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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 1 Copyright 2002, Pearson Education Canada Three Basic Economic Questions 2 Copyright 2002, Pearson Education Canada 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? 3 Copyright 2002, Pearson Education Canada 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. 5 Copyright 2002, Pearson Education Canada 4 Copyright 2002, Pearson Education Canada 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. 6 Copyright 2002, Pearson Education Canada 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 7 Copyright 2002, Pearson Education Canada 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 9 Copyright 2002, Pearson Education Canada 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. 8 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. 10 Copyright 2002, Pearson Education Canada 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 Copyright 2002, Pearson Education Canada Consumer goods 11 Copyright 2002, Pearson Education Canada 12 Copyright 2002, Pearson Education Canada 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. 13 Copyright 2002, Pearson Education Canada 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. Copyright 2002, Pearson Education Canada 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 17 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 Copyright 2002, Pearson Education Canada Economic Growth and Shifts in the PPF (Figure 2.4) Economic Growth 15 14 Point on PPF Copyright 2002, Pearson Education Canada 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. 16 Copyright 2002, Pearson Education Canada 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? 18 Copyright 2002, Pearson Education Canada 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 19 Copyright 2002, Pearson Education Canada 20 Copyright 2002, Pearson Education Canada 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. 21 Copyright 2002, Pearson Education Canada 22 Copyright 2002, Pearson Education Canada 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 23 Copyright 2002, Pearson Education Canada 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 24 Copyright 2002, Pearson Education Canada 4 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 25 z z z z z z z z z market opportunity cost outputs price producers production PPF resources or inputs three basic questions Copyright 2002, Pearson Education Canada 5