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

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1 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.

2 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)

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5 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 C D E F F 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.

6 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)

7 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 selfsufficiency 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 selfinterest 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.

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10 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.

11 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