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The Economic
Problem: Scarcity
and Choice
2
CHAPTER OUTLINE
Scarcity, Choice, and
Opportunity Cost
Scarcity and Choice in a OnePerson Economy
Scarcity and Choice in an Economy
of Two or More
The Production Possibility Frontier
The Economic Problem
Economic Systems
Command Economies
Laissez-Faire Economies:
The Free Market
Mixed Systems, Markets, and
Governments
The process that transforms scarce resources into useful goods and services is called production.
The three key factors of production are land, labor, and capital.
Opportunity Cost
The concepts of constrained choice and scarcity are central to the discipline of
economics.
Given the scarcity of time and resources, there will be a trade-off of doing one
activity rather than another.
Opportunity Cost
Point
on ppf
Total
Corn Production
(Millions of
Bushels Per Year)
Total
Wheat Production
(Millions of Bushels
Per Year)
700
100
650
200
510
380
400
500
300
550
Consider the figure below. As this country moves from point D to point B
along the production possibility frontier AE,
a.
the opportunity cost of building more consumer goods rises.
b.
the opportunity cost of building more capital goods rises.
c.
the opportunity cost is not affected because the curve does not shift.
d.
the opportunity cost of producing more of either consumer goods or
capital goods rises.
26.1
36.1
48.7
78.5
95.3
107.2
112.8
120.6
134.4
138.2
145.6
152.8
108
53
20
7
4
3
NAa
NAa
NAa
NAa
NAa
NAa
19351939
19451949
19551959
19651969
19751979
19811985
19851990
19901995
1998
2001
2006
2007
a
WHEAT
Labor Hours
Per 100 Bushels
67
34
17
11
9
7
NAa
NAa
NAa
NAa
NAa
NAa
Economic Growth
Economic Systems
Command Economies
command economy An economy in which a central
government through a combination of government ownership
of state enterprises and central planning, either directly or
indirectly sets output targets, incomes, and prices.
While the extremes of central planning have been rejected,
so too has the idea that markets solve all problems.
One of the major themes of this book is that government
involvement, in theory, may improve the efficiency and
fairness of the allocation of a nations resources.
At the same time, a poorly functioning government can
destroy incentives, lead to corruption, and result in the waste
of a societys resources.
Economic Systems
Laissez-faire Economies: The Free Market
At the opposite end of the spectrum from the command economy
is the laissez-faire economy.
laissez-faire economy Literally from the French: allow [them]
to do. An economy in which individual people and firms pursue
their own self-interest without any central direction or regulation.
The central institution through which a laissez-faire system
answers the basic questions is the market, a term that is used
in economics to mean an institution through which buyers and
sellers interact and engage in exchange.
Some markets are simple and others are complex, but they all
involve buyers and sellers engaging in exchange. The behavior
of buyers and sellers in a laissez-faire economy determines what
gets produced, how it is produced, and who gets it.
Economic Systems
Laissez-faire Economies: The Free Market
Consumer Sovereignty
In a free market, goods and services are produced
and sold only if the supplier can make a profit, i.e. if
selling goods or services for more than it costs to
produce them is possible.
Its not possible to make profits unless someone wants
the product that you are selling.
This logic leads to the notion of:
consumer sovereignty The idea that consumers
ultimately dictate what will be produced (or not
produced) by choosing what to purchase (and what
not to purchase).
Economic Systems
Laissez-faire Economies: The Free Market
Individual Production Decisions: Free Enterprise
Under a free market system, individual producers must also determine
how to organize and coordinate the actual production of their products or
services.
Often the market system is called a free enterprise system.
free enterprise The freedom of individuals to start and operate private
businesses in search of profits.
Proponents of free market systems argue that free enterprise leads to
more efficient production and better response to diverse and changing
consumer preferences. In a free market economy competition forces
producers to use efficient techniques of production. It is competition then
that ultimately dictates how output is produced.
Economic Systems
Laissez-faire Economies: The Free Market
Distribution of Output
In a free market system the distribution of output who
gets what- is also determined in a decentralized way.
The amount that any one household gets depends on its
income and wealth.
Income is the amount that a household earns each year.
It comes in a number of forms: wages, salaries, interest,
and the like.
Wealth is the amount that households have accumulated
out of past income through saving or inheritance.
Economic Systems
Laissez-faire Economies: The Free Market
Price Theory
The basic coordination mechanism in a free market system is price
A price is the amount that a product sells for per unit, and reflects
what society is willing to pay.
Prices of inputs- labor, land, and capital determine how much it
costs to produce a product.
Prices of various kinds of labor, or wage rates, determine the rewards
for working in different jobs and professions.
Economic Systems
Mixed Systems, Markets, And Governments
The differences between command economies and laissez-faire
economies in their pure forms are enormous.
In fact, these pure forms do not exist in the world; all real systems
are in some sense mixed.
That is, individual enterprise exists and independent choice is
exercised even in economies in which the government plays a major
role.
Conversely, no market economies exist without government
involvement and government regulation.
Economic Systems
Mixed Systems, Markets, And Governments
Advocates of free market argue that such markets work best when
left to themselves. The result is quality and variety. But market
systems have problems too.
1) They do not always produce what people want at the lowest cost
there are inefficiencies
2) Rewards (income) may be unfairly distributed and some groups
may be left out
3) Periods of unemployment and inflation recur with some regularity
Many people point to these problems as reasons for government
involvement. Indeed for some problems government involvement
may be the only solution. But governments may fail to improve
matters as well.
Exercise: Consider the following data for the harvest of crabs versus the
harvest of fish off the coast of Virginia, US, in answering the following
questions.