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The Economic Problem:
Scarcity and Choice
Resources (Inputs) Used in Production
z Capital
Chapter 2
y Things that have already been produced that are
used to produce other goods and services, e.g.,
buildings, machinery, roads.
z Human Resources
y Labour, Skills and Knowledge
z Natural Resources
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Three Basic Economic Questions
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Opportunity Cost
z What will be produced?
z How will it be produced?
z Recall, opportunity cost is that which we give up
or forgo, when we make a decision or choice.
z Who will get what is produced?
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The Theory of Comparative Advantage
z Ricardo’s theory that specialization and free
trade will benefit all trading parties, even those
that may be absolutely more efficient producers.
z A person or country is said to have a
comparative advantage in producing a good if it
is relatively more efficient than a trading partner
at doing so. In other words, they have a lower
opportunity cost.
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Comparative Advantage Example
Production per
day
Shelter ( logs )
Food ( baskets )
Colleen
10
10
Ivan
5
8
Production values assume that each person is only
producing that good, so for instance Colleen can
produce 10 logs or 10 baskets of food.
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1
Calculate Opportunity Cost
How should each specialize?
z 10 logs cost Colleen 10 baskets of food
z 5 logs cost Ivan 8 baskets of food
z For Shelter:
z Colleen can produce logs cheaper than Ivan and
therefore should produce shelter.
y 1 log costs Colleen 1 basket of food
y 1 log cost Ivan 1.6 baskets of food
z For Food:
y 1 basket costs Colleen 1 log
y 1 basket costs Ivan .625 logs
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Consumer Goods, Capital Goods and
Investment
z A capital good can be considered as anything
that is produced that will be used to produce
other valuable goods or services over time.
z Investment is the process of using up resources
for the production of capital or simply
purchasing capital.
z Consumer goods are those produced for present
consumption
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Production Possibility Frontier
z Ivan can produce food/baskets cheaper than
Colleen and therefore should produce food.
z If each produces according to his/her
comparative advantage, production is
maximized.
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Production Possibility Frontier (PPF)
z The PPF is a graph that shows all the
combinations of goods and services that can be
produced if all of society’s resources are used
efficiently.
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PPF and Opportunity Cost (Figure 2.3)
z Producing tomatoes at D
instead of E, means
producing beef at D
instead of E. 250 million
more tomatoes at a cost
of 100 million kg of beef.
z The curve has a negative
slope.
z The curve is concave to
the origin.
Capital goods
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Consumer goods
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2
Law of Increasing Opportunity Cost
PPF and Production Possibilities Schedule
for Beef and Tomatoes (Figure 2.3 and Table 2.1)
z The opportunity cost of producing a good
increases as more resources are shifted into its
production.
z This is clearly shown in the Production
Possibility Schedule for tomato and beef
production.
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z Economic growth is an increase in the total
output of an economy.
z It occurs when a society acquires new resources
or when it learns to produce more using existing
resources.
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The PPF shows us several things . .
z
z
z
z
z
z
Productive efficiency (or maximum output)
Scarcity
Choice
Opportunity costs
Increasing opportunity costs
Economic growth
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Total Tomato
Production(millions
of kg)
Total Beef
Production(millions of
kg)
A
1500
0
B
1400
400
C
1100
800
D
800
1100
E
550
1300
F
0
1400
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Economic Growth and Shifts in the
PPF (Figure 2.4)
Economic Growth
15
14
Point on
PPF
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z New resources or
technology can
shift the PPF
outward.
z The shift may or
may not be parallel
depending on
where the
productivity
increases are
concentrated; in
this case, tomatoes
more than beef.
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The Economic Problem
z Given scarce resources how exactly, do large,
complex societies go about answering the three
basic economic questions?
y What will be produced?
y How will it be produced?
y Who will get what is produced?
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3
Economic Systems
Command Economy
z Command Economy
z An economy in which a central authority or
agency draws up a plan that establishes what
will be produced and when, sets production
goals, and makes rules for distribution.
z Laissez-Faire Economies: Free Market
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Laissez-faire Economy
Markets
z Literally from the French: “allow (them) to do”
z An economy in which individuals and firms
pursue their self-interests without any central
direction or regulation.
z The central institution in these economies is
called the market.
z The institutions through which buyers and
sellers interact and engage in exchange.
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Important aspects of Market
Economies:
A Role for Government:
Mixed Market Economies
z Consumer sovereignty
z
z
z
z
y The idea that consumers ultimately dictate what will
be produced (or not produced) by choosing what to
purchase (and what not to purchase).
z Individual production decisions
z Distribution of output decentralized
z Price theory
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Minimize market inefficiencies
Provision of public goods
Redistribution of income
Stabilize the macroeconomy
y Promote low levels of unemployment
y Promote low levels of inflation
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Review Terms and Concepts
z
z
z
z
z
z
z
z
z
capital
command economy
comparative advantage
consumer goods
consumer sovereignty
economic growth
economic problem
investment
laissez-faire economy
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z
z
z
z
z
z
z
z
z
market
opportunity cost
outputs
price
producers
production
PPF
resources or inputs
three basic questions
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