.

CHAPTERCHAPTER
Economic Growth
• From point D, theFrom point D, the
economy caneconomy can
choose anychoose any
combination ofcombination of
output between Foutput between F
and G.and G.

CHAPTERCHAPTER
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.

CHAPTERCHAPTER
Capital Goods and Growth
in Poor and Rich Countries
• Rich countries devote
more resources to capital
production than poor
countries.
• As more resources flow into
capital production, the rate
of economic growth in rich
countries increases, and so
does the gap between rich
and poor countries.

CHAPTERCHAPTER
Economic Growth
• By specializing and engaging in trade,
Colleen and Bill can move beyond their
own production possibilities.

CHAPTERCHAPTER
Economic Systems
• The economic problem:
Given scarce resources,
how, exactly, do large,
complex societies go about
answering the three basic
economic questions?

CHAPTERCHAPTER
Economic Systems
• Economic systems are the basic
arrangements made by societies to
solve the economic problem. They
include:
• Command economies
• Laissez-faire economies
• Mixed systems

CHAPTERCHAPTER
Economic Systems
• In a command economy, a central
government either directly or
indirectly sets output targets,
incomes, and prices.
• In a laissez-faire economy,
individuals and firms pursue their own
self-interests without any central
direction or regulation.

CHAPTERCHAPTER
Economic Systems
• The central institution of a laissez-
faire economy is the free-market
system.
• A market is the institution through
which buyers and sellers interact
and engage in exchange.

CHAPTERCHAPTER
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).

CHAPTERCHAPTER
Economic Systems
• Free enterprise: under a free
market system, individual
producers must figure out how to
plan, organize, and coordinate
the production of products and
services.

CHAPTERCHAPTER
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.

CHAPTERCHAPTER
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.

CHAPTERCHAPTER
Mixed Systems,
Markets, and Governments
Since markets are not perfect, governments intervene
and often play a major role in the economy. 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

CHAPTERCHAPTER
Review Terms and Concepts
absolute advantage
capital
command economy
comparative advantage,
theory of
consumer goods
consumer sovereignty
economic growth
economic problem
investment
laissez-faire economy
marginal rate of transformation (mrt)
market
opportunity cost
outputs
price
production
production possibility frontier (ppf)
resources or inputs
three basic questions

CHAPTERCHAPTER
Assigment Week-2
Question # 1. Human wants are unlimited, but
resources available to fulfill :
a. but resources are not
b. and neither does resources
c. and so the respurces
d. all are true
e. all are false
Question # 2. What gets produced? How is it
produced? and Who gets what is produced?
are :
a. three un-important questions
b. three fundamental questions
c. three basic questions
d. (b) and (c) are true
e. All are false
39 of 44
Question # 3. The process that transforms scarce
resources into useful goods and services,
called :
a. consumption
b. production
c. distribution
d. transfortation
e. transformation
Question # 4. The basic resources that are
available to a society are factors of
production:
a. Land
b. Labor
c. Capital
d. All are true
e. All are false

CHAPTERCHAPTER
Assigment Week-2
Question # 5. Opportunity cost is best defined
as :
a. the money spent once a choice is made.
b. the sum of all alternatives given up when a
choice is made.
c. the cost of a good, less profits.
d. the highest valued alternative given up when a
choice is made.
e. the cost of capital resources used in the
production of additional capital
Question # 6. If a producer (country or region)
can produce a product using fewer resources,
it is call that the producer :
a. has a comparative advantage
b. has an absolut advantage
c. competitive advantage
d. has a resources advantage
e. all are true 40 of 44
Question #7. If a producer (country or
region) can produce a product using
lower opportunity costs, it is call that
the producer :
a.has a comparative advantage
b.has an absolut advantage
c.competitive advantage
d.has a resources advantage
e.all are true
Question # 8. Those goods that used
to produce other goods and services,
called :
a.consumer goods and services
b.capital goods and services
c.productive goods and services
d.investment goods and services
e.all are true

CHAPTERCHAPTER
Assigment Week-2
Question # 9. Those goods that produced for
present consumption, called :
a. consumer goods and services
b. capital goods and services
c. productive goods and services
d. investment goods and services
e. all are true
Question # 10. 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, called :
a. production possibility frontier
b. consumption possibility frontier
c. distribution possibility froniter
d. transportation possibility frontier
e. transformation possibility frontier
41 of 44
Question # 11. If a nation is operating at a point
lying inside its production possibilities curve (at point
H), that is a sign of which of the following
conditions?
a.The nation is not fully or efficiently utilizing its
resources.
b.The nation has likely just discovered a
technological advance in one of its key industries.
c.The nation is clarly utilizing its resources
efficiently.
d.The nation is producing the maximum output that
can be produced with a limited quantity and quality
of resources.
e.The nation is producing the maximum output that
can be produced with its unlimited quantity of
resources.

CHAPTERCHAPTER
Assigment Week-2
Question # 12. An economy that produces only
bread and petroleum jelly, operating on a
bowed-out PPC (or PPF), now discovers a
new source of oil. Assume oil is an input only
in the production of petroleum jelly. Which of
the graphs in the figure below depicts the
resulting shift of the PPC?
a. Figure A
b. Figure B
c. Figure C
d. Figures B and C are both possible
e. None of these
42 of 44
Question # 13. Economic growth can be
illustrated :
a. by an inward shift of the production possibilities
curve.
b.by a downward movement along the production
possibilities curve.
c.by a movement toward the production
d.by an upward movement along the production
e.by an outward shift of the production possibilities
curve.
Question # 14. Marginal opportunity cost is
defined to be :
a.the declining ability of a country to correct its
balance of trade deficit.
b.always unchanging.
c.always decreasing.
d.less productive resources.
e.the amount of one good or service that must be
forgone to obtain an additional unit of another
good.

CHAPTERCHAPTER
Assigment Week-2
Question # 15. Given the differences in
opportunity costs within individual
countries, it makes sense for countries
a. to force protectionism of the most
important domestic industries, using
tariffs and quotas.
b. to devalue their currencies at least once
a year.
c. to specialize in activities in which
opportunity costs are highest and then
avoid trade in order to manage trade
deficit.
d. to insist upon protection against foreign
competition through legislation.
e. to specialize in activities in which
opportunity costs are lowest and then
trade.
43 of 44
Question # 16. When economists refer
to the public sector, they refer to:
a.the firms.
b.the public universities.
c.the political parties.
d.the government.
e.the households.
Question # 17. In general, the purpose of
markets is to
a.provide a means for unrecorded
payments.
b.provide a forum for exchange of political
benefits.
c.provide a means for illegal transactions.
d.facilitate the exchange of goods and
services between buyers and sellers.
e.facilitate the exchange of illegal
commodities

CHAPTERCHAPTER
Assigment Week-2
Question #18. Barter is trade :
a. without the use of money.
b. only with the use of money.
c. within countries who are
experiencing foreign currency
exchange problems.
d. only in underdeveloped
countries.
e. barter does not exist in
modern economy
44 of 44
Question # 19. Consumer sovereignty refers to :
a.the idea that the desires of both producers and the
government ultimately decide what is produced.
b.the idea that consumers try to maximize their
expenditures.
c.the idea that consumers ultimately determine what is
produced.
d.a situation in which the government decides what is
produced.
e.the fact that consumers' choices are limited to what the
producers decide to produce.
Question # 20. According to what we have learned,
there are significant differences between the market
system and the centrally planned system. All of the
following are differences except :
a.private individuals starting new businesses.
b.private ownership of land.
c.private ownership of businesses.
d.the existence of a government.
e.private choices and purchases of goods and services.

Chapter 2-the-economic-problems

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Similar to Chapter 2-the-economic-problems

Similar to Chapter 2-the-economic-problems (20)

Recently uploaded

Recently uploaded (20)

Chapter 2-the-economic-problems