1. The Fundamental
Economic Problem:
Scarcity and Choice
Our necessities are few but are wants are endless.
INSCRIPTION ON A FORTUNE COOKIE

2. Contents
Contents
● Scarcity, Choice, and Opportunity Cost
● Scarcity, Choice, and Opportunity Cost
● Scarcity and Choice for a Single Firm
● Scarcity and Choice for a Single Firm
● Scarcity and Choice for the Entire Society
● Scarcity and Choice for the Entire Society
● The Concept of Efficiency
● The Concept of Efficiency
● The Three Coordination Tasks of any
● The Three Coordination Tasks of any
Economy
Economy
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3. Contents (continued)
Contents (continued)
● Specialization Fosters Efficient Resource
● Specialization Fosters Efficient Resource
Allocation
Allocation
● Specialization Leads to Exchange
● Specialization Leads to Exchange
● Markets, Prices, and the Three Coordination
● Markets, Prices, and the Three Coordination
Tasks
Tasks
● A Last Word: Don’t Confuse Ends with
● A Last Word: Don’t Confuse Ends with
Means
Means
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4. Scarcity, Choice and
Scarcity, Choice and
Opportunity Cost
Opportunity Cost
● Scarcity of resources ⇒ necessity of
● Scarcity of resources ⇒ necessity of
choices
choices
● Opportunity cost = value of the best
● Opportunity cost = value of the best
forgone alternative
forgone alternative
♦ True cost of a scarce resource
♦ True cost of a scarce resource
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5. Opportunity Cost and Money
Opportunity Cost and Money
Cost
Cost
● Opportunity cost: Closely related to money
● Opportunity cost: Closely related to money
cost if markets are well functioning
cost if markets are well functioning
● No explicit prices for some valuable
● No explicit prices for some valuable
resources, e.g., time
resources, e.g., time
● Total cost = money cost + opportunity
● Total cost = money cost + opportunity
cost
cost
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6. Opportunity Cost and Money
Opportunity Cost and Money
Cost
Cost
● Example of opportunity cost: a firm that
● Example of opportunity cost: a firm that
produces two outputs with a fixed supply of
produces two outputs with a fixed supply of
inputs
inputs
● More of one output ⇒ less of the other
● More of one output ⇒ less of the other
output
output
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7. Scarcity and Choice for a
Scarcity and Choice for a
Single Firm
Single Firm
● Production Possibilities Frontier
● Production Possibilities Frontier
♦ Production possibilities frontier = a graph
♦ Production possibilities frontier = a graph
showing different combinations of output for a
showing different combinations of output for a
given amount of inputs
given amount of inputs
♦ More of one good ⇒ less of another
♦ More of one good ⇒ less of another
♦ Illustrates opportunity costs in production
♦ Illustrates opportunity costs in production
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8. TABLE 1 Production Possibilities
TABLE 1 Production Possibilities
Open to a Farmer
Open to a Farmer
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9. The Production Possibilities
The Production Possibilities
Frontier
Frontier
● Negatively sloped
● Negatively sloped
● Slope = opportunity cost
● Slope = opportunity cost
● Illustrates the trade-off in the production of
● Illustrates the trade-off in the production of
one good (or class of goods) against another
one good (or class of goods) against another
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10. FIGURE 1 PPF for Production by
FIGURE 1 PPF for Production by
a Single Farmer
a Single Farmer
A Unattainable
Soybeans
40
region
B
30 Attainable
region C
20
D
10
0 E
10 20 30 38 52 60 65
Wheat
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11. The Principle of Increasing Costs
The Principle of Increasing Costs
♦ Shape: concave
♦ Shape: concave
♦ Principle of increasing costs:
♦ Principle of increasing costs:
↑ production of one good ⇒
↑ production of one good ⇒
↑ opportunity cost of producing another
↑ opportunity cost of producing another
unit
unit
♦ Reason: Inputs tend to be specialized.
♦ Reason: Inputs tend to be specialized.
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12. FIGURE 2
FIGURE 2 PPF with No
PPF with No
Specialized Resources
Specialized Resources
50
A
40
Black Shoes
B
30
C
20
D
10
0
10 20 30 40 50
Brown Shoes
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13. The Principle of Increasing Costs
The Principle of Increasing Costs
● Productivity constant along a production
● Productivity constant along a production
possibilities frontier.
possibilities frontier.
∉ ∆ productivity ⇒ shift of the frontier
∉ ∆ productivity ⇒ shift of the frontier
♦ Skills
♦ Skills
♦ Technology
♦ Technology
♦ Capital stock
♦ Capital stock
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14. Scarcity and Choice for the
Scarcity and Choice for the
Entire Society
Entire Society
● Resources are scarce for the entire society.
● Resources are scarce for the entire society.
● Choices must be made: More of one good
● Choices must be made: More of one good
implies less of another.
implies less of another.
● Production possibilities frontier applicable
● Production possibilities frontier applicable
to the economy as a whole.
to the economy as a whole.
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15. FIGURE 3 PPF for Entire
FIGURE 3 PPF for Entire
Economy
Economy
700
B
Thousands of Automobiles per Year
600
D
500
E
400
300 G
F
200
100
0 C
100 200 300 400 500
Missiles per Year
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16. Scarcity and Choice for the
Scarcity and Choice for the
Entire Society
Entire Society
● Economic growth = increase in production
● Economic growth = increase in production
of goods and services
of goods and services
● Trade-off between consumption goods and
● Trade-off between consumption goods and
capital goods
capital goods
● Investment in capital goods shifts out the
● Investment in capital goods shifts out the
production possibilities frontier.
production possibilities frontier.
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17. Growth in the United States and
Growth in the United States and
Asia
Asia
G
F g
Next year’s
N production Next year’s
A production
possibilities possibilities
Consumption Goods
Consumption Goods
f This year’s
production
possibilities
This year’s
production
possibilities
B
F G f g
Capital Goods Capital Goods
(a) United States (b) Asia
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18. Scarcity and Choice Elsewhere
Scarcity and Choice Elsewhere
in the Economy
in the Economy
● Problems of scarcity and choice are
● Problems of scarcity and choice are
everywhere in the economy.
everywhere in the economy.
● Households, firms, and government must
● Households, firms, and government must
decide how to allocate their income.
decide how to allocate their income.
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19. The Concept of Efficiency
The Concept of Efficiency
● Efficiency = no waste
● Efficiency = no waste
● All available resources are utilized.
● All available resources are utilized.
● Sources of inefficiency
● Sources of inefficiency
♦ Assigning inputs to the wrong task
♦ Assigning inputs to the wrong task
♦ Unemployment
♦ Unemployment
♦ Discrimination
♦ Discrimination
● Competition should eliminate inefficiency.
● Competition should eliminate inefficiency.
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20. The Concept of Efficiency
The Concept of Efficiency
● Efficiency and the production possibilities
● Efficiency and the production possibilities
frontier
frontier
♦ Every point on a production possibilities
♦ Every point on a production possibilities
frontier is efficient.
frontier is efficient.
♦ Efficiency does not tell us which point is best.
♦ Efficiency does not tell us which point is best.
♦ Any point inside the frontier is inefficient.
♦ Any point inside the frontier is inefficient.
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21. The Three Coordination
The Three Coordination
Tasks of Any Economy
Tasks of Any Economy
● How to utilize its resources efficiently.
● How to utilize its resources efficiently.
● What combination of goods and services to
● What combination of goods and services to
produce.
produce.
● How much of each good to distribute to
● How much of each good to distribute to
each person.
each person.
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22. Specialization Fosters
Specialization Fosters
Efficient Resource Allocation
Efficient Resource Allocation
● The Wonders of the Division of Labor
● The Wonders of the Division of Labor
♦ Breaking a task into a set of smaller, more
♦ Breaking a task into a set of smaller, more
specialized tasks
specialized tasks
♦ Specialization ⇒ productivity growth
♦ Specialization ⇒ productivity growth
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23. Specialization Fosters
Specialization Fosters
Efficient Resource Allocation
Efficient Resource Allocation
● The Amazing Principle of Comparative
● The Amazing Principle of Comparative
Advantage
Advantage
♦ Principle of comparative advantage =
♦ Principle of comparative advantage =
specialization in the production of the good
specialization in the production of the good
with the lowest opportunity cost
with the lowest opportunity cost
♦ Comparative advantage ⇒ specialization
♦ Comparative advantage ⇒ specialization
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24. Specialization Leads to
Specialization Leads to
Exchange
Exchange
● Specialization requires exchange
● Specialization requires exchange
● Trading ⇒ ↑ production because it permits
● Trading ⇒ ↑ production because it permits
specialization
specialization
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25. Markets, Prices, and the
Markets, Prices, and the
Three Coordination Tasks
Three Coordination Tasks
● Markets ⇒ solutions to the three
● Markets ⇒ solutions to the three
coordination tasks
coordination tasks
● Consumers are in control
● Consumers are in control
● Sometimes the solutions are compatible
● Sometimes the solutions are compatible
with society’s goals, other times not.
with society’s goals, other times not.
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26. Last Word: Don’t Confuse
Last Word: Don’t Confuse
Ends with Means
Ends with Means
● Economic analysis ≠ judgment of
● Economic analysis ≠ judgment of
capitalism
capitalism
● Values ⇒ ends
● Values ⇒ ends
● Pragmatism ⇒ means
● Pragmatism ⇒ means
● Economic analysis concerns means, not
● Economic analysis concerns means, not
ends.
ends.
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