Mogadishu University

Faculty of Political Science & Public Administration

Department of PA 1st year, 2ndSemester
PRINCIPLES OF ECONOMICS

Lecture 02
Scarcity Means Making
Choices, Making Choices Means
Incurring Opportunity Costs

Course Lecturer
Mr. Mohamed Irshaad
Date: Feb 2021

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 Scarcity Means Making Choices
• Without enough resources to satisfy all our wants we
have to choose which wants (of the unlimited number
we have) we will satisfy.
• Example: Maria earns $500a month. She wants a new
laptop computer, 10 new books, a trip to Djibouti , a
new car, and many other things.
• The problem is that she can’t have everything she
wants, given her income which is $500 .
• She has to choose between the new laptop computer
or the 10 new books.
• She also has to choose between the trip to Djibouti and
a down payment on aMr.new car.
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 Opportunity cost
• Every time you make a choice, such as
choosing to buy a shirt instead of two pairs of
shoes, you incur an opportunity cost.
• The most valued opportunity or alternative
you give up to do something is that
something’s opportunity cost.
• The opportunity cost of your choosing to buy
a shirt is two pairs of shoes.

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 Trade-offs
• Economists often say that life is full of trade-offs.
• The nature of a trade-off is that you can get more
of one good, but only by getting less of another
good.
• Speaking about trade-offs is just another way of
speaking about opportunity cost.

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 Production Possibility Frontier (PPF)
One Diagram with three Economic Concepts
• The diagram illustrates the three economic
concepts we have discussed: scarcity, choice,
and opportunity cost.
• It called a production possibilities frontier (or
PPF, for short).
• A production possibilities frontier shows
possible combinations of two goods that an
economy can produce in a certain period of
time (Exhibit 1-2).
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 a) Scarcity and the PPF
• Scarcity, as you know, is the condition in which our
wants are greater than the resources available to
satisfy them. The PPF illustrates this concept.
• Any point on the PPF itself, such as points A–D, is
available to us. We can also have the combination
of goods represented by any point below the PPF,
such as point E.
• But we can’t have point F, which lies beyond the
PPF because we don’t have enough resources to
produce it.
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 b) Choices and the PPF
• Because of scarcity we cannot be at points A–
D at the same time.. Thus, we must make
choices.

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 Economics Is a Way of Thinking
• Economists have a particular way of looking at the
world.
a) Thinking in Terms of Costs and Benefits
• According to an economist, almost everything we do
involves costs (negatives, disadvantages) and benefits
(positives, advantages). Eg. Making Cost-Benefit
Decisions
– Eg. A person will want to do a particular activity only if the
benefits are greater than the costs.
– A person will buy a computer only if the benefits of buying
the computer are expected to be greater than the costs of
buying it.
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 b) Thinking at the Margin
• That word is marginal, In economics, means
“additional.”
• Economists believe that when people make
decisions, they do not think of the total costs
and benefits involved in the decision.
• They think about the additional, or marginal,
costs and benefits.

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 c) Thinking in Terms of Incentives
• An incentive is something that encourages or motivates
a person to take an action.
– For example, suppose that Aisha lives in a country where every
dollar she earns is taxed (by government) at 100 percent.
• With a tax rate of 100 percent, an economist might argue
that Aisha does not have an incentive to produce
anything for sale.
• Now let’s lower the tax rate in Aisha’s country from 100
percent to 20 percent.
• The lower tax rate encourages or motivates Aisha toward
a particular action—working and producing—because
now Aisha can keep 80 cents out of every dollar she
earns. Mr. Mohamed Irshaad 12
d) Thinking in Terms of Trade-Offs
• Trade-offs involve opportunity costs.
• When more of one thing necessarily means
less of something else, we have a trade-off.
• For example, when we drive our cars, we
pollute the air… One way to cut down on the
amount of pollution is to drive less.
• More driving means less clean air, and less
driving means more clean air.
• So we can trade off b/w driving a cur or
amount of air pollution.
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 Societies Face Trade-Offs
• Just as individuals face trade-offs, so do
societies.
• At any one point in time, the federal
government has only so much money from tax
revenues.
• If more tax dollars go for, say, education, it
means fewer tax dollars to spend on roads and
highways.

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 Societies Face Trade-Offs
• Trade-offs sometimes lead to conflicts in
society.
• One group may think it better to spend more
money on national defense and less on health
and welfare. Another group might prefer the
opposite.

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Thinking in Terms of the Small and the Big
• microeconomics vs macroeconomics
• In microeconomics, economists look at the small
picture/ small economic units, such as an
individual or a single business firm.
– For example, in microeconomics, an economist
would study and discuss the unemployment that
exists in a particular industry. Eg. a car industry;
• Economists who deal with macroeconomics look
at the big picture/ the entire economy
– In macroeconomics for example, an economist
would investigate the unemployment that exists in
the nation. Mr. Mohamed Irshaad 16
 Economic Systems
• The two major economic systems are free
enterprise and socialism.
• Free enterprise, also called capitalism or a
market economy, is an economic system in
which individuals own most, if not all, the
resources and control their use.
• In socialism, also referred to as a command
economy, government controls and may own
many of the resources.

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 Major Differences Between
Free Enterprise and Socialism
1- Resources
• In a free enterprise economic system, the
resources are owned and controlled by private
individuals.
• In a socialist economic system, the
government controls and may own many of
the resources.

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 Major Differences Between
Free Enterprise and Socialism
2- Government’s Role in the Economy
• In a free enterprise economic system,
government plays a small role in the economy.
• It does not make decisions on things like what
goods and services will be produced or how
they will be produced.
• Under socialism, government may make those
decisions.

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 Major Differences Between
Free Enterprise and Socialism
3- Economic Plans
• Under socialism, government decision makers
may write an economic plan,
– For example, a plan may state that over the next
five years, the nation’s economy will produce more
manufactured goods (such as cars and trucks) and
fewer agricultural goods (such as wheat and corn).
• A free enterprise economic system would have
no such plan.
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 Major Differences Between
Free Enterprise and Socialism
• 4- Income Distribution
• Income distribution refers to how all the
income earned in a country is divided among
different groups of income earners.
• Government decision makers under socialism
are more likely to use government’s powers to
redistribute income, usually directing it away
from society’s high earners.

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 Major Differences Between
Free Enterprise and Socialism
5- Controlling Prices
• In a free enterprise economic system, prices are
allowed to fluctuate—that is, to go up and
down. Government does not attempt to control
prices.
• In a socialist economic system, government
decision makers do control prices..
• Price Ceiling Vs Price Floor

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 Major Differences Between
Free Enterprise and Socialism
6- Private Property
• Under free enterprise, private property is
sacred.
• According to socialists, it would be better for
government to own most of the non-labor
property in the economy (such things as
factories, raw materials, and machinery).

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 Mixed Economies
• Economies with features of both free enterprise
and socialism are called mixed economies.
• A mixed economy is economy that is neither
purely capitalist nor purely socialist
• Most countries in the world have mixed
economies.
• Most countries today have some elements of both
capitalism and socialism in their economic system.

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 The Visions Behind Free
Enterprise and Socialism
• Both free enterprise and socialism are the
products of certain visions of
1- Adam Smith, a 18th century economist, is a
major thinker whose ideas are fundamental to
free enterprise
2- Karl Marx, an 18th century economist, whose
ideas are at the heart of socialism (and
communism).
• He pointed out what he believed were many of
the failures and injustices of free enterprise.
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 The Visions Behind Free
Enterprise and Socialism
• To get a sense of how their visions differed,
and how the two major economic systems
differ, let’s take a closer look at one major idea
from both Smith and Marx.

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 The Idea of Self-Interest
• Adam Smith said that from the minute we enter
this world until the day we go to our graves, we
feel a desire to make ourselves better off.
• Smith felt that self-interest is a major part of
who we are.
• He believed that our self-interest prompts us to
work hard, take risks, and in the end benefit
others through our activities.
• Smith believed that if people wanted to serve
their own self-interest, they had to serve others
first. Mr. Mohamed Irshaad 28
 Labor Theory of Value
• Karl Marx didn’t see self-interest as leading to
good things; instead, he saw it as hurting others.
• Marx believed that capitalists, in pursuing their
self-interests, actually exploited the workers.
• How does this happen?
• Marx believed that the owners of factories and
businesses exploited the workers by paying
them far less than they were worth.

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 surplus value
• For example, suppose a worker produced $100 a
day worth of value for the factory owner but was
only paid $20.
• The difference between the total value of
production ($100) and the wages paid to the worker
($20) is what Marx called surplus value ($80).
• According to Marx this surplus should go to the
worker, but instead is stolen by the capitalist for
himself.

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 END!
Thank you for listening

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