The Economic Problem: Scarcity and Choice

Scarcity, Choice, and Opportunity Cost

Human wants are unlimited, but resources are not. Three basic questions must be answered in order to understand an economic system:
What to produce? How to produce? For whom to produce?

Scarcity, Choice, and Opportunity Cost

Capital refers to the things that are themselves produced and then used to produce other goods and services. The basic resources that are available to a society are factors of production:
Land Labor Capital

Scarcity, Choice, and Opportunity Cost

Production is the process that transforms scarce resources into useful goods and services. Resources or factors of production are the inputs into the process of production; goods and services of value to households are the outputs of the process of production.

Capital Goods and Consumer Goods

Capital goods are goods used to produce other goods and services. Consumer goods are goods produced for present consumption.

The Production Possibility Frontier

The production possibility frontier (ppf) is a graph that shows all of the combinations of goods and services that can be produced if all of societys resources are used efficiently.

The Production Possibility Frontier

The production possibility frontier curve has a negative slope, which indicates a trade-off between producing one good or another.

The Production Possibility Frontier

Points inside of the curve are inefficient.
At point H, resources are either unemployed, or are used inefficiently.

The Production Possibility Frontier

Point F is desirable because it yields more of both goods, but it is not attainable given the amount of resources available in the economy.

The Production Possibility Frontier

Point C is one of the possible combinations of goods produced when resources are fully and efficiently employed.

The Production Possibility Frontier

A move along the curve illustrates the concept of opportunity cost. From point D, an increase the production of capital goods requires a decrease in the amount of consumer goods.

Economic Growth
Economic growth is an increase in the total output of the economy. It occurs when a society acquires new resources, or when it learns to produce more using existing resources. The main sources of economic growth are capital accumulation and technological advances.

Economic Growth
Outward shifts of the curve represent economic growth.

An outward shift means that it is possible to increase the production of one good without decreasing the production of the other.

Economic Growth
From point D, the economy can choose any combination of output between F and G.

Economic Systems
The economic problem: Given scarce resources, how, exactly, do large, complex societies go about answering the three basic economic questions?

Economic Systems
Economic systems are the basic arrangements made by societies to solve the economic problem. They include:
Command economies (Socialist Economies) Laissez-faire economies Mixed systems

Economic Systems
In a command economy, a central government either directly or indirectly sets output targets, incomes, and prices. In a laissez-faire economy, individuals and firms pursue their own self-interests without any central direction or regulation.

Economic Systems
The central institution of a laissez-faire economy is the free-market system. A market is the institution through which buyers and sellers interact and engage in exchange.

Economic Systems
Consumer sovereignty is 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
The basic coordinating mechanism in a free market system is price. Price is the amount that a product sells for per unit. It reflects what society is willing to pay.

Mixed Systems, Markets, and Governments

Since markets are not perfect, governments intervene and often play a major role in the economy. Some of the goals of government are to: Minimize market inefficiencies Provide public goods Redistribute income Stabilize the macroeconomy:
Promote low levels of unemployment Promote low levels of inflation

Rationality
The theory of rationality rests on the following conception of human behavior: There exists a set of conceivable actions which every individual may undertake and which lead to certain consequences. Individuals possess a mental order of preferences concerning all the possible consequences of their actions. They evaluate these consequences, and , given the constraints, decide upon a particular action. They therefore make their choice coherently with their preferences and with the constraints upon them. The choice is therefore the outcome of a rational computing activity, and it matters how complex the calculations required for rationality is.

Every decision will lead to maximization of utility.

Marginalism
Marginal means additional To get the most out of our resources, we should only take an action when the marginal benefits are greater than the marginal costs. MU, MR and MC.

Marginal Decision Examples

How clean is our house? Do we clean to 100% cleanliness? How about when company is coming? You clean to the point where the marginal costs outweigh the expected marginal benefits!

Opportunity cost It is the process of choosing one good or service over another. The item that you dont pick is the opportunity cost.

Partial(Closed Economy) and General Equilibrium(Open Economy)

In partial equilibrium analysis, the determination of the price of a good is simplified by just looking at the price of one good, and assuming that the prices of all other goods remain constant. The Marshallian theory of demand and supply is an example of partial equilibrium analysis. Partial Equilibrium Analysis The impact of a change in supply or demand in one market onlythe market directly impacted. The general equilibrium refers to the equilibrium in which production, consumption, prices, and international trade are determined simultaneously for all goods produced and consumed in the economy. General Equilibrium Analysis The impact of a price change in one market on the equilibrium prices and quantities in all other markets. Spillover Effect A change in one markets equilibrium as a result of a change in another markets equilibrium. (All the economic and financial crisis, OPEC effect, imposing of high tariff, currency of China and its impact on US)