CHAPTER 2 THE
ECONOMIC PROBLEM:
SCARCITY AND CHOICE
2.1 Three basic questions
EX: American Airline It uses
• runways – land
• pilots and mechanics – labor <= Resources • airplanes – capital
to produce transportation services <= producers
2.2 Scarcity and opportunity cost
Scarcity
EX 1 – I want to buy an island, but I only make $1,000 a month
=> constraint is money
EX 2 – If I spend one hour studying for an economic exam, I have one less hour to spend studying for a math exam or going to the movies. Should I study economics or math or watch movies?
2.2 Scarcity and opportunity cost
Scarcity
EX 3 – if BMW devotes some of the scarce workers and machines in producing Z4 roadsters, those resources will not be available to produce more SUVs. Should BMW produce Z4 or SUV?
2.2 Scarcity and opportunity cost
Opportunity cost
EX1: the O.C. of going to college for a year
• tuition
• books and fees • forgone wages
2.2 Scarcity and opportunity cost
Opportunity cost
EX2: the O.C. of seeing a movie
• the price of the ticket
2.2 Scarcity and opportunity cost
Opportunity cost
EX3: the O.C. of going to a basketball game may be the five or ten extra points you might have earned on an exam by staying home and studying that night
2.3 One-person economy
2.3 One-Person Economy
• Resource – time (24 hours)
• Allocation:10 hours for production, 4 hours for lying on
beach, 8 hours for sleep
fish bird
2.3.1 Production Possibilities Frontier –
O.C. is constant
1) Production Possibilities Frontier (PPF): a graph showing the maximal different combinations of output for a given
amount of inputs
• More of one good Less of another
2.3.1 Production Possibilities Frontier-
O.C. is constant
• Efficiency = no waster
• Production efficiency: all available resources are utilized
• Cannot produce more of one good without decreasing
2.3.1 Production Possibilities Frontier-
O.C. is constant
• Any point inside the PPF is a point where we’re wasting
resources
• Any point on the PPF is a point of efficiency
• Any point outside the PPF is a point you might love to
2.3.2 Production Possibilities Frontier –
O.C. is not constant
Story change: it gets harder and harder to catch fish
Questions:
What does this imply about the opportunity cost of fishing?
2.3.2 Production Possibilities Frontier –
O.C. is not constant
• In reality, we have increasing marginal opportunity costs
• It means the more resources already devoted to an
activity, the smaller the payoff to devote the additional resources to that activity.
2.4 Two-Person Economy
Data: 10 hours for production
Birds (per hour) Fish (per hour) Robinson 5 10 Peter 2 8
Robinson’s O.C. Peter’s O.C.
One fish 1/2 bird 1/4 bird
2.4 Two-Person Economy
2.4 Two-Person Economy
Principle of comparative economics: specialize good with the lowest opportunity cost of production
2.4 Two-Person Economy
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Comparative advantage is the basis for exchange
• Comparative advantage specialization • Specialization requires exchange
• Trading leads to increased production because it permits
2.4 Two-Person Economy
• All nations would be better off as more total output could
be produced and living standards would increase
• It’s the difference in comparative advantage that leads to
specialization.
2.5 Economic Systems
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Command economy (centrally planned economy): Central authority, or “planner”, directs all economic decisions
• Problem 1: government decisions are made by people
who may act in their own self- interest.
2.5 Economic Systems
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Free-Market Economy (lasses-faire economy): People and firms are “Free to Choose” all activities
• Problem1: they do not always produce what people want
at the lowest cost – there are inefficiencies, like monopoly
• Problem 2: income may be unfairly distributed • Problem 3: unemployment and inflation recur
2.5 Economic Systems
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Mixed economy: hybrid of the two systems. Government plays a role (to varying degrees) in economic decisions.
• All real-world economies are mixed, with differing degrees
of government intervention.
• Government sets and enforces the rules for an economy
The protection of private property
The enforcement of laws governing intellectual property
