Scarcity, Choice, and Economic Systems

1
Scarcity, Choice, and Economic Systems

• Outline
• The concept of opportunity cost
• Production possibility frontiers
• The law of increasing opportunity cost
• Productive inefficiency
• Gains from specialization Comparative advantage
• Systems of resource allocation

2
Opportunity cost

• Resources are scarce therefore, individuals and
  societies must make choices.
• Choice entails foregone alternatives, or
  opportunity cost.
• Opportunity cost is defined as the value of the
  next best alternative foregone as the result of
  choosing.

3
If I go to the movies, I give up both time and
money.

• Opportunity cost equals
• The value of the goods or services that could
  have been purchased with the money used to pay
  for the movie ticket plus
• The value of the time that could have been used
  for something else, like work or study.

4
Time is money!
I can make 150 per hour as a consultant. So I am
giving up a lot by sitting around a doctors
office or an airport. Cell phones help to reduce
my opportunity cost at time like these.
5
Production Possibilities Frontier
The PPF illustrateswhat is possible in termsof
production with given resources and technology

• Assumptions
• Fixed endowment of economic resources
• Fixed technology
• Resources fully utilized

6
Digression on technology

• Technology is applied know how.
• A sharp knife is better than a dull knife.
• Specialization is the inevitable consequence of
  technology.

7
A hypothetical economy
8
Feasible zone
The PPF

• U is a productively inefficient point
• I is an impossible point

A
200
B
I
175
C
130
Defense goods
U
F
0
160
75
125
Nondefense goods
9
Why is the PPF bow-shaped?
1MOC is defined as marginal opportunity cost.
10
Law of increasing opportunity cost
Resources are specializedand hence not
perfectlyadaptable to alternative uses
A
D
200
E
175
155
F
125
Defense goods
0
160
75
100
125
Nondefense goods
11
The production possibilities frontier
Figure 1, p. 23
A
B
1,000,000
950,000
D
How many lives should we save?
700,000
Quantity of all other goods
E
400,000
F
0
400,000
300,000
100,000
500,000
Number of lives saved
12
Notes on Figure 1, p. 23

• If resources are fully allocated to saving lives,
  500,000 lives could be saved--but that means zero
  production of all other goods.
• Notice that the opportunity cost of the first
  100,000 lives saved (point A to point B) is
  units 50,000 units of all other goods whereas
  the opportunity cost of the 4th 100,000 lives
  saved (point D to point E) is 300,000 units.

13
To save more lives we must allocate resources
specialized in the production of food, apparel,
new structures, entertainment,education, and
other goods and services to various
life-savingservices such as health care and
personal security
14
I just got a freelunch!
Economists say there is nofree lunch from
societys point of view. Preparing the lunch
took resources that couldhave been used to
produce something else.
15
In search of a free lunch
R
Moving from point U to an efficient point is like
getting a free lunch.
S
Defense goods
T
U
Nondefense goods
16
Micro versus Macro

• Micro is from the Greek word mikros, meaning
  small.
• Microeconomics is the study of individual
  economic agentshouseholds, firms, and government
  units and their interaction in specific markets.
• Macro is from the Greek work macros, meaning
  large.
• Macroeconomics is the study of the economy as a
  wholethat is, the study of the forces that
  determine total output, total employment, or the
  general price level.

17
Microeconomics attempts to explain why this
society might end up at point C instead of point
B.Macroeconomics attempts to explain why society
could end up at a point like point U.
A
200
B
175
C
130
Defense goods
U
F
0
160
75
125
Nondefense goods