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CHAPTER 1
SCARCITY, CHOICE, AND OPPORTUNITY COSTS
After reading Chapter 1, SCARCITY, CHOICE, AND OPPORTUNITY COSTS, you should be able to:
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Define ECONOMICS.
Identify and explain the major themes in studying economics such as SCARCE RESOURCES,
CHOICE, SPECIALIZATION, and EXCHANGE.
Discuss factors that differ between ECONOMIC SYSTEMS.
Define the ECONOMIC PROBLEM and explain the role played by society's limited resources
compared to people's unlimited wants.
Illustrate the PRODUCTION POSSIBILITIES FRONTIER and discuss the meaning of
OPPORTUNITY COST.
Differentiate between MACROECONOMICS and MICROECONOMICS.
Distinguish between POSITIVE and NORMATIVE ECONOMICS and give an example of each.
CHAPTER OUTLINE
I.
DEFINITION OF ECONOMICS AND ITS BASIC CONCEPTS
A.
B.
Economics studies how economic agents are guided by the existing economic system to choose how
to use their scarce resources to specialize in production and how they engage in exchange in order
to consume a variety of different goods and services.
The six basic concepts in the definition of economics are:
1. ECONOMIC AGENTS: Participants in the economy such as households, governments and
business firms.
2. SCARCE RESOURCES: Productive resources (also called factors of production) such as
land, labor, and capital, for which the limited amount available is less than the amount that
would be demanded if the resource was given away for free.
3. CHOICE: Because resources are scarce, people must decide how to use them.
4. SPECIALIZATION: Agents produce a limited number of things that they can make better
than others.
5. EXCHANGE: Because agents produce only a few things, to consume other goods they must
engage in trade with other (specialist) producers.
6. ECONOMIC SYSTEM: The set of arrangements society uses to deal with the fact that there
are only a limited amount of products and resources available. In a capitalist society, people
own the productive resources; in a socialist economy, the government owns most of the scarce
resources.
II. LIMITED RESOURCES VERSUS UNLIMITED WANTS
A.
Human wants (the amounts of goods that would be desired if they were free) are unlimited but
resources are limited. Thus, the law of scarcity states that wants always exceed society's ability to
meet them. Therefore, every society faces the ECONOMIC PROBLEM of somehow choosing
what to produce, how to produce, and for whom to produce.
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B.
C.
The three basic questions in this decision are:
1. WHAT: What goods and services should be produced?
2. HOW: What combinations of resources should be devoted to manufacturing the goods and
services produced?
3. FOR WHOM: How many of the goods and services produced will each individual receive?
The imbalance between wants and the ability to meet them requires an economic system to provide
for orderly allocation of scarce resources.
III. OPPORTUNITY COST
A.
B.
C.
The OPPORTUNITY COST of any action is the loss of the next best alternative that the action
eliminates.
A FREE GOOD has zero opportunity cost because no other good has to be given up in order to
have more of the free good.
A SCARCE GOOD has a positive opportunity cost, because in order to have more of it some other
good must be sacrificed.
IV. PRODUCTION-POSSIBILITIES AND OPPORTUNITY COST
A.
B.
The
PRODUCTIONPOSSIBILITIES
FRONTIER
(PPF),
illustrated above,
shows all the possible
combinations
of
output that can be produced
when resources are
used to their fullest.
1. Points on the
frontier, such as b, are
attainable by
the economy and are
efficient.
2. Points beyond
the frontier, such as c, are
not attainable.
3. Points within the frontier, such as a, are attainable but are inefficient since they occur when
resources are either unemployed or incorrectly allocated.
The production-possibilities frontier is bowed out because of the LAW OF INCREASING
COSTS, which states that as more of any product is produced the opportunity cost of its production
rises.
V. MACROECONOMICS AND MICROECONOMICS
A.
B.
MACROECONOMICS studies economy-wide issues such as total employment and
unemployment, the general movement of prices (inflation), the determinants of total output, and
economic growth.
MICROECONOMICS studies the behavior of individual parts of the economy, such as firms,
industries and households.
VI. ECONOMIC THEORIES
A.
ECONOMIC THEORIES are explanations of how and why certain economic facts are related.
Because the real world is immensely complicated, by necessity theories focus on only the most
important factors necessary to understand the economic event. Theories contain predictions about
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B.
C.
the associations between facts.
POSITIVE ECONOMICS: Statements about how the world actually operates.
NORMATIVE ECONOMICS: Statements about how the world should be.
REVIEW QUESTIONS
True or False
If the statement is correct, write true in the space provided; if it is wrong, write false. Below the question
give a short statement that supports your answer.
____ 1.
Economics deals with only large issues such as total output and unemployment.
____ 2.
Economics does not contribute to an understanding of how business firms decide to produce
their products.
____ 3.
Scarcity exists even in very rich societies.
____ 4.
All factors of production are scarce goods.
____ 5.
Salt water from the ocean is not a scarce good because there is more than the amount people
want when it is free.
____ 6.
The "what" question concerns what goods society should produce.
____ 7.
The use of skilled labor to produce automobiles involves an opportunity cost.
____ 8.
The law of increasing costs is the reason why the production possibilities frontier is bowed out.
____ 9.
Normative economics tries to explain how various facts are related.
____ 10. Economists frequently agree on positive issues but disagree on normative subjects.
____ 11. Clean air in the middle of a smog alert is a scarce good.
____ 12. Total output and unemployment are topics studied in macroeconomics.
____ 13. Bubble gum is not a scarce good, because I can get as much of it as I want.
____ 14. People's wants are small compared to the production capacity of a modern economy such as that
of the United States.
____ 15. Because this course in economics is so valuable, the time spent studying it has no opportunity
cost.
____ 16. Points beyond the production possibilities frontier are attainable and efficient.
____ 17. If the economy is producing at a point on the production possibilities frontier, it is possible for
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the economy to produce more of all types of goods.
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____ 18. The "how" question refers to how society decides who gets what quantities of the produced
goods.
____ 19. Every time a scarce good is used, an opportunity cost is involved.
Multiple Choice
Circle the letter corresponding to the correct answer.
1.
The fundamental reason people must choose which goods to buy and consume is because of
a. scarcity.
b. specialization.
c. people engaging in exchange.
d. the fact there are many different economic agents.
e. the great abundance of free resources.
2.
Which of the following is not a scarce resource?
a. Labor, when the unemployment rate is near 10 percent
b. Fertile land in Kansas
c. Sunshine for solar power in the deserts of Arizona
d. Factories used to produce personal computers
e. People able to repair industrial robots
3.
The primary reason people engage in exchange is because
a. most people have not studied economics.
b. there are many economic agents in every society.
c. people increase their well-being by specializing.
d. economic agents must make choices.
e. all of the above.
4.
An example of the "for whom" part of the economic problem is
a. Should pro-football quarterbacks be paid more than economists?
b. Who should decide what goods are produced?
c. How does the nation decide who should be a doctor and who should be a writer?
d. Should more food and fewer diamonds be produced?
e. None of the above
5.
Microeconomics studies such topics as
a. the factors that determine inflation.
b. the forces that influence the price of shoes.
c. the determinants of total output.
d. whether the unemployment rate will rise or fall.
e. the overall trend in stock market prices.
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Use the following production possibilities frontier for the next three questions.
6.
Which point(s) is
production?
a. A
b. B
c. C
d. D
e. C and D
currently not an attainable point of
7.
Which point(s)
production?
a. A
b. B
c. C
d. D
e. B and C
shows an efficient combination of
8.
Which point(s) shows production levels where there is either unemployment or another type of
misallocation of resources?
a. A
b. B
c. C
d. D
e. A and C
9.
Which of the following is a positive economic statement?
a. If the government increases its tax on gasoline, the price people pay for gasoline will rise.
b. The government should not let the price of gasoline rise, because this increase would harm poor
people.
c. The government should let the price of gasoline rise, because this would help retired people who
own stock in petroleum companies.
d. The government ought not to control the price of gasoline, because its price should be determined in
the free marketplace.
e. None of the above, because they are all normative in nature.
10. Economists tend to disagree primarily about
a. the implications of scarcity for our economy.
b. which resources are free.
c. topics in positive economics.
d. issues of normative economics.
e. the importance of the law of increasing costs.
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Essay Questions
Write a short essay answering each question.
1. Some futurists claim that we currently are emerging from a "world of scarcity" and entering a "world of
abundance." If this is so, what changes will we see in people's buying habits? Based on the discussion
in this chapter, do you think such a claim can be valid?
2. Suppose an increase in the minimum wage makes some people better off and others worse off. Is it
possible to make a positive economic statement that the minimum wage should be raised? Why?
3. "Because macroeconomics studies issues that affect the entire economy, it must be a more important
subject than microeconomics." Comment on this statement.
4. Why do people specialize? Why don't they try to be as self-sufficient as possible?
5. Draw a production possibility frontier between two goods, say Good Y, measured on the vertical axis,
and Good X, measured on the horizontal axis. Why is the production possibilities frontiers bowed out?
ANSWERS TO REVIEW QUESTIONS
True or False
False
1. Macroeconomics deals with large issues; microeconomics, however, studies the behavior of
individual participants in the economy.
False
2. This is one of the topics studied by microeconomics.
True
3. Even very rich societies cannot have everything their citizens would want if everything were
free. All societies face scarcity.
False
4. While most factors of production are scarce, a few, such as sunlight, are free.
True
5. This is the definition of a "free good."
True
6. This is one of the three questions that make up the economic problem.
True
7. For example, if the skilled laborers were not manufacturing cars, they could be producing
tractors. Thus, the tractors sacrificed are the opportunity cost of the cars.
True
8. If the production of one type of good is increased, eventually resources that are poorly suited
for its production must be used, and the opportunity cost of producing more of it increases.
False
9. Positive economics explains how facts are related; normative economics is a value judgment
about whether a policy or outcome is good or bad.
True
10. Disagreements among economists, which are often widely publicized, usually center around
normative judgments about what is good for the country.
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True
11. Notice how something that is usually a free good can turn into a scarce good at certain times
and places.
True
12. These are two very important economy-wide issues examined by macroeconomics.
False
13. While I may be able to get all the gum I would want if it were free, the total amount of gum
provided is less than what everyone in society would want if the gum were free.
False
14. The amount of things people would demand if all prices were zero (which is the definition of
their wants) dwarfs the productive capacity of the American economy.
False
15. The opportunity cost is the next best alternative for your time that you sacrificed so you could
study this course.
False
16. Points beyond the frontier are not attainable by the society.
False
17. Along the frontier, an increase in the production of one product necessarily requires a decrease
in the production of another good. This reduction is the opportunity cost of raising the output of
the first good.
False
18. The "how" question refers to how things will be produced.
True
19. Scarce goods are defined as goods with a positive opportunity cost.
Multiple Choice
1.
a. If resources were not scarce, everyone could have everything he or she wanted, so there would be
no need to choose between alternative goods.
2.
c. If the prices of all the other resources listed were set to zero, the amount people would want of
them would vastly exceed the amount offered. Therefore, by definition, these resources are scarce.
3.
c. Since people typically specialize in the production of only a few goods, in order to consume a
variety of different goods, people must trade with other (specialist) producers.
4.
a. The "for whom" question asks for whom the goods should be produced. If quarterbacks are paid
more than economists, quarterbacks will be able to buy more goods and services so that more of
society's products will be produced for them.
5.
b. Microeconomics studies the decision making of individual economic actors, such as the pricing
decisions of individual shoe companies.
6.
d. Point D lies beyond the frontier line, so it is unattainable.
7.
e. Any point on the production possibilities frontier is an efficient point of production; thus both B
and C are efficient. Of course, at point C no food is being produced, so while this may be an
unlikely production point, nonetheless it is an efficient point.
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8.
a. Points inside the frontier line are inefficient levels of production.
9.
a. This statement could be wrong, but because it tries to explain how the world actually works it is a
positive statement.
10. d. Economists, like any other group of people, may well disagree about what policies are best for the
nation.
Essay Questions
1. If the world were truly entering a period of "abundance," people's economic problems would be solved.
Resources would not be scarce and so there would not be any hard choices about buying one good rather
than another. This utopian view of the future is unrealistic, for some resources (such as human labor)
will remain scarce forever. The world will never enter a time in which infinite amounts of everything
can be produced; scarcity will continue to be with us.
2. No, it is not possible. Any decision about the desirability of raising the minimum wage must balance the
people who will be helped against those who will be harmed. Such a comparison inevitably involves a
decision about whether the government should help or harm the different groups and so it involves
normative issues.
3. Macroeconomics is not more important than microeconomics. Microeconomics issues play an
important role in determining our standard of living. For instance, microeconomics studies factors that
determine people's wages. In addition, it examines under what conditions firms will produce their output
as efficiently as possible, which also an important topic.
4. People specialize because it allows them to increase their overall level of well-being. Specialization
allows people to become experts in their fields. An economy made up of experts can produce more than
one in which there are none. If everyone were self-sufficient, they would forego the opportunity to trade
with other specialist-experts.
5. The
production
possibilities diagram is illustrated
above. The bowed-out
shape reflects the law of increasing
costs. As more of a good
is produced, additional resources must
be devoted to its
manufacture and away from the
production of other
items. As more and more of these
extra resources are used,
they become increasingly less
suitable.
Thus
the
amount of resources that must be
shifted increases, so the
reduction in the production of other
things increases. For
example, consider moving from point
A to point B on the
production possibilities frontier. This
requires that resources
be switched away from the production
of good Y and into the production of good X. The first resources that are shifted are those that are
relatively good at producing X (and bad at producing Y). Eventually, however, resources must be moved
that are not so good at producing X (and not so bad at producing Y). Hence, since the resources are not
as well suited at producing X, more must be switched. As a result, the opportunity cost of producing
more X (in terms of the amount of Y that must be sacrificed) increases.
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