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CHAPTER OUTLINE:
Scarcity, Choice, and
Opportunity Cost
Scarcity and Choice in a
One-Person Economy
Scarcity and Choice in an
Economy of Two or More
The PPF
The Economic Problem
Economic Systems
Command Economies
Laissez-Faire Economies:
The Free Market
Mixed Systems, Markets,
and Governments
Factors of production :
The inputs into the process of production. Another term for resources.
Factor 1: Land
means all natural resources on or under the ground includes:
water, forests, wildlife, mineral deposits.
Factor 2: Labor
is all the human time, effort, talent used to make products physical and
mental effort used to make a good or provide a service.
Factor 3: Capital
is a producer’s physical resources includes tools, machines, offices, stores,
roads, vehicles; sometimes called physical capital or real capital
Factor 4: Entrepreneurship
vision, skill, ingenuity, willingness to take risks. Entrepreneurs anticipate
consumer wants, satisfy these in new ways develop new products, methods of
production, marketing or distributing risk time, energy, creativity, money to
make a profit.
production
The process that transforms scarce resources into useful
goods and services.
inputs or resources
Anything provided by nature or previous generations that
can be used directly or indirectly to satisfy human wants.
outputs
Goods and services of value to households.
Three Basic Economic Questions
Every society must answer three basic economic questions
because of scarcity.
What will be produced?
How will it be produced?
Who will get what is produced?
Societies answer these questions differently, leading to a
variety of economic systems.
Scarcity
is the economic problem of having seemingly
unlimited human needs and wants, in a world of
limited resources.
Why does it exist?
It exists because wants are unlimited and resources are
limited.
Wants — desires that can be met by consuming products.
Needs — things necessary for survival.
The concepts of constrained choice and scarcity are
central to the discipline of economics.
Opportunity cost
is that which we give up or forgo, when we make a
decision or a choice.
or
Opportunity cost
is value of next-best alternative a person gives up
-not the value of all possible alternatives-
An idea closely related to opportunity cost is
called comparative advantage.
Comparative advantage
the ability to produce a good at a lower opportunity
cost than another producer.
if you produce a good at a lower opportunity cost then
you should specialize in it.
Theory of comparative advantage
Ricardo’s theory that specialization and free trade will
benefit all trading parties, even those that may be
“absolutely” more efficient producers.
Comparative Advantage and the Gains From Trade
Daily Production
Colleen
Bill
Wood
(logs)
Food
(bushels)
10
4
10
8
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.
Capital goods
are goods used to produce other
goods and services.
Consumer goods
are goods produced for present
consumption.
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.
The production possibility frontier curve has a negative
slope, which indicates a trade-off between producing
one good or another.



Points inside of the curve are
inefficient.
At point H, resources are either
unemployed, or are used
inefficiently.
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.
 Point C is one of the possible
combinations
of
goods
produced when resources are
fully and efficiently employed.
 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.
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
the
production of one good, we
sacrifice progressively more
of the other.
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.
 Outward shifts of the curve
represent economic growth.
 An outward shift means that it is
possible to increase the production
of one good without decreasing the
production of the other.
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.
Economic Systems
The economic problem:
Given scarce resources, how, exactly, do large,
complex societies go about answering the three basic
economic questions?
Economic systems
are the basic arrangements made by societies to solve
the economic problem.
They include:
 Command economies
 Laissez-faire economies
 Mixed systems
Economic Systems
Command economies
In a command economy,
a central government either directly or indirectly sets
output targets, incomes, and prices.
Economic Systems
Laissez-faire economies
In a laissez-faire economy, individuals and firms
pursue their own self-interests without any central
direction or regulation.
The central institution of a laissez-faire economy is
the free-market system.
market
is the institution through which buyers and sellers
interact and engage in exchange.
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).
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.
Income
is the amount that a household earns each year. It
comes in a number of forms: wages, salaries, interest,
and the like.
Wealth
is the amount that households have accumulated out of
past income through saving or inheritance.
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.
Economic Systems
Mixed systems
Most modern economies are a mixture
of market systems and centralized decisionmaking. These are known as mixed economies.
Differences Between Command Economies,
Free Market Economies, And Mixed
Economies
There are differences in terms of the ways they address the
three basic economic questions:
 Market-type economic systems answer these questions in a
decentralized manner.
Differences Between Command Economies,
Free Market Economies, And Mixed
Economies
There are differences in terms of the ways they address the
three basic economic questions:
 Command economies, on the other hand, address these
questions via centralized decision-making, usually by a
centralized governmental authority.
Differences Between Command Economies,
Free Market Economies, And Mixed
Economies
There are differences in terms of the ways they address the
three basic economic questions:
 Mixed economies combine market-type systems with some
degree of governmental intervention.