CHAPTER 3
THE FUNDAMENTAL ECONOMIC PROBLEM:
SCARCITY AND CHOICE
TEST YOURSELF
1. In case (b), the production possibilities frontier will be further from the origin in 2007,
since Stromboli will have more pizza ovens with which it can produce more pizzas.
2. Figure 2 shows the production possibilities frontier. It is a straight line rather than a
curve, because for each additional box of brand X that Jasmine buys, no matter how
many boxes she already has, she must cut her purchases of Brand Y by the same amount,
3/5 of a bag. The production possibilities frontier in this question is really like a budget
constraint. Brand X is $0.60, Brand Y is $1.00.
FIGURE 2
3. This question asks the students to apply opportunity cost to a straightforward decision: to
rent or buy. After buying the house, the person would no longer have to pay $24,000
annual rent. On the other hand, she would lose the $8,000 she currently earns in interest
from her bank account. She would be ahead by $16,000, and the purchase is therefore a
good deal. In order to get a service (housing) for which she had been willing to pay
$24,000, she only has to give up (that is, the opportunity cost is) goods and services
worth $8,000. It is worth pointing out to students that if she did continue to rent the
361
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362 ™ Part II/Solutions
house, it must be because the services she receives from the landlord are worth more than
$16,000. Also, it is important to realize that this question is very simplified—it ignores
home equity, property taxes, etc.
4. Figure 1 shows the production possibilities frontier. The principle of increasing cost
holds, because the curve is concave. For example, begin at the point of producing 20
pizza ovens and 0 pizzas. To produce 15 pizzas we must give up the production of 2
pizza ovens; this brings us the point of 18 pizza ovens and 15 pizzas. To gain another 15
pizzas, we must now give up the production of 3 pizza ovens. As we continue to produce
more pizzas we must give up increasing quantities of pizza ovens. There are diminishing
returns as resources are shifted from pizzas to pizza ovens, or vice versa.
FIGURE 1 (Pizza numbers are in millions, ovens are in thousands)
DISCUSSION QUESTIONS
1. The answer to this question obviously depends upon the student. Students should be
encouraged to think broadly. A student who leaves college would not have to pay tuition
and fees, nor the college room and board expenses (on the other hand, these may be paid
currently by her parents, so they would not represent a savings to her). She would earn
money from a job, but she might have to pay for her own living expenses.
The point to stress is that the opportunity cost of a college education includes indirect
items (such as income foregone from a job) as well as costs that the student pays directly.
2. Under the former communist regime, the farmer was allocated a certain amount of each
type of feed, at a fixed cost, and was also given a quota for the number of chickens to be
produced. The farmer did as he was told, and took few if any risks or innovations. Under
private enterprise now, the farmer can get richer by producing more chickens. He is free
to buy any combination of feed grains, subject only to the limit of his budget, at the going
market prices. Through a process of trial and error, he will select the combination of feed
grains that maximizes his profit—and if the price of soy meal rises, he will shift toward
corn. The price of soy meal will in fact rise if soy meal becomes scarcer in the economy
as a whole. Thus the market system leads the farmer to economize in his use of a resource
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Chapter 3/The Fundamental Economic Problem: Scarcity and Choice ™ 363
that is becoming increasingly scarce—a task that used to be the responsibility of the
central planning agency.
3. This question will help students begin to develop a better understanding of their
institution. They may be surprised to learn that about 90 percent of the college’s budget
goes to wages and benefits—and that therefore a reduction in the budget implies a
reduction in programs and the laying off of people. An important trade-off to consider is
between the level of services per student on the one hand, and the size of the student body
on the other.
4. There are countless good answers to this question. An increase in defense purchases, for
example, may require a reduction in educational expenditures.
5. (a) The poorest person on earth has access to so few resources that she is in danger of
perishing. The opportunity cost of any additional good or service is life threatening.
For example, if she takes the time to cut and sharpen a stick for hunting, she may not
be able to gather the food she needs to stay alive.
(b) Even the richest person in America faces resource limitations. If he buys a shipping
company, he will lack the resources to buy an oil company. He is constantly
approached for philanthropic donations; he cannot support them all, and if he
increases his donations, he may lack the funds to expand into new business ventures.
(c) A farmer in Kansas (or anywhere) has limited resources with which to produce goods,
and therefore hard choices to make. If she produces more wheat, she will have to cut
back its production of soybeans.
(d) The government of Indonesia has the authority to command the use of a certain
amount of labor and other productive resources. If it decides to increase the
production of petroleum, it will have to shift some productive resources away from
another use, thereby causing the output of coffee, for example, to fall.
This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. This may not be
resold, copied, or distributed without the prior consent of the publisher.