Chapter 2
The Economic
Problem
Scarcity and
Choice
Some of your faculty will study how Apple and Samsung compete in
smartphones. Others will look at discrimination in labour markets. Still
others may be exploring the effects of microfinance in a country. On
the surface, these issues seem quite different from one another.
But fundamental to each of these inquiries is the concern with choice
in a world of scarcity
Economics explores how individuals make choices in a world of scarce
resources and how those individual’s choices come together to
determine three key features of their society:
■■ What gets produced?
■■ How is it produced?
■■ Who gets what is produced?
Introduction
Scarcity and Choice in One Person
Economy
Given that resources are limited, Bill must decide
how to best use them to satisfy his hierarchy of
wants. Food would probably come close to the top
of his list.
Should he spend his time gathering fruits and
berries? Should he clear a field and plant seeds?
The answers to those questions depend on the
character of the island, its climate, its flora and
fauna (are there any fruits and berries?).
The extent of his skills and knowledge (does he
know anything about farming?), and his preferences
Opportunity Cost
• The concepts of constrained choice and scarcity are
central to the discipline of economics.
• They can be applied when discussing the behavior of
individuals such as Bill and when analyzing the behavior
of large groups of people in complex societies.
• The best alternative that we forgo, or give up, when we
make a choice or a decision
Scarcity and Choice in an Economy Two or More
• Modern industrial societies must answer the same
questions that Colleen and Bill must answer, but the
mechanics of larger economies are more complex.
• Instead of two people living together, the United States
has more than 300 million people. Still, decisions must be
made about what to produce, how to produce it, and who
gets it.
Specialization, Exchange and
Comparative Advantage
• To keep things simple, suppose that Colleen and Bill have
only two tasks to accomplish each week: gathering food to
eat and cutting logs to burn.
• If Colleen could cut more logs than Bill in one day and Bill
could gather more nuts and berries than Colleen could,
specialization would clearly lead to more total production.
• Both would benefit if Colleen only cuts logs and Bill only
gathers nuts and berries, as long as they can trade.
Negative Slope and
Opportunity Cost
• The slope of the ppf (production possibility
frontier) is negative, reflecting the fact that a
society’s choices are constrained by available
resources and existing technology.
• When those resources are fully and efficiently
employed, society can produce more capital
goods only by reducing production of consumer
goods. The opportunity cost of the additional
capital is the forgone production of consumer
goods.
Corn and Wheat Production in Ohio
and Kansas
• The ppf illustrates that the opportunity cost of
corn production increases as we shift resources
from wheat production to corn production.
• Moving from point E to D, we get an additional
100 million bushels of corn at a cost of 50
million bushels of wheat. Moving from point B to
A, we get only 50 million bushels of corn at a
cost of 100 million bushels of wheat.
• The cost per bushel of corn measured in lost
wheat has increased.
The Efficient Mix of Output
• To be efficient, an economy must produce what people want. This
means that in addition to operating on the ppf, the economy must be
operating at the right point on the ppf.
• This is referred to as output efficiency, in contrast to production
efficiency. Suppose an economy devotes 100 percent of its resources
to beef production and the beef industry runs efficiently using the
most modern techniques.
• If everyone in the society were a vegetarian and there were no trade,
resources spent on producing beef would be wasted. It is important
to remember that the ppf represents choices available within the
constraints imposed by the current state of agricultural technology.
• In the long run, technology may im prove, and when that happens,
we have growth.
Capital Goods and Growth in Poor and Rich
Countries
• Rich countries find it easier than poor countries
to devote resources to the production of capital,
and the more resources that flow into capital
production, the faster the rate of economic
growth.
• Thus, the gap between poor and rich countries
has grown over time.
Command Economies and Laissez –
Faire Economies : The Free Market
• In a pure command economy, like the system in place in
the Soviet Union or China some years ago, the basic
economic questions are answered by a central government.
• Through a combination of government ownership of state
enterprises and central planning, the government, either
directly or indirectly, sets output targets, incomes, and
prices.
• At the opposite end of the spectrum from the command
economy is the laissez-faire economy.
Mix Systems, Markets and
Government
• No market economies exist without government
involvement and government regulation.
• The United States has basically a free market economy,
but government purchases accounted for slightly more
than 17 percent of the country’s total production in
2017.
• Governments in the United States (local, state, and
federal) directly employ about 14 percent of all workers.
They also redistribute income by means of taxation and
social welfare expenditures, and they regulate many
economic activities.
