Psalm 30:5

For His anger is but for a moment, His favor is for

life: Weeping may endure for a night. But joy comes
in the morning.

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The Economic Problem: Scarcity & Choice
Face to face Session – Basic Microeconomics [Chapter 2-Lesson1]

February 20, 2023

The Economic Problem: Scarcity & Choice
Introduction

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The Economic Problem: Scarcity & Choice
Introduction

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The Economic Problem: Scarcity & Choice
Introduction

Capital Factors of production (factors)

Things that are themselves produced and that are then The inputs into the process of production. Another term
used in the production of other goods and services. for resources.

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The Economic Problem: Scarcity & Choice
Introduction

Production Inputs Outputs

The process that transforms resources Anything provided by nature or previous Usable products.
into useful goods and services. generations that can be used directly or
indirectly to satisfy human wants.

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Scarcity, Choice & Opportunity Cost

Scarcity and choice in one-person economy

Nearly all the same basic decisions that characterize complex economies must also be
made in a simple economy.

Even if you are alone in an island, you still need to figure out:
✓ What you want to produce? – Based on your priority and choice.
✓ What can you do to satisfy you wants? – Look at possibilities and be aware of your constraints.
✓ Given limited resources, you’ll still find ways how to best use them to satisfy your hierarchy of wants.

CONSTRAINED OPTIMIZATION
- Constrained Choice
- Scarcity

Everything involves trade-offs. Everything has an OPPORTUNITY COST. The best alternative that we give
up, or forgo, when we make a choice or decision.

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Scarcity, Choice & Opportunity Cost
Concepts of Specialization, Exchange & Comparative Advantage

Scarcity and choice in an economy of two or more.

Still considering the example of living in an island, the minute someone else appears, several
decision-making arrangements immediately become possible. Two people may agree to cooperate,
or they may go off to live alone at opposite ends of the island. Even if they live apart, they may
take advantage of each other’s presence by specializing and trading.

THEORY OF COMPARATIVE ADVANTAGE

✓ Introduced by David Ricardo, a major 19th century British economist.

✓ Ricardo’s theory that specialization and free trade will benefit all trading parties, even those that
may be absolutely more efficient producers.

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Scarcity, Choice & Opportunity Cost
Concepts of Specialization, Exchange & Comparative Advantage

Scarcity and choice in an economy of two or more.

THEORY OF COMPARATIVE ADVANTAGE

✓ Introduced by David Ricardo, a major 19th century British economist.

✓ Ricardo’s theory that specialization and free trade will benefit all trading parties, even those that
may be absolutely more efficient producers.

If there are 2 people in the island, Collen and Bill and they only have 2 tasks: (1) Gathering food
and (2) cutting logs to burn.

Situation 1: If Colleen could cut more logs that Bill in 1 day and Bill could gather more fruits that
Colleen, then SPECIALIZATION would clearly lead to more TOTAL PRODUCTION. Both would
benefit as long as they can trade.

Situation 2: If Bill is slow in his fruit gathering and that Colleen is better at cutting logs & fruit
gathering. At first, I might seem that since Colleen is better at everything, she should do
everything. But that is not possible.
> DUE TO CONSTRAINED RESOURCES. Colleen’s time is limited after all.
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Scarcity, Choice & Opportunity Cost
Concepts of Specialization, Exchange & Comparative Advantage

Scarcity and choice in an economy of two or more.

THEORY OF COMPARATIVE ADVANTAGE

✓ Introduced by David Ricardo, a major 19th century British economist.

✓ Ricardo’s theory that specialization and free trade will benefit all trading parties, even those that
may be absolutely more efficient producers.

Absolute Advantage
A producer has an absolute advantage over another in the production of a good or service if it can
produce that product using fewer resources.

Comparative Advantage
A producer has a comparative advantage over another in the production of a good or service if it
can produce that product at a lower opportunity cost.

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Specialization, Exchange & Comparative Advantage

Production per hour

Philippines 3 tons of rice 1 ton of steak

Production per hour

Australia 1 ton of rice 4 tons of steak

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Specialization, Exchange & Comparative Advantage

Production per hour

Philippines has an
absolute advantage in
rice production.
Philippines 3 tons of rice 1 ton of steak

Production per hour

Australia has an
absolute advantage in
Australia 1 ton of rice 4 tons of steak the steak production.

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Specialization, Exchange & Comparative Advantage

Opportunity Cost of
producing 1 ton of
rice is 1/3 ton of
1 ton of steak
steak.
Philippines 3 tons of rice
Philippines has the
comparative
advantage in
producing rice.
Opportunity cost of
producing 1 ton of
rice is 4 tons of
Australia 1 ton of rice 4 tons of steak steak.

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Specialization, Exchange & Comparative Advantage

Weighing Present and Expected Future Costs and Benefits

A society trades present for expected future benefits when it devotes a portion of its resources to research and development or to investment
in capital.

Capital goods
In its broadest definition is anything that has already been produced that will be used to produce other valuable goods or services over time.

Consumer goods
Goods produced for present consumption.

Investment
The process of using resources to produce new capital.

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The Production Possibility Frontier (PPF)

production possibility frontier (ppf)

A graph that shows all the combinations of goods and
services that can be produced if all of society’s
resources are used efficiently.

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The Production Possibility Frontier (PPF)

production possibility frontier (ppf)

A graph that shows all the combinations of goods and
services that can be produced if all of society’s
resources are used efficiently.

Although an economy may be operating with full employment

of its land, labor, and capital resources, it may still be
operating inside its ppf, at a point such as D.

The economy could be using those resources inefficiently.

Periods of unemployment also correspond to points inside

the ppf, such as point D.

Moving onto the frontier from a point such as D means

achieving full employment of resources.

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The Production Possibility Frontier (PPF)

production possibility frontier (ppf)

A graph that shows all the combinations of goods and
services that can be produced if all of society’s
resources are used efficiently.

One of the most important concepts

incorporated in the ppf is opportunity cost.

Note: Mathematically, the slope of the ppf is

called marginal rate of transformation (MRT).

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The Production Possibility Frontier (PPF)

Unemployment
During economic downturns or recessions, industrial plants run at less than their total capacity. When there is unemployment
of labor and capital, we are not producing all that we can.

Inefficiency
Waste and mismanagement are the results of a firm operating below its potential.
Sometimes inefficiency results from mismanagement of the economy instead of mismanagement of individual private firms.

To be efficient, an economy must produce what people want. This means that in addition to operating on the ppf, the
economy must be operating at the right point on the ppf. This is referred to as output efficiency, in contrast to production
efficiency.

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The Economic Problem

Recall the three basic questions facing all economic systems:

(1) What gets produced?

(2) How is it produced?

(3) Who gets it?

Given scarce resources, how do large, complex societies go about answering the three basic
economic questions?

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Economic Systems

Command Economy
✓ An economy in which a central government either directly or indirectly sets output targets, incomes, and prices.
✓ Also called “planned economy”.

Laissez-Faire Economies: The Free Market

✓ Literally from the French: “allow [them] to do.” An economy in which individual people and firms pursue their own self-
interest without any central direction or regulation.
✓ Free-market capitalism that opposed government intervention.

Market
The institution through which buyers and sellers interact and engage in exchange.

***Some markets are simple, and others are complex, but they all involve buyers and sellers engaging in exchange. The
behavior of buyers and sellers in a laissez-faire economy determines what gets produced, how it is produced, and who gets
it.

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Economic Systems

Consumer Sovereignty
✓ The idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and
what not to purchase).

Free Enterprise
✓ The freedom of individuals to start and operate private businesses in search of profits.

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The End