Scarcity, Choices and Opportunity Cost

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Scarcity, Choices and Opportunity Cost

• September 2nd 4th,2009

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Scarcity

• Societys wants are virtually unlimited and
  insatiable.
• The resources for producing the goods and
  services to satisfy societys wants are limited
  or scarce.

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Scarcity

• Resources or factors of production are inputs
  used in the production of things that people
  want.
• Land
• Labor
• Physical Capital
• Human Capital
• Entrepreneurship

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Scarcity

• Scarcity Scarcity is a situation in which the
  ingredients for producing the things that people
  desire are insufficient to satisfy all wants.
• It exists in all societies and at all income
  levels because human wants exceed what can be
  produced with the limited resources and time that
  nature makes available.
• Scarcity is not a shortage.
• It is also not poverty.
• High incomes do not reduce scarcity.

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Choices and Opportunity Cost

• Scarcity requires choices be made. When one
  choice is made, then another is given up.
• Opportunity Cost The highest valued, next-best
  alternative that must be sacrificed for the
  choice that was made. In economics, cost is
  always a forgone opportunity.

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Choices and Opportunity Cost

• How could we explain the relationship of
  scarcity, choices, and opportunity cost in a
  simple economic model?
• Limited resources Unlimited wants
  Scarcity Choices
  Opportunity Cost

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Production in a Robinson Crusoe Economy

• The Robinson Crusoe model is loosely based on
  William Defoe's book in which Robinson is
  stranded on a deserted island and must make
  everything he will consume.

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Production in a Robinson Crusoe Economy

• Besides the three basic assumptions in every
  economic models (Rationality, Preference, Local
  Nonsatiation), the assumptions for this model
  also include
• All that is produced is consumed.
• Two goods are produced soda and pizza
• Robinson works 12 hours a day.
• The only input to producing soda and pizza is
  Robinsons labor effort.

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Production in a Robinson Crusoe Economy

• Table 1-Production Schedule in a Robinson Crusoe
  Economy

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Production in a Robinson Crusoe Economy

• Table 2- Production Possibilities in a Robinson
  Crusoe Economy(12 hours worked)

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Production in a Robinson Crusoe Economy

• Figure 1- Robinsons Production Possibilities
  Frontier(Curve)

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Production in a Robinson Crusoe Economy

• The different combinations of soda and pizza that
  Robinson can produce in twelve hours define his
  Production Possibility Frontier(Curve).
• Production Possibility Frontier(Curve)
• A curve representing the maximum possible
  combinations of total output that could be
  produced assuming a fixed amount of resources of
  a given quality.
• The PPF depicts the limit between what can and
  cannot be produced.

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Production in a Robinson Crusoe Economy

• Assumptions Underlying the Production
  Possibilities Frontier (Curve)
• Resources are fully employed.
• Production takes place over a specific time.
• Resources are fixed in both quantity and quality.
• Technology does not change over this period of
  time.

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Production in a Robinson Crusoe Economy

• Any point outside the PPF(PPC) cannot be reached
  for the time period assumed. Any point inside the
  PPC is attainable, but resources are not being
  fully utilized.
• Efficiency The case in which a given level of
  inputs is used to produce the maximum output
  possible. It is also a situation in which a given
  output is produced at a minimum cost. An economy
  is efficient when it is on its PPC. An
  inefficient point is any point below the
  production possibilities curve.

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Production in a Robinson Crusoe Economy

• PPF and Scarcity
• PPF and Choices
• PPF and Opportunity cost
• A movement from one point to another on the PPC
  shows that some of one good must be given up to
  have more of another.

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Production in a Robinson Crusoe Economy

• Calculate the opportunity cost in this economy.
• What is the opportunity cost if Robinson allocate
  his first two hours to produce pizza? (A B)
• What is the opportunity cost if Robinson spend
  two more hours to produce pizza? (B C)
• What is the opportunity cost if Robinson allocate
  his first two hours to produce soda? (G F)
• What is the opportunity cost if Robinson spend
  two more hours to produce soda? (F E)

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Production in a Robinson Crusoe Economy

• The opportunity cost is calculated as the loss
  divided by the gains.
• On the graph of PPF in this simple Robinson
  Crusoe Economy, to calculate the opportunity cost
  of the good on the horizontal axis is to
  calculate the slope of the PPF.
• What assumption we have made here for the linear
  PPF?

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Production in a Robinson Crusoe Economy
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Production in a Robinson Crusoe Economy

• When inputs are equally suited to producing both
  of the goods, PPF(PPC) is linear.
• When some resources are better suited to either
  output, PPF(PPC)is no longer linear. The new
  PPF(PPC) lies above the linear PPF(PPC) except at
  the x and y intercepts.
• Nonlinearity of PPF(PPC) is caused by the
  Specialization of Resources.

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Production in a Robinson Crusoe Economy
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The law of Increasing Cost

• The Production Possibilities Frontier(Curve) does
  not in practice have constant opportunity cost of
  one good for another and is typically a curve
  that is bowed outward(concave to the origin).
• The Law of Increasing Cost The fact that the
  opportunity cost of additional units of a good
  generally increases as society attempts to
  produce more of that good. This accounts for the
  bowed-out shape of the production possibilities
  curve.

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The law of Increasing Cost

• Table 2- Societys Trade-Off Between Cloth and
  Wheat

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The law of Increasing Cost
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The law of Increasing Cost

• The more highly specialized resources are, the
  more bowed outward the PPC will be.