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A Lecture Presentation
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to accompany
Essentials of Economics
Second Edition
by Robert L. Sexton
Copyright © 2003 Thomson Learning, Inc.
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Printed in the United States of America
ISBN 0030342333
Copyright © 2003 by Thomson Learning, Inc.
Chapter 3
Scarcity, Trade-Offs and
Economic Growth
Copyright © 2003 by Thomson Learning, Inc.
3.1 The Three Economic Questions
Every Society Faces


Because of scarcity, certain economic
questions must be answered regardless
of the level of affluence of the society or
its political structure.
Three fundamental questions that
inevitably must be faced in a world of
scarcity are:
What is to be produced?
 How are these goods to be produced?
 For whom are the goods produced?

Copyright © 2003 by Thomson Learning, Inc.
3.1 The Three Economic Questions
Every Society Faces



In market-oriented economies, people
“vote” with their dollars.
Consumer sovereignty describes how
individual consumers in market
economies determine what is to be
produced.
Market economies largely rely on a
decentralized decision-making process, in
which literally millions of individual producers
and consumers of goods and services
determine what goods will be produced
Copyright © 2003 by Thomson Learning, Inc.



Economies are organized in different ways to answer
the question of what is to be produced.
Command economies rely on central planning,
where decisions about what is produced is largely
determined by a government official or a committee
associated with the central planning organization.
Most countries, including the United States, have
mixed economies in which the government and
private sector together determine the allocation of
resources.
Copyright © 2003 by Thomson Learning, Inc.
Exhibit 1: Government Spending as a
Percentage of GDP
70
60
50
40
30
20
10
0
Copyright © 2003 by Thomson Learning, Inc.
3.1 The Three Economic Questions
Every Society Faces




All economies, regardless of political structure,
must decide how, from several possible ways,
to produce the goods and services that they
want.
For example, when digging a ditch, a contractor
must decide between many workers using their
hands, a few workers with shovels, or one
person with a backhoe.
A decision must be made as to which method is
appropriate.
The best method is the least-cost method.
Copyright © 2003 by Thomson Learning, Inc.
3.1 The Three Economic Questions
Every Society Faces



The best or "optimal" form of production
will vary from one economy to the next.
Each nation tends to use the production
processes that conserve its relatively
scarce (and thus relatively more
expensive) resources and use more of its
relatively abundant resources.
Labor intensive methods will be used
where capital is relatively scarce and
capital intensive methods will be used
where labor is relatively scarce.
Copyright © 2003 by Thomson Learning, Inc.
3.1 The Three Economic Questions
Every Society Faces

In every society, some mechanism must
exist to determine how goods and
services are to be distributed among the
population.
Who gets what?
 The distribution of income is an issue
that always arouses strong emotional
responses.

Copyright © 2003 by Thomson Learning, Inc.
3.1 The Three Economic Questions
Every Society Faces


In a market economy, the amount of
output one is able to obtain depends on
one's income, which in turn, depends on
the quantity and quality of the scarce
resources that the individual controls.
For example, Tiger Woods' income is
very large because his skills are unique
and marketable.
Copyright © 2003 by Thomson Learning, Inc.
Why do actors make so much money?
Copyright © 2003 by Thomson Learning, Inc.
3.2 The Circular Flow Model

Goods and services bought and sold
flow continuously between the
producers of goods and services (firms),
and the buyers of goods and services
(households).
Copyright © 2003 by Thomson Learning, Inc.
3.2 The Circular Flow Model


Income also flows continuously from
firms to households as firms buy the
inputs to produce the goods and
services they sell.
These exchanges take place in product
markets and factor markets.
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3.2 The Circular Flow Model

Product markets



the markets for consumer goods and
services
Households buy and firms sell.
Payments for purchases flow to firms at the
same time that goods and services flow to
households.
Copyright © 2003 by Thomson Learning, Inc.
3.2 The Circular Flow Model

Factor or input markets

the markets where households sell their
factors of production to firms.
capital
 land
 labor
 entrepreneurship


Households receive money payments from
firms as compensation.
Copyright © 2003 by Thomson Learning, Inc.
3.2 The Circular Flow Model

Circular flow model of income and
output


Illustrates the continuous flow of goods and
payments between firms and households,
with the product market on the top half and
the factor or input markets on the bottom
half.
However, the main point is that buyers
have sellers.
Copyright © 2003 by Thomson Learning, Inc.
The Circular Flow Model of Income and
Output
Spending ($) (=GDP)
Revenues ($) (=GDP)
Product Markets
Goods and
Services
Purchased
Goods and
Services Sold
Flows of Goods and Services
Firms
Households
Flows of Dollars
Labor, Land, Capital
and Entrepreneurship
Inputs for
Production
Factor Markets
Income ($) (=GDP)
Copyright © 2003 by Thomson Learning, Inc.
Wages, Rent, Interest
and Profits ($) (=GDP)
3.3 The Production Possibilities Curve


The economic concepts of scarcity, choice
and trade-offs can be illustrated by the use
of a production possibilities curve,
which represents the potential total output
combinations of any two goods for an
economy.
That is, it illustrates an economy's potential
for allocating its limited resources for
producing various combinations of goods,
in a given time period.
Copyright © 2003 by Thomson Learning, Inc.
3.3 The Production Possibilities Curve

The production possibilities curve
discussion begins with a straight-line
production possibilities curve, with the
goods being one's grade in economics
and one's grade in history.
Copyright © 2003 by Thomson Learning, Inc.
Expected Grade in Economics
Exhibit 1: Production Possibilities Curve:
"Producing" Grades in Economics and History
A 95
10 Hours Economics
0 Hours History
7.5 Hours Economics
2.5 Hours History
B 85
5 Hours Economics
5 Hours History
C 75
2.5 Hours Economics
7.5 Hours History
D 65
F 55
55
F
0 Hours Economics
10 Hours History
65
75
85
95
D
C
B
A
Expected Grade in History
Copyright © 2003 by Thomson Learning, Inc.
3.3 The Production Possibilities Curve

On a production possibilities curve, we
assume that the economy has a given
quantity and quality of resources and
technology available to use for
production.
Copyright © 2003 by Thomson Learning, Inc.
3.3 The Production Possibilities Curve


Using an example involving food and
shelter we can see a concave (bowed)
production possibilities curve.
Each point represents the potential
amounts of food and shelter that can be
produced in a given time period, given
the quantity and quality of resources
available.
Copyright © 2003 by Thomson Learning, Inc.
Shelter (units)
Exhibit 2: Production Possibilities Curve: The
Trade-Off Between Shelter and Food
10 A
9
8
7
6
5
4
3
2
1
0
 All
B
N
(Not Attainable)
C
I
(Inefficient)
20
D
40
60
Food (units)
 Any
E
80
the points on
the production
possiblilities
curve are
efficient.
 Any points in the
shaded area are
inefficient.
point outside the production possibilities
curve is not attainable at the present time.
Copyright © 2003 by Thomson Learning, Inc.
3.3 The Production Possibilities Curve


The economy cannot produce beyond
the levels indicated by the production
possibilities curve during a given time
period, because there are not enough
resources to produce that output.
However, it is possible to operate inside
the production possibilities curve.
Copyright © 2003 by Thomson Learning, Inc.
3.3 The Production Possibilities Curve


If an economy is operating inside its
production possibilities curve, it is not at
full capacity, and is operating
inefficiently.
The economy is not getting the most it
can from its scarce resources; as a
result, actual output is less than
potential output.
Copyright © 2003 by Thomson Learning, Inc.
3.3 The Production Possibilities Curve


Efficiency requires society to use its
resources to the fullest extent—getting
the most we can out of our scarce
resources; that is, there are no wasted
resources.
If resources are being used efficiently,
at a point along a production
possibilities curve, more of one good or
service requires the sacrifice of another
good or service as its cost.
Copyright © 2003 by Thomson Learning, Inc.
3.3 The Production Possibilities Curve


Efficiency does not tell us which point
along the production possibilities curve
is best.
But it does tell us that points inside the
curve cannot be best because some
resources are wasted.
Copyright © 2003 by Thomson Learning, Inc.
3.3 The Production Possibilities Curve


The production possibilities curve is not
a straight line.
It is concave from below (that is, bowed
outward from the origin), reflecting
increasing opportunity costs of
producing additional amounts of a good.
Copyright © 2003 by Thomson Learning, Inc.
Shelter (unit)
Exhibit 3: Increasing Opportunity Cost and the
Production Possibilities Curve
10
9
8
7
6
5
4
3
2
1
A
Opportunity cost in forgone shelter
(1) to obtain 20 additional food
0
Copyright © 2003 by Thomson Learning, Inc.
B
Opportunity cost in forgone shelter
(2) to obtain 20 additional food
C
Opportunity cost in
forgone shelter (3) to
obtain 20 additional
food
D
Opportunity cost in
forgone shelter (4) to
obtain 20 additional
food
E
20
40
60
Food (units)
80
3.3 The Production Possibilities Curve


The basic reason for increasing
opportunity cost is that some resources
and skills cannot be easily adapted from
their current uses to alternative uses.
Easily adaptable resources are soon
exhausted and resources and workers
that are less well suited or appropriate
(those with a relatively greater
opportunity cost) must then be
employed to increase output further.
Copyright © 2003 by Thomson Learning, Inc.
Exhibit 4: Opportunity Costs
for Cattle and Wheat
Quantity of Cattle
A
B
50
C
45
Opportunity cost
40
D
in forgone cattle
35
(25) to obtain 10
30
E additional
25
bushels of wheat
20
15
10
F
5
0 5 10 15 20 25 30 35 40 45 50
Quantity of Wheat (bushels)
Copyright © 2003 by Thomson Learning, Inc.
3.4 Economic Growth and the
Production Possibilities Curve


To generate economic growth, a society
must produce fewer consumer goods
and more capital goods in the present.
They must sacrifice some consumption
of consumer goods in the present in
order to experience growth in the future.
Copyright © 2003 by Thomson Learning, Inc.
3.4 Economic Growth and the
Production Possibilities Curve


Investing in capital goods will increase
the future production capacity of the
economy.
So an economy that invests more and
consumes less now will be able to
produce and consume more in the
future.
Copyright © 2003 by Thomson Learning, Inc.
3.4 Economic Growth and the
Production Possibilities Curve


An economy can only grow with
qualitative or quantitative changes in the
factors of production–land, labor, capital
and entrepreneurship.
Advancements in technology,
improvements in labor productivity or
new natural resource finds could all lead
to outward shifts of the production
possibilities curve.
Copyright © 2003 by Thomson Learning, Inc.
3.4 Economic Growth and the
Production Possibilities Curve


Economic growth means an outward
shift in the “menu” of possible bundles
of output illustrated by the production
possibilities curve.
With growth comes the possibility to
have more of both goods than were
previously available.
Copyright © 2003 by Thomson Learning, Inc.
Shelter (unit)
Exhibit 1: Economic Growth
and Production Possibilities
18
16
14
12
A
10
B
9
8
C
7
6
Old
5
production
4
3 possibilties
2 curve
New
production
possibilties
curve
F (FUTURE)
D
1
0
E
20
40
60
80
Food (units)
Copyright © 2003 by Thomson Learning, Inc.
100
120
3.4 Economic Growth and the
Production Possibilities Curve



It is important to remember that
increases in a society's output do not
make scarcity disappear.
Even when output has grown more
rapidly than population, so people are
made better off, they still face trade-offs.
At any point along the production
possibilities curve, in order to get more
of one thing, you must give up
something else.
Copyright © 2003 by Thomson Learning, Inc.
3.4 Economic Growth and the
Production Possibilities Curve


An economy that invests more of its
resources for the future devotes a larger
share of its productive capacity to
capital goods rather than consumption
goods.
Economies that choose to invest more
of their resources for the future will grow
faster than those that don't, other things
equal.
Copyright © 2003 by Thomson Learning, Inc.
Exhibit 2: Economic Growth
and the Production Possibilities Curve
Capital Goods (K)
Economy (A)
2012
KA
2002
CA
Consumer Goods (C)
Copyright © 2003 by Thomson Learning, Inc.
Exhibit 2: Economic Growth
and the Production Possibilities Curve
Capital Goods (K)
Economy (B)
2012
2002
KB
CB
Consumer Goods (C)
Copyright © 2003 by Thomson Learning, Inc.
3.4 Economic Growth and the
Production Possibilities Curve


The production possibilities curve can
be used to illustrate the economic
concepts of scarcity, choice, opportunity
costs, efficiency, and economic growth.
Scarcity is represented by the fact that
resource combinations outside the
production possibility curve are
unattainable.
Copyright © 2003 by Thomson Learning, Inc.
3.4 Economic Growth and the
Production Possibilities Curve


Choice is the fact that one must choose
among the alternative bundles available
along the production possibilities curve.
Opportunity costs are how much of one
good you give up to get another unit of
the second good as you move along the
production possibilities curve.
Copyright © 2003 by Thomson Learning, Inc.
3.4 Economic Growth and the
Production Possibilities Curve


Efficiency would mean being on the
production possibilities curve rather
than inside it.
Economic growth is represented by
shifting out the production possibilities
curve.
Copyright © 2003 by Thomson Learning, Inc.
Quantity of Military Goods
Exhibit 3: Production Possibilities Curve
Economic
growth
D
C
B
A
0
Quantity of Consumer Goods
Copyright © 2003 by Thomson Learning, Inc.
Average Annual per Capita Real GDP
Growth Rate (1970–90)
Exhibit 4: Correlation
of Investment and Growth
4.0
Irelan
d
3.5
3.0
2.5
2.0
1.5
Japa
n
Icelan
d
Portugal
Finlan
d
Austria
Norwa
y
Turke
Canad Italy
y
Belgium
Spai
a Greec
n
United
German
e
Luxembourg
Kingdom
y
Franc
Australi
e
Denmark
Netherlands a
Sweden
United
Switzerlan
States
New Zealand
d
1.0
0.5
0.0
16
18
20
22
24
26
28
Investment as Share of GDP (average, 1970-1990)
Copyright © 2003 by Thomson Learning, Inc.
30
32