Module 1

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Module 1 Scarity Choice
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Contents

• Meet Scarcityman
• The Production Function
• The Production Possibilities Frontier
• Opportunity Cost
• The PPF and Economic Growth
• Choice Investment or Consumption?
• Now or Later Summing Up Economic Growth
• Public vs. Private Spending

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Scarcity

• Allow me to introduce myselfI am Scarcityman
  the nasty little man who will never fail to
  remind you that theres no such thing as a free
  lunch. You cant get get away from scarcity it
  is simply an inherent condition in nature, that
  we all must endure. I am sure you have noticed
  that you cant just have or produce everything.
  Opportunity costs exist and we must constantly
  make choices. Decisions will always be about
  this or that, not this and that and now or
  later not now and later.

Scarcityman wont have to remind us to take our
bitter pill, scarcity, we will constantly run
into it as we further our study of
Macroeconomics. We will come to realize that
scarcity exists for everyone, rich or poor.
No Free Lunch!
For the richer country, scarcity forces people to
work instead of play. If resources were not
scarce, the people would pursue more leisure
activities like vacation.
For the poorer country, poverty and appalling
living conditions make scarcity a matter of life
and death.
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The Production Function
Scarcity ordains that we cannot get output
without the requisite inputs. Hence, the concept
of...

• The production function represents the
  transformation of inputs (labor (n), capital (k),
  institutional structure (inst) ) into outputs
  (final goods and services for a certain time
  period).
• The algebraic representation is
• y F ( n, k, inst)

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The Production Possibilities Frontier(The PPF)

• Our goal in working with the PPF is to portray
  the potential output that can be produced given a
  certain amount of inputs.
• So, first assume that as a nation, our inputs
  (n,k,inst) are fixed and we produce 2 goods, q1
  and q2. In other words, right now, we only have a
  certain amount of workers, and capital to work
  with and a certain level of institutional
  efficiency within our society.
• Next, wed like to determine what combinations
  of our 2 goods we could produceso here we go.

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Lets say you decide to produce the amount of
goods q2 and q1 shown in brackets.
q2a
q1a
Or you could cut back on q2 and increase your
production of q1.
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Opportunity Cost

• The downward slope of the PPF depicts the
  opportunity cost. Producing more of one good
  requires a sacrifice of the other. That sacrifice
  is its opportunity cost--its next best
  alternative to a unit of q2.

Suddenly you decide to produce some of good q1
without reducing the production of good q2.
Lets say you are at point A, producing only good
q2.
Notice that in order to gain 1 unit of q1, you
had to give up 1 unit (10-9) of good q2.
Here is the opportunity cost!
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The PPF and Economic Growth

• Suppose we can increase our inputs (n,k,inst).
  This will shift out our PPF, making it possible
  to produce at a higher PPF.

x2
PPF
Remember that any points that lie beyond even
the higher PPF...
are still unattainable!!!
x1
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ChoiceConsumption or Investment?
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Consumption or investment? There is no better
choice, it just depends on whether one places a
higher value on current consumption, than on
growth. Keep in mind that investment implies
future consumption, so the decision is really
about when to consume.
A nation choosing point C, is said to have a Low
Rate of Time Preference.
A nation choosing point B, is said to have a
High Rate of Time Preference.
B
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Now or Later Summing Up Economic Growth
Investment feeds capital, hence growth is a
matter of choice.
First, allow me to introduce the fundamental
national income accounting identity
y c i x g
Now lets add the governments choice between now
or later.
y c i x gc gi
Later
Government Spending on Consumption
Government Spending on Investment
(igix)
Investment by private public sector
(cgc)
Now
Consumption by private public sector
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Public vs. Private Spending

• The issue of Public and Private spending must
  also run into the boundaries set by scarcity.
  There is an opportunity cost whereby more
  government output means less private output.

Starting at point A, if the government decides to
increase public spending...
It must diminish private spending and land at
point B.
This is known as
Taxation!