Chapter 2 Lecture: Scarcity and the World of Trade-Offs

Production - any activity that results in the conversion of resources into products that can be used in

consumption.

The Factors of Production are responsible for the goods and services we consume.

Economic Goods - Tangible merchandise, from which we derive satisfaction and about which we must

constantly make decisions regarding their best use. Quantity demanded exceeds quantity supplied at zero

price.

Services - tasks that are performed by individuals (for someone else), intangible goods.

Wants and Needs

The term “needs” is objectively indefinable. Usually means someone desires something they do not

currently have.

Humans have unlimited wants. If you could have everything you wanted today, does it mean you would

never want anything else? This is the reality of scarcity.

Scarcity, Choice, and Opportunity Costs

Scarcity means we have to make choices. When we make a choice to do something, buy something, or

produce something, we are also making a choice not to do something else; not to do something else, not to

buy something else, or not to produce something else.

The value given up when a choice is made is according to each individual.

Opportunity Cost - the highest valued, or next best, alternative that must be sacrificed to obtain something

or to satisfy a want. In other words, “what you lose.”

The World of Trade-Offs

When you think of any alternative, you are thinking of trade-offs.

This can be explained by Graphical Analysis or the Production Possibilities Curve. This is:

� A curve that shows the possibilities available for increasing the output of one good or service by

reducing the amount of the other

� One-to-one is a straight-line PPC

Assumptions Underlying the PPC

� Resources are fully employed

� Production takes place over a specific period of time (one year).

� The resource inputs, in both quantity and quality, used to produce two goods, are fixed over the period

of time.

� Any change would cause a new PPC.

� Technology does not change over this time period.

A point on and off of the PPC

� Any point on the PPC is Productive Efficient - this is the lowest cost maximum output with given

technology and resources (points A, B, C, D, E)

� A point outside the PPC is impossible (point G)

� A point inside the PPC is inefficient (point F)

Law of Increasing Additional Costs - opportunity costs increase when resources are taken from

one good and applied to another. Certain resources are better suited for producing some goods than they

are for other goods.

This is the reason the PPC is normally bowed outward.

Give up Get Marginal Marginal

Point Smartphones Tablets Costs Benefits

A

B 2 10 2 10

C 3 10 3 10

D 5 10 5 10

E 7 10 7 10

F 10.5 10 10.5 10

F 22.5 10 22.5 10

Marginal Costs vs. Marginal Benefits

In Economics the word “marginal” means change.

Marginal costs is a change in the cost of producing an additional unit.

Marginal benefit is a change in the benefit of consuming an additional unit.

Trade-Off Between the Present and Future

Consumer Goods vs. Capital Goods

To have consumer goods in the future, we must accept fewer consumer goods today. There is an

opportunity cost involved.

� Capital goods today means more consumer goods in the future.

� Capital goods today means Economic Growth for the future

� Shifts the Production Possibility Curve to the right (increase)

Gains from Trade

Suppose we could operate at a point outside the PPC while holding resources fixed.

This can be accomplished through Specialization.

Specialization - the organization of economic activity so that what each person (or region) consumes is not

identical to what that person (or region) produces. An individual may specialize, for example, in law or

medicine. A nation may specialize in the production of coffee, e-book readers, or digital cameras.

Specialization is possible with Comparative Advantage.

1. A person has a comparative advantage in an activity if that person can perform the activity at a lower

opportunity cost than anyone else. If the person gives up the least amount of other goods and services to

produce a particular good or service, the person has the lowest opportunity cost of producing that good or

service. Comparative advantage is based on the output forgone.

2. A person has an absolute advantage in production when he or she uses the least amount of time or

resources to produce one unity of that particular good or service. Absolute advantage is a measure of

productivity in using inputs.

3. People can compare consumption possibilities from producing all goods and services through self-

sufficiency against specializing in producing only those goods that reflect their comparative advantage and

trading their output with others who do the same. People can then see that the consumption possibilities

from specialization and trade are greater than under self-sufficiency. Therefore, it is in people’s own self-

interest to specialize.

Adam Smith pointed out in the Wealth of Nations how individuals voluntarily engage in the socially

beneficial and cooperative activity through the pursuit of their own self-interest, rather than for society’s

best interest.

4. From society’s standpoint, the total output of goods and services available for consumption is greater

with specialization and trade. From an individual’s perspective, each person who specializes enjoys being

able to consume a larger bundle of goods and services after trading with others who have also specialized,

than would otherwise be possible under self-sufficiency. The increases are the gains from specialization

and trade for society and for individuals.

5. As long as people have different opportunity costs of producing goods or services, total output is higher

with specialization and trade than if each individual produced goods and services under self-sufficiency.

This increase in output is the gains from trade.

The Market System

Trade involves the decisions of millions of people around the world and is coordinated and carried out in

markets. One of the great wonders of the market system is that it manages to successfully coordinate the

independent activities of so many households and firms.

Market - a group of buyers and sellers of a good or service and the institution or arrangement by which

they come together to trade.

Households and Firms interact in two types of markets: product markets and factor markets.

Product Market - a market for goods

Factor Market - a market for the factors of production

We use a simple economic model call the Circular-Flow Model to see how participants in markets are

linked.

The Legal Basis of a Successful Market System

Government has to take active steps to provide a legal environment that will allow markets to operate

efficiently. If property rights are not enforced, fewer goods and services will be produced, resulting in less

economic efficiency and leaving the economy inside the Production Possibility Curve.

� Protection of Private Property

� The market system won’t work unless a significant number of people are willing to risk their

funds by investing them in businesses

� In high-income countries, someone who starts a new business or invests in an existing business

doesn’t have to worry that the government, the military, or criminal gangs might decide to

seize the business or demand payments for not destroying the business.

� Protection of Intellectual Property Rights

� Patent - gives and inventor, often a firm, the exclusive right to produce and sell a new product

for a period of 20 years from the date the patent was filed

� Copyright - the creator of a book, film, or piece of music has the exclusive right to use the

creation during the creator’s lifetime. The creator’s heirs retain this exclusive right for 50

years after the death of the creator.

� Enforcement of Contracts and Property Rights

� Contracts are legal agreements between two or more parties agreeing to carry out some action

in the future

� If there is a breach of the contract by one party, the other can go to court to have the

agreement enforced