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Exploring EconomicsExploring Economics3rd Edition3rd Edition

by Robert L. Sextonby Robert L. SextonCopyright © Copyright © 20052005 Thomson Learning, Inc. Thomson Learning, Inc.

Thomson Learning™ is a trademark used herein under license.Thomson Learning™ is a trademark used herein under license.

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A Lecture PresentationA Lecture Presentation

Scarcity, Trade-Offs Scarcity, Trade-Offs and Economic Growthand Economic Growth

Chapter 3Chapter 3

3.1 Three Economic Questions 3.1 Three Economic Questions Every Society FacesEvery Society Faces

Because of scarcity, certain Because of scarcity, certain economic questions must be economic questions must be answered regardless of the level answered regardless of the level of affluence of the society or its of affluence of the society or its political structure. political structure.

Three fundamental questions that Three fundamental questions that inevitably must be faced in a world of inevitably must be faced in a world of scarcity are: scarcity are: What is to be produced? What is to be produced? How are these goods to be produced?How are these goods to be produced? For whom areFor whom are the goods produced? the goods produced?

In market-oriented economies, people In market-oriented economies, people “vote” on economic affairs with their “vote” on economic affairs with their dollars. dollars.

Consumer sovereigntyConsumer sovereignty describes describes how individual consumers in market how individual consumers in market economies determine what is to be economies determine what is to be produced.produced.

Command economiesCommand economies rely on rely on central planning, where decisions central planning, where decisions about what is produced is largely about what is produced is largely determined by a government official determined by a government official or a committee associated with the or a committee associated with the central planning organization. central planning organization.

Economies are organized in different Economies are organized in different ways to answer the question of what ways to answer the question of what is to be produced.is to be produced.

Market economiesMarket economies, on the other , on the other hand, largely rely on a hand, largely rely on a decentralized decentralized decision-making processdecision-making process, in which , in which literally millions of individual literally millions of individual producers and consumers of goods producers and consumers of goods and services determine what goods and services determine what goods will be produced. will be produced.

Most countries, including the United Most countries, including the United States, haveStates, have mixed economiesmixed economies in in which the government and private which the government and private sector together determine the sector together determine the allocation of resources. allocation of resources.

All economies, regardless of political All economies, regardless of political structure, must decide how, from structure, must decide how, from several possible ways, to produce the several possible ways, to produce the goods and services that they want.goods and services that they want.

For example, when digging a ditch, For example, when digging a ditch, a contractor must decide between a contractor must decide between many workers using their hands, a many workers using their hands, a few workers with shovels, or one few workers with shovels, or one person with a backhoe.person with a backhoe.

A decision must be made as to which A decision must be made as to which method is appropriate. method is appropriate.

The best method is the least-cost The best method is the least-cost method.method.

The best or "optimal" form of The best or "optimal" form of production will vary from one production will vary from one economy to the next.economy to the next.

Each nation tends to use the Each nation tends to use the production processes that conserve production processes that conserve its relatively scarce (and thus its relatively scarce (and thus relatively more expensive) resources relatively more expensive) resources and use more of its relatively and use more of its relatively abundant resources. abundant resources.

Labor intensiveLabor intensive methods will be methods will be used where capital is relatively used where capital is relatively scarce.scarce.

Capital intensiveCapital intensive methods will be methods will be used where labor is relatively used where labor is relatively scarce.scarce.

In every society, some mechanism In every society, some mechanism must exist to determine how goods must exist to determine how goods and services are to be distributed and services are to be distributed among the population.among the population.

Who gets what? Who gets what?

In a market economy, with private In a market economy, with private ownership and control of the means of ownership and control of the means of production, the amount of output one production, the amount of output one is able to obtain depends on one's is able to obtain depends on one's income, which in turn, depends on the income, which in turn, depends on the quantity and quality of the scarce quantity and quality of the scarce resources that the individual controls.resources that the individual controls.

For example, Serena Williams' income For example, Serena Williams' income

is very large because her skills are is very large because her skills are unique and marketable.unique and marketable.

3.2 The Circular Flow Model3.2 The Circular Flow Model

Product marketsProduct markets are the markets for goods are the markets for goods and services.and services.

In the product market, households are buyers In the product market, households are buyers and firms are sellers.and firms are sellers.

FactorFactor or or input marketsinput markets are where households are where households sell the use of their inputs (capital, land, labor sell the use of their inputs (capital, land, labor and entrepreneurship) to firms. and entrepreneurship) to firms.

In the factor markets, households are the sellers In the factor markets, households are the sellers and firms are the buyers.and firms are the buyers.

Wages, rents, interest and profit are the Wages, rents, interest and profit are the payments for labor, land, capital and payments for labor, land, capital and entrepreneurship. entrepreneurship.

3.3 The Production Possibilities Curve3.3 The Production Possibilities Curve

The economic concepts of scarcity, choice The economic concepts of scarcity, choice and trade-offs can be illustrated by the use and trade-offs can be illustrated by the use of a of a production possibilities curveproduction possibilities curve, , which represents the potential total output which represents the potential total output combinations of any two goods for an combinations of any two goods for an economy. economy.

That is, it illustrates an economy's potential That is, it illustrates an economy's potential for allocating its limited resources for for allocating its limited resources for producing various combinations of goods, producing various combinations of goods, in a given time period.in a given time period.

The production possibilities curve The production possibilities curve discussion begins with a straight-line discussion begins with a straight-line production possibilities curve, with production possibilities curve, with the goods being one's grade in the goods being one's grade in economics and one's grade in economics and one's grade in history.history.

On a production possibilities curve, On a production possibilities curve, we assume that the economy has a we assume that the economy has a given quantity and quality of given quantity and quality of resources and technology available resources and technology available to use for production.to use for production.

Using an example involving food and Using an example involving food and shelter we can see a concave (bowed) shelter we can see a concave (bowed) production possibilities curve.production possibilities curve.

Each point represents the potential Each point represents the potential amounts of food and shelter that can amounts of food and shelter that can be produced in a given time period, be produced in a given time period, given the quantity and quality of given the quantity and quality of resources available.resources available.

The economy cannot produce beyond The economy cannot produce beyond the levels indicated by the production the levels indicated by the production possibilities curve during a given time possibilities curve during a given time period, because there are not enough period, because there are not enough resources to produce that output.resources to produce that output.

However, it is possible to operate However, it is possible to operate inside the production possibilities inside the production possibilities curve.curve.

If an economy is operating inside its If an economy is operating inside its production possibilities curve, it is not production possibilities curve, it is not at full capacity, and is operating at full capacity, and is operating inefficiently. inefficiently.

The economy is not getting the most The economy is not getting the most it can from its scarce resources.it can from its scarce resources.

As a result, actual output is less than As a result, actual output is less than potential output. potential output.

EfficiencyEfficiency requires society to use its requires society to use its resources to the fullest extent—resources to the fullest extent—getting the most we can out of our getting the most we can out of our scarce resources; that is, there are no scarce resources; that is, there are no wasted resources. wasted resources.

If resources are being used efficiently, If resources are being used efficiently, at a point along a production at a point along a production possibilities curve, more of one good possibilities curve, more of one good or service requires the sacrifice of or service requires the sacrifice of another good or service as its cost.another good or service as its cost.

Efficiency does not tell us which point Efficiency does not tell us which point along the production possibilities along the production possibilities curve iscurve is best best..

But it does tell us that points inside But it does tell us that points inside the curve cannot be best because the curve cannot be best because some resources are wasted.some resources are wasted.

The production possibilities curve is The production possibilities curve is not a straight line. not a straight line.

It is concave from below (that is, It is concave from below (that is, bowed outward from the origin), bowed outward from the origin), reflecting reflecting increasing opportunity increasing opportunity costscosts of producing additional of producing additional amounts of a good.amounts of a good.

The basic reason for increasing The basic reason for increasing opportunity cost is that some resources opportunity cost is that some resources and skills cannot be easily adapted from and skills cannot be easily adapted from their current uses to alternative uses.their current uses to alternative uses.

Easily adaptable resources are soon Easily adaptable resources are soon exhausted and resources and workers exhausted and resources and workers that are less well suited or appropriate that are less well suited or appropriate (those with a relatively greater (those with a relatively greater opportunity cost) must then be employed opportunity cost) must then be employed to increase output further.to increase output further.

3.3 Economic Growth and the Production 3.3 Economic Growth and the Production Possibilities CurvePossibilities Curve

To generate economic growth, a To generate economic growth, a society must produce fewer consumer society must produce fewer consumer goods and more capital goods in the goods and more capital goods in the present.present.

They must sacrifice some They must sacrifice some consumption of consumer goods in consumption of consumer goods in the present in order to experience the present in order to experience growth in the future.growth in the future.

Investing in capital goods will Investing in capital goods will increase the future production increase the future production capacity of the economy.capacity of the economy.

So an economy that invests more and So an economy that invests more and consumes less now will be able to consumes less now will be able to produce and consume more in the produce and consume more in the future.future.

An economy can only grow with An economy can only grow with qualitative or quantitative changes in qualitative or quantitative changes in the factors of production–land, labor, the factors of production–land, labor, capital and entrepreneurship. capital and entrepreneurship.

Advancements in technology, Advancements in technology, improvements in labor productivity improvements in labor productivity or new natural resource finds could or new natural resource finds could all lead to outward shifts of the all lead to outward shifts of the production possibilities curve.production possibilities curve.

Economic growth means an outward Economic growth means an outward shift in the “menu” of possible shift in the “menu” of possible bundles of output illustrated by the bundles of output illustrated by the production possibilities curve. production possibilities curve.

With growth comes the possibility to With growth comes the possibility to have more of both goods than were have more of both goods than were previously available. previously available.

It is important to remember that It is important to remember that increases in a society's output do not increases in a society's output do not make scarcity disappear. make scarcity disappear.

Even when output has grown more Even when output has grown more rapidly than population, so people are rapidly than population, so people are made better off, they still face trade-offs. made better off, they still face trade-offs.

At any point along the production At any point along the production possibilities curve, in order to get more of possibilities curve, in order to get more of one thing, you must give up something one thing, you must give up something else.else.

An economy that invests more An economy that invests more of its resources for the future devotes of its resources for the future devotes a larger share of its productive a larger share of its productive capacity to capital goods rather than capacity to capital goods rather than consumption goods.consumption goods.

Economies that choose to invest more Economies that choose to invest more of their resources for the future will of their resources for the future will grow faster than those that don't, grow faster than those that don't, other things equal. other things equal.

The production possibilities curve can The production possibilities curve can be used to illustrate the economic be used to illustrate the economic concepts of scarcity, choice, concepts of scarcity, choice, opportunity costs, efficiency, and opportunity costs, efficiency, and economic growth.economic growth.

Scarcity is represented by the fact Scarcity is represented by the fact that resource combinations outside that resource combinations outside the production possibility curve are the production possibility curve are unattainable. unattainable.

Choice is the fact that one must Choice is the fact that one must choose among the alternative bundles choose among the alternative bundles available along the production available along the production possibilities curve.possibilities curve.

Opportunity costs are how much of Opportunity costs are how much of one good you give up to get another one good you give up to get another unit of the second good as you move unit of the second good as you move along the production possibilities along the production possibilities curve.curve.

Efficiency would mean being on the Efficiency would mean being on the production possibilities curve rather production possibilities curve rather than inside it. than inside it.

Economic growth is represented by Economic growth is represented by shifting out the production shifting out the production possibilities curve.possibilities curve.