Lecture 2

Scarcity and the Human Condition

Scarcity and the Human Condition

Readings: Chapter 2

Familiarize yourself with myeconlab

Scarcity and the Human Condition

In the last lecture, I argued that economists understand the forces shaping human social values and human social behaviour as originating from a response to the existential problem of scarcity.

But is this true? Are there not other existential problems shaping human social life? Death Class Parent-Child Relationship

While these are important, Scarcity is perhaps the least well understood existential problem.

Scarcity and the Human Condition

Can scarcity be overcome? Since unlimited human wants (greed) is the cause of

scarcity, no amount of economic growth solves this problem.

Reducing poverty and inequality are good, but they will not eliminate scarcity.

Even the richest person on earth cannot overcome scarcity.

We have mostly failed to re-educate humans to be satisfied with a sustainable living.

Increasing the pace of globalization or reversing it will not cure scarcity. Self sufficiency won’t do it either.

This may not be such a bad thing.

Scarcity and the Human Condition

What are the implications of scarcity on for human social life?

Having more education means sacrificing consumption for a time.

Having more economic growth may mean sacrificing security.

Higher environmental quality usually requires the sacrifice of consumption.

Implication: Choice is unavoidable when individual or social objectives are pursued. Choice involves tradeoffs.

Scarcity and the Human Condition

How can we analyse these fundamental economic choice problems?

Develop a simple economic model of the problem

Call the model the parable of goat island

Scarcity and the Human Condition

The Parable of Goat Island The people of Goat Island live communally in a tropical

paradise. Their only decision is how many acres of land should be fenced and planted in yams, and how many acres of land should be used to free-range goats.

There are 1000 acres of land on the island, 500 acres of which are rocky mountainside, with the remaining 500 acres being rich volcanic plain.

One acre of mountainside can support 1 goat or produce 1 tonne of yams. One acre of plain can support 1 goat or produce 4 tonnes of yams. The alternatives facing the communal activity are described in the following table.

Scarcity and the Human Condition

Acres in Yams, Acres in Goats Tonnes of Yams Tonnes of Goats

0, 1000 0 1000

100, 900 400 900

200, 800 800 800

300, 700 1200 700

400, 600 1600 600

500, 500 2000 500

600, 400 2100 400

700, 300 2200 300

800, 200 2300 200

900, 100 2400 100

1000, 0 2500 0

Scarcity and the Human Condition

The choice society must make is how many yams and how many goats to produce.

A production possibilities frontier (PPF) is one way to represent all the choices available.

PPF of a Yam-Goat society

2000

1000

500

1000

2500

Yams (tonnes)

Goats

Scarcity and the Human Condition

What if there are more types of land?

Goats

Yams

Coke - Pizza Society Production Possibilities

Frontier (PPF) for two goods: cola and pizza. Any point on the frontier

such as E and any point inside the PPF such as Z are attainable.

Points outside the PPF are unattainable.

Scarcity and the Human Condition

Tradeoff Along the PPF Every choice along

the PPF involves a tradeoff.

On this PPF, we must give up some cola to get more pizzas or give up some pizzas to get cola.

Production Possibilities and Opportunity Cost

Opportunity Cost As we move down

along the PPF, we produce more pizzas, but the quantity of cola we can produce decreases.

The opportunity cost of a pizza is the cola forgone.

Production Possibilities and Opportunity Cost

In moving from E to F, the quantity of pizzas increases by 1 million.

The quantity of cola decreases by 5 million cans.

The opportunity cost of the fifth 1 million pizzas is 5 million cans of cola.

One of these pizzas costs 5 cans of cola.

Production Possibilities and Opportunity Cost

In moving from F to E, the quantity of cola produced increases by 5 million.

The quantity of pizzas decreases by 1 million.

The opportunity cost of the first 5 million cans of cola is 1 million pizzas.

One of these cans of cola costs 1/5 of a pizza.

Production Possibilities and Opportunity Cost

Note that the opportunity cost of a can of cola is the inverse of the opportunity cost of a pizza.

One pizza costs 5 cans of cola.

One can of cola costs 1/5 of a pizza.

Production Possibilities and Opportunity Cost

Because resources are not equally productive in all activities, the PPF bows outward—is concave.

The outward bow of the PPF means that as the quantity produced of each good increases, so does its opportunity cost.

Production Possibilities and Opportunity Cost

All the points along the PPF are efficient. To determine which of the alternative efficient

quantities to produce, we compare costs and benefits.

The PPF and Marginal Cost The PPF determines opportunity cost. The marginal cost of a good or service is the

opportunity cost of producing one more unit of it.

Using Resources Efficiently

Figure 2.2 illustrates the marginal cost of pizza.

As we move along the PPF in part (a), the opportunity cost of a pizza increases.

The opportunity cost of producing one more pizza is the marginal cost of a pizza.

Using Resources Efficiently

Using Resources Efficiently

The bars illustrate the increasing opportunity cost of pizza.

The black dots and the line MC show the marginal cost of pizza.

The MC curve passes through the centre of each bar.

Scarcity and the Human Condition

What else does the PPF model tell us about economic choice?

We can use it to examine the impact of racism, sexism, and recession.

Each of these causes resources to be under-employed.

This moves us to the interior of the PPF. This is grossly inefficient because more of

everything could be produced and consumed.

We achieve production efficiency if we cannot produce more of one good without producing less of some other good.

Points on the frontier are efficient.

Scarcity and the Human Condition

Any point inside the frontier, such as Z, is inefficient.

At such a point, it is possible to produce more of one good without producing less of the other good.

At Z, resources are either unemployed or misallocated.

Production Possibilities and Opportunity Cost

Scarcity and the Human Condition

What else does our PPF model help us understand?

Technological Progress and Capital Accumulation

War and Natural Disaster

The expansion of production possibilities—and increase in the standard of living—is called economic growth.

Two key factors influence economic growth: Technological change is the development of new

goods and of better ways of producing goods and services.

Capital accumulation is the growth of capital resources, which includes human capital.

Economic Growth

The Cost of Economic Growth To use resources in research and

development and to produce new capital, we must decrease our production of consumption goods and services.

So economic growth is not free. The opportunity cost of economic growth is

less current consumption.

Economic Growth

Figure 2.5 illustrates the tradeoff we face.

We can produce pizzas or pizza ovens along PPF0.

By using some resources to produce pizza ovens today, the PPF shifts outward in the future.

Economic Growth

Scarcity and the Human Condition

What about war and natural disaster? War and natural disaster destroys capital and

kills the labour force. This must push the PPF in until peace and

good weather are re-established. Some Implications:

The tsunami in Japan pushed the PPF in The Arab spring had a much higher cost in Libya

and Syria than in Egypt or Tunisia. With a new government, Libya will likely attract new investment and may recover quickly. Syria is in trouble.

Global warming is a real threat to long term economic prosperity.

Scarcity and the Human Condition

What does this model fail to tell us about economic choice?

Where on the PPF society should choose to locate.

How society should organize production. How the product of society should be distributed. How much of society’s resources should be

devoted to investment and research (to expand the PPF).

Scarcity and the Human Condition

How will these economic choices be made? Depends on how the economy is organized. Much depends on the relative importance of

government and markets in making these decisions. In Canada’s mixed economy both markets and

government influence where society locates on the PPF. Both markets and governments influence how this social product is distributed. Finally, both markets and governments influence how much is invested.

This raises two related questions: Why should markets be involved? Why not let democratic government make all the crucial

decisions on how scarce resources should be allocated and distributed?

Scarcity and the Human Condition

Markets have a number of advantages that most societies exploit.

1. The market mechanism is decentralized and automatic, making possible rapid and virtually costless social decisions.

2. Governments are centralized, slow and costly. (Example: Hurricane Katrina -2005).

3. The market mechanism rewards innovation with profits. Governments are less effective at rewarding innovation.

4. Democratic governments tend to respond to the demands of their narrow constituency in making decisions. The market responds to all consumers - consumer sovereignty.

Scarcity and the Human Condition

Mixed economies tend to rely on markets to make most of the allocation and distribution decisions. In mixed economies, democratic decision-making is aimed at fine tuning policy instruments that bend market outcomes to better suit the interests of the ruling party and their constituency.

Government use tax and subsidy instruments to alter market prices and so bend market outcomes. For instance, governments heavily subsidize university education, which increases enrolment at universities.

Scarcity and the Human Condition

Government also buys goods and services in the marketplace, and then uses market and non-market channels to distribute these goods and services to members of the public.

For example, governments buy health services from health care providers and then distribute these services through government run insurance schemes. Most government services (education, defence, etc) are largely purchased in markets and then distributed by government.

Scarcity and the Human Condition

Markets play the key organizing function in mixed economies.

Attempting to understand how the market system organizes our vast and complicated modern economy is where micro-economics begins, and this is where we turn next.

Scarcity and the Human Condition

Next Day: Lecture 3 – The Market Mechanism Readings – Chapter 3, Demand and Supply