Transcript Chapter 2 - Scarcity, Choice, and Economic Systems

Scarcity, Choice, and
Economic Systems
Slides by: John & Pamela Hall
ECONOMICS 3e / HALL & LIEBERMAN
SCARCITY, CHOICE, AND ECONOMIC SYSTEMS
© 2005 South-Western/Thomson Learning
The Concept of Opportunity Cost
• Opportunity cost of any choice
– What we forego when we make that choice
• Most accurate and complete concept of
cost
• Direct money cost of a choice may only be
a part of opportunity cost of that choice
• Opportunity cost of a choice includes both explicit
costs and implicit costs
– Explicit cost—dollars actually paid out for a choice
– Implicit cost—value of something sacrificed when no
direct payment is made
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Opportunity Cost and Society
• All production carries an opportunity
cost
– To produce more of one thing
• Must shift resources away from producing
something else
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Production Possibilities Frontiers (PPF)
• Curve showing all combinations of two
goods that can be produced with resources
and technology available
• Society’s choices are limited to points on or
inside the PPF
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Figure 1: The Production
Possibilities Frontier
Quantity of All
Other Goods
per Period
1,000,000
950,000
850,000
At point A, all
resources are used
for "other goods."
A
B
C
D
700,000
500,000
400,000
Moving from point A to point B
requires shifting resources out of
other goods and into health care.
W
E
At point F. all
resources are used
for health care.
F
100,000 200,000 300,000 400,000 500,000 Number of Lives
Saved per Period
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Increasing Opportunity Cost
• According to law of increasing
opportunity cost
– The more of something we produce
• The greater the opportunity cost of
producing even more of it
• This principle applies to all of society’s
production choices
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The Search for a Free Lunch
• Productive Inefficiency
– More of at least one good can be produced
• Without pulling resources from the production of any
other good
• No industry, firm or economy is ever 100%
productively efficient
– However, cases of gross inefficiency are not as
common as you might think
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Recessions
• A slowdown in overall economic activity
when resources are idle
– Widespread unemployment
– Factories shut down
• Land and capital are not being used
• An end to the recession would move the economy
from a point inside its PPF to a point on its PPF
– Using idle resources to produce more goods and
services without sacrificing anything
• Can help us understand an otherwise confusing episode in
U.S. economic history
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Recessions
• During early 1940s, standard of living in U.S. did not
decline as we might have expected but actually improved
slightly. Why?
–
U.S. entered World War II and began using massive amounts of
resources to produce military goods and services
• Instead of pitting “health care” against “all other goods,” we look at
society’s choice between military goods and civilian goods
• U.S. was still suffering from the Great Depression when it entered
WWII
• Joining war effort helped end the Depression and moved economy
from a point like A, inside the PPF, to a point like B, on the frontier
– Military production increased, but so did the production of civilian goods
– Although there were shortages of some consumer goods
» Overall result was a rise in the material well-being of the average
U.S. citizen
– War is only one factor that can reverse a downturn
– No rational nation would ever choose war as an economic policy designed
to cure a recession
» Alternative policies that virtually everyone would find preferable
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Figure 2: Production and Unemployment
Military Goods
per Period
1. Before WWII the United States
operated inside its PPF . . .
B
2. then moved to the PPF
during the war. Both
military and civilian
production increased.
A
Civilian Goods per Period
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Economic Growth
• If economy is already operating on its PPF
– Cannot exploit opportunity to have more of everything by moving to it
• But what if the PPF itself were to change? Couldn’t we then
produce more of everything?
– This happens when an economy’s productive capacity grows
• Many factors contribute to economic growth, but they can be
divided into two categories
– Quantities of available resources—especially capital—can increase
• An increase in physical capital enables economy to produce more of
everything that uses these tools
– More factories, office buildings, tractors, or high-tech medical equipment
• Same is true for an increase in human capital
– Skills of doctors, engineers, construction workers, software writers, etc.
– Technological change enables us to produce more from a given
quantity of resources
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Economic Growth
• Increases in capital and technological change often go
hand in hand
• For instance, PET body scanners will enable us to save
even more lives than our current set of resources
– Moving horizontal intercept of PPF rightward, from F to F‘
– Impact of PET scanners stretches PPF outward along horizontal
axis
• How can a technological change in lifesaving enable us to
produce more goods in other areas of the economy?
– Society can choose to use some of increased lifesaving potential
to shift other resources out of medical care and into production of
other things
• Because of technological advance and new capital, we can shift
resources without sacrificing lives
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Economic Growth
• If we can produce more of the things that we value,
without having to produce less of anything else, have we
escaped from paying an opportunity cost?
– Yes . . . and no
– Figure 3 tells only part of story
• Leaves out steps needed to create this shift in the PPF
• For example, technological innovation doesn’t just “happen”—
resources must be used to create it
– Mostly by research and development (R&D) departments of large
corporations
• In order to produce more goods and services in the future,
we must shift resources toward R&D and capital
production
– Away from production of things we’d enjoy right now
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Figure 3: The Effect of a New Medical
Technology
Quantity of All
Other Goods
per Period
1,000,000
2. But not its vertical
intercept.
4. or more lives saved and greater
production of other goods.
A
J
700,000
H
D
1. A technological advance in
saving lives increases this
PPF's horizontal intercept . . .
300,000
3. The economy can end
up with more lives
saved and un-changed
production of other
goods . . .
F
F'
500,000 600,000
Number of Lives Saved per Period
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Specialization and Exchange
• Specialization
– Method of production in which each person concentrates on a
limited number of activities
• Exchange
– Practice of trading with others to obtain what we want
• Allows for
– Greater production
– Higher living standards than otherwise possible
• All economics exhibit high degrees of specialization and
exchange
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Further Gains to Specialization
• Absolute Advantage: A Detour
– Ability to produce a good or service using fewer
resources than other producers use
• Comparative Advantage
– If one can produce some good with a smaller
opportunity cost than others can
– Total production of every good or service will be
greatest when individuals specialize according to their
comparative advantage
– Another reason why specialization and exchange lead
to higher living standards than self-sufficiency
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Specialization in Perspective
• While specialization gives us material gains
– There may be opportunity costs to be paid in
the loss of other things we care about
• The right amount of specialization can be
found by balancing gains against costs
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Resource Allocation
• Problem of resource allocation
– Which goods and services should be produced
with society’s resources?
• Where on the PPF should economy operate?
– How should they be produced?
• No capital at all
• Small amount of capital
• More capital
– Who should get them?
• How do we distribute these products among the
different groups and individuals in our society?
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The Three Methods of
Resources Allocation
• Traditional Economy
– Resources are allocated according to long-lived
practices from the past
• Command Economy (Centrally-Planned)
– Resources are allocated according to explicit
instructions from a central authority
• Market Economy
– Resources are allocated through individual
decision making
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The Nature of Markets
• A market is a group of buyers and
sellers with the potential to trade with
each other
– Global markets
• Buyers and sellers spread across the globe
– Local markets
• Buyers and sellers within a narrowly defined
area
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The Importance of Prices
• A price is the amount of money that must be
paid to a seller to obtain a good or service
• When people pay for resources allocated by
the market
– They must consider opportunity cost to society
of their individual actions
• Markets can create a sensible allocation of
resources
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Resource Allocation in the United
States
• Numerous cases of resource allocation outside
the market
– Such as families
• Various levels of government collect about onethird of our incomes as taxes
– Enables government to allocate resources by command
• Government uses regulations of various types to
impose constraints on our individual choice
• The market is the dominant method of resource
allocation in United States
– However, it is not a pure market
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Resource Ownership
• Communism
– Most resources are owned in common
• Socialism
– Most resources are owned by state
• Capitalism
– Most resources are owned privately
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Types of Economic Systems
• An economic system is composed of
two features
– Mechanism for allocating resources
• Market
• Command
– Mode of resource ownership
• Private
• State
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Figure 4: Types of Economic
Systems
Resource Allocation
Private
Market
Command
Market
Capitalism
Centrally
Planned
Capitalism
Market
Socialism
Centrally
Planned
Socialism
Resource
Ownership
State
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Economic Systems
and This Book
• This book will focus on market capitalist
economies
• About 400 million people have come under
the sway of the market in past decade
• More are being added as China changes to
a market economy
• Study of modern economies is study of
market capitalism
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Using The Theory:
Are We Saving Lives Efficiently?
• Could be productive inefficiency in saving human lives
• Some economists have argued that we waste significant
amounts of resources in our lifesaving efforts
– How have they come to such a conclusion?
• Saving a life—no matter how it is done—requires use of
resources
– Any lifesaving action we might take requires certain quantities of
resources
• For example, putting another hundred police on the streets, building
another emergency surgery center, or running an advertising
campaign to encourage healthy living
– In a market economy, resources sell at a price
• Allows us to use the dollar cost of a lifesaving method to measure
value of resources used up by that method
• Can compare “cost per year of life saved” of different methods
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Using The Theory:
Are We Saving Lives Efficiently?
• Cost per life saved of various life-saving methods ranges widely
– From $150 per year of life saved for a physician warning a patient to quit
smoking, to over $66,000,000 per year of life saved from the ban on
asbestos in automatic transmissions
• Some lifesaving methods are highly cost effective but some serious
productive inefficiency exists in lifesaving
• Allocating lifesaving resources is much more complicated than our
discussion so far has implied
– Benefits of lifesaving efforts are not fully captured by “life-years saved”
• Or even by an alternative measure, which accounts for improvement in quality
of life
• Another difficulty in allocating our lifesaving resources efficiently is
uncertainty
– Trying to gauge and improve our productive efficiency in saving lives—
which was never an exact science—has become even less exact in the
post-9/11 era
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