CHAPTER 2 THE
ECONOMIC PROBLEM:
SCARCITY AND CHOICE
2.1 Three basic questions
EX: American Airline
It uses
• runways – land
• pilots and mechanics – labor <= Resources
• airplanes – capital
to produce transportation services <= producers
for households
2.2 Scarcity and opportunity cost
Scarcity
EX 1 – I want to buy an island, but I only make $1,000 a
month
=> constraint is money
EX 2 – If I spend one hour studying for an economic exam,
I have one less hour to spend studying for a math exam or
going to the movies. Should I study economics or math or
watch movies?
=> constraint is time
2.2 Scarcity and opportunity cost
Scarcity
EX 3 – if BMW devotes some of the scarce workers and
machines in producing Z4 roadsters, those resources will
not be available to produce more SUVs. Should BMW
produce Z4 or SUV?
=> constraint is labor
2.2 Scarcity and opportunity cost
Opportunity cost
EX1: the O.C. of going to college for a year
• tuition
• books and fees
• forgone wages
2.2 Scarcity and opportunity cost
Opportunity cost
EX2: the O.C. of seeing a movie
• the price of the ticket
• the value of the time you spend in the theater
2.2 Scarcity and opportunity cost
Opportunity cost
EX3: the O.C. of going to a basketball game may be the
five or ten extra points you might have earned on an exam
by staying home and studying that night
2.3 One-person economy
• Story: Robinson Crusoe in an island
2.3 One-Person Economy
• Resource – time (24 hours)
• Allocation:10 hours for production, 4 hours for lying on
beach, 8 hours for sleep
Catch per hour
fish
bird
10
5
2.3.1 Production Possibilities Frontier –
O.C. is constant
1) Production Possibilities Frontier (PPF): a graph showing
the maximal different combinations of output for a given
amount of inputs
• More of one good  Less of another
• It illustrates opportunity costs in production (the slope)
2.3.1 Production Possibilities FrontierO.C. is constant
• Efficiency = no waster
• Production efficiency: all available resources are utilized
• Cannot produce more of one good without decreasing
production of another good
2.3.1 Production Possibilities FrontierO.C. is constant
• Any point inside the PPF is a point where we’re wasting
resources
• Any point on the PPF is a point of efficiency
• Any point outside the PPF is a point you might love to
be at, but it’s at a point that’s unattainable
2.3.2 Production Possibilities Frontier –
O.C. is not constant
Story change: it gets harder and harder to catch fish
Questions:
 What does this imply about the opportunity cost of
fishing?
 What does this imply about the shape of the PPF
2.3.2 Production Possibilities Frontier –
O.C. is not constant
• In reality, we have increasing marginal opportunity costs
• It means the more resources already devoted to an
activity, the smaller the payoff to devote the additional
resources to that activity.
2.4 Two-Person Economy
Data: 10 hours for production
Birds
(per hour)
Fish
(per hour)
Robinson
5
10
Peter
2
8
Robinson’s O.C.
Peter’s O.C.
One fish
1/2 bird
1/4 bird
One bird
2 fish
4 fish
2.4 Two-Person Economy
• If Peter trade 50 units of fish for 18 units of birds, then,
2.4 Two-Person Economy
Principle of comparative economics: specialize good with
the lowest opportunity cost of production
• It is developed by David Ricardo (1772-1823)
18
2.4 Two-Person Economy
Comparative advantage is the basis for exchange
• Comparative advantage  specialization
• Specialization requires exchange
• Trading leads to increased production because it permits
specialization
2.4 Two-Person Economy
• All nations would be better off as more total output could
be produced and living standards would increase
• It’s the difference in comparative advantage that leads to
specialization.
• Then, we have exchange and have trade and market
20
2.5 Economic Systems
Command economy (centrally planned economy): Central
authority, or “planner”, directs all economic decisions
• Problem 1: government decisions are made by people
who may act in their own self- interest.
• Problem 2: they don’t know market much
21
2.5 Economic Systems
Free-Market Economy (lasses-faire economy): People and
firms are “Free to Choose” all activities
• Problem1: they do not always produce what people want
at the lowest cost – there are inefficiencies, like monopoly
• Problem 2: income may be unfairly distributed
• Problem 3: unemployment and inflation recur
22
2.5 Economic Systems
Mixed economy: hybrid of the two systems. Government
plays a role (to varying degrees) in economic decisions.
• All real-world economies are mixed, with differing degrees
of government intervention.
• Government sets and enforces the rules for an economy
 The protection of private property
 The enforcement of laws governing intellectual
property
Have a Nice Weekend!