The Economic Problem: Scarcity, Wants, and Choices

The
The Economic
Economic Problem:
Problem:
Scarcity,
Scarcity, Wants,
Wants, and
and Choices
Choices
Chapter 2
Chapter 2 S M Khan 1
Chapter
Chapter 22 Topics
Topics
 The Foundation of Economics
 Available Resources / factors of
production
 Basic problems of an economy
 Unemployment, Growth & the Future
– Production Possibilities
 Economic Systems
 The Circular Flow Model
The
The Foundation
Foundation of
of Economics
Economics
 Society has virtually unlimited
wants…
 But resources are limited or scarce
UNLIMITED
UNLIMITED WANTS
WANTS
 Goods & services provide utility.
 Desire for a particular good can be
satisfied, but not desire for goods in
general.
Utility
Utility and
and it’s
it’s types
types
 Utility – ability of a product to satisfy
one’s need.
Types of utility
 Form utility
 Time utility
 Place utility
 Possession utility
RESOURCE
RESOURCE CATEGORIES
CATEGORIES (1)
(1)
Property Resources
– Land
– Capital
Human Resources
– Labor
– Entrepreneurial Ability
RESOURCE
RESOURCE CATEGORIES
CATEGORIES (2)
(2)
Property Resources
 Land –
refers to
 all natural resources.
 “gift of nature”.
 usable in the productive process.
 as land, forests, mineral & oil etc.
RESOURCE
RESOURCE CATEGORIES
CATEGORIES (3)
(3)
Property Resources
 Capital Notes....
• All manufactured aid to INVESTMENT

production- as, machinery,
equipment, factory, storage. MONEY
CAPITAL
• Capital goods vs. consumer
goods; REAL
CAPITAL
• Capital as here does not refer to
money;
RESOURCE
RESOURCE CATEGORIES
CATEGORIES (4)
(4)
Property Resources
 Land
 Capital
Human Resources
 Labour
RESOURCE
RESOURCE CATEGORIES
CATEGORIES (5)
(5)
Property Resources
 Land
 Capital
Human Resources
 Labour
 Entrepreneurial Ability
Labour
Labour
 All physical and mental talents of
men and women available and
usable in producing goods and
service.
 Retail clerk, teacher, Professional
football player etc.
RESOURCE
RESOURCE CATEGORIES
CATEGORIES (6)
(6)
 Entrepreneurial Ability
– Takes initiative
– Makes basic business policy decisions
– Source of innovation
– Bears the risk
Resource
Resource Payments
Payments
PROPERTY RESOURCES
LAND RENT
CAPITAL INTEREST
HUMAN RESOURCES
LABOUR WAGES
PROFIT &
ENTREPRENEUR
LOSS
Relative
Relative Scarcity
Scarcity
 Resources are scarce or limited in
supply
 Ultimate constraints on production
Basic
Basic problems
problems of
of an
an economy
economy
 What to produce
 How to produce
 For whom to produce
Chapter
Chapter 22 Topics
Topics
 The Foundation of Economics
 Getting the Most From Available
Resources
 Unemployment, Growth & the
Future
Definition
Definition of
of Economics
Economics
 Social science concerned with using
scarce resources to attain maximum
fulfillment of society’s unlimited
wants
 Doing the best with what we have
Getting
Getting the
the Most
Most from
from Available
Available
Resources
Resources
 Full employment: using available
resources
 Full production: using resources
efficiently
– allocative efficiency – producing right
goods.
– productive efficiency – right way
Production
Production Possibilities
Possibilities
 The production possibility
frontier (PPF) is a curve depicting
all maximum output possibilities for
two goods, given a set of inputs
consisting of resources and other
factors.
Production
Possibilities
Assumes:
 full employment & productive efficiency
 fixed resources
 fixed technology
 two goods
– pizzas symbolize consumer goods
– industrial robots symbolize capital goods
PRODUCTION POSSIBILITIES
What if we could only produce ...
10,000 Robots
10,000 Robots
or
400,000 Pizzas
using all our resources?

10,000 Robots
or
400,000 Pizzas
To get some pizza, we must

give up some robots!
for example....
PIZZA 0 1 2 3 4
(in hundred thousands)
ROBOTS 10 9 7 4 0
(in thousands)
PIZZA 0 1 2 3 4
ROBOTS 10 9 7 4 0
(in thousands)
12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
pizza (hundred thousands)
PIZZA 0 1 2 3 4
ROBOTS 10 9 7 4 0
(in thousands)
12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
PIZZA 0 1 2 3 4
ROBOTS 10 9 7 4 0
(in thousands)
12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
PIZZA 0 1 2 3 4
ROBOTS 10 9 7 4 0
(in thousands)
12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
PIZZA 0 1 2 3 4
ROBOTS 10 9 7 4 0
(in thousands)
12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
PIZZA 0 1 2 3 4
ROBOTS 10 9 7 4 0
(in thousands)
12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
PIZZA 0 1 2 3 4
ROBOTS 10 9 7 4 0
(in thousands)
12
robots (thousands)
10
PRODUCTION 8
6
POSSIBILITIES 4
CURVE 2
0
0 1 2 3 4 5
Figure 2-1
Q Unattainable
A B
10
Robots (thousands)
C
9 W
Robots (thousands)
8
7 D
6 Attainable and
5 attainable efficient
4 but
3
2 inefficient
1 E
Q
1 2 3 4 5 6 7 8
Pizzas (hundred thousands)
Production
Possibilities
 the production possibilities curve
(frontier) marks the boundary between
attainable & unattainable production
levels
 points on the curve are attainable &
efficient
 points above the curve are unattainable
 points below the curve are attainable &
inefficient
Production
Possibilities
Opportunity Costs:
 The cost of passing up the next best
choice when making a decision. For
example, if an asset such as capital is
used for one purpose, the opportunity
cost is the value of the next best purpose
the asset could have been used for.
Production
Possibilities
Law of Increasing Opportunity Costs:
 opportunity cost increases with
amount produced
 as we make more pizzas, the
robots we have to give up (per
pizza) increases
illustrated...
PIZZA 0 1 2 3
4
ROBOTS
(in hundred thousands)10 9 7 4
0
(in thousands)
 Opportunity Cost 1st Pizza unit
=1 Robot unit
1 (hundred thousand) pizzas “cost” 1

(thousand) robots
PIZZA 0 1 2 3
4
ROBOTS
0
(in thousands)
 Opportunity Cost 2nd Pizza unit
=2 Robot units

(thousand) robots
PIZZA 0 1 2 3
4
ROBOTS
0
(in thousands)
 Opportunity Cost 3rd Pizza unit
= 3 Robot units

(thousand) robots
PIZZA 0 1 2 3
4
ROBOTS
0
(in thousands)
 Opportunity Cost 4th Pizza unit
= 4 Robot units

(thousand) robots
PIZZA 0 1 2 3
4
ROBOTS
 0Opportunity Cost 1st Pizza Unit = 1 Robot Unit
(in thousands)
 Opportunity Cost 2nd Pizza Unit = 2 Robot Units
 Opportunity Cost 3rd Pizza Unit = 3 Robot Units
 Opportunity Cost 4th Pizza Unit = 4 Robot Units
the more pizzas we make, the more each

one costs, in terms of robot units foregone
12
10
1st pizza unit 8
robots(thousands)
6
costs 1
robot unit 4
2
0
0 1 2 3 4 5
12
10
2nd pizza unit 8
robots(thousands)
6
costs 2
robot units 4
2
0
0 1 2 3 4 5
12
10
3rd pizza unit 8
robots(thousands)
6
costs 3
robot units 4
2
0
0 1 2 3 4 5
the more
12
pizza
we make, the 10
more robots 8
we have robots(thousands)
to give up 6
 the steeper 4
the curve
2
0
0 1 2 3 4 5
LAW
LAW OF
OF INCREASING
INCREASING
OPPORTUNITY
OPPORTUNITY COSTS
COSTS
 Means a graph of the production
possibilities curve will be
CONCAVE — bowed out from the
origin
 Economic resources are not
completely adaptable to other uses
Production
Possibilities
 Which point on the frontier is BEST?
 Need more information to decide on
allocative efficiency.
Allocative
Allocative Efficiency
Efficiency Revisited
Revisited
 Decide on allocative efficiency by
comparing Marginal (extra) Cost (MC)
to Marginal Benefit (MB).
 Marginal Benefit is the extra benefit
associated with consuming one more
unit.
 Marginal Cost is the extra opportunity
cost of that extra unit.
Allocative
Revisited
Figure 2-2 MB > MC
under allocation of
resources
MC
Marginal benefit and
15
marginal cost
10
5
MB
0
0 1 2 3
Quantity of pizza (hundred thousands)
Allocative
Revisited
Figure 2-2 MB < MC
over allocation of
resources
MC
15
marginal cost
10
5
MB
0
0 1 2 3
Allocative
Revisited
Figure 2-2
MC
15 MB=MC
marginal cost
too few too many

10
5
MB
0
0 1 2 3
Production Possibilities Curve
Q
Unemployment &
10 Underemployment
Robots (thousands)
9
Robots (thousands)
8 Shown by Point U
7
6
5 U
4
3
2
1
Q
1 2 3 4 5 6 7 8
Production Possibilities Curve
Figure 2-3
Q
Unemployment &
10 Underemployment
Robots (thousands)
9
Robots (thousands)
8 Shown by Point U
7
6
5
4 U More of either or
3
2 both is possible
1
Q
1 2 3 4 5 6 7 8
Production
Possibilities Curve
Curve
 Economic Growth: a rightward
shift of the production
possibilities curve caused by....
1. Increases in resource supplies
2. Advances in technology
A’ Figure 2-4
Q 14 Economic Growth
13 B’
12
11
Robots (thousands)
10
C’
9
8
7
6 D’
5
4
3
2
1 E’
1 2 3 4 5 6 7 8 Q
Two Examples of Economic Growth
Figure 2-5
FAVOURING
PRESENT GOODS
Goods for the Future
FUTURE
CURVE
Goods for the Present
Two Examples of Economic Growth
Figure 2-5
FAVOURING FAVOURING
PRESENT GOODS FUTURE GOODS

FUTURE FUTURE
CURVE CURVE
Goods for the Present Goods for the Present
Qualification:
Qualification: International
International Trade
Trade
 An individual nation is limited by the
production possibilities curve
 But NOT when there is international
specialization and trade!
– possible to consume ABOVE the
production possibilities curve
Examples
Examples &
& Applications
Applications
 Unemployment & Productive
Inefficiency
– the Great Depression
– discrimination
 Tradeoffs & Opportunity Costs
– logging or wilderness?
 Shifts in Production Possibilities
Curves
– cell phones, the Internet
Chapter
Chapter 22 Topics
Topics
 Getting the Most From Available
Resources
 Unemployment, Growth & the
Future
Economic
Economic Systems
Systems
 Market economy
 Command economy
 Mix economy
 Islamic economy
Economic
Economic Systems
Systems
 Resource allocation methods
differ according to:
– resource ownership
– co-ordination method
The
The Market
Market System
System
 Private ownership of capital
 Prices & markets co-ordinate activity
 Independent actions of buyers
& sellers
 Limited role for government
The
The Command
Command System
System
 Socialism, communism
 Government owns most resources
 Central planning
Mixed
Mixed economy
economy
 Both Govt. and private
Islamic
Islamic economy
economy
 As stated of holy Quran …… and
found in Pakistan,Iran, Saudi
Arabia and other Islamic states.
Chapter
Chapter 22 Topics
Topics
 Getting the Most From Available
Resources
 Unemployment, Growth & the
Future
 Economic Systems
Circular
Circular Flow
Flow Model
Model
Figure 2-6
BUSINESSES
Circular
Circular Flow
Flow Model
Model
Figure 2-6
BUSINESSES HOUSEHOLDS
Circular
Circular Flow
Flow Model
Model
Figure 2-6
RESOURCE
MARKET
RESOURCES INPUTS
Circular
Circular Flow
Flow Model
Model
Figure 2-6
$I
NC
S
ST
O ME
RESOURCE
O
C
S
MARKET
$
RESOURCES INPUTS
Circular
Circular Flow
Flow Model
Model
Figure 2-6
$
S
IN
ST
C
RESOURCE
O
O
C
M
MARKET
$
ES
RESOURCES INPUTS
GOODS & GOODS &

SERVICES SERVICES
PRODUCT
MARKET
Circular
Circular Flow
Flow Model
Model
Figure 2-6
$
S
IN
ST
C
RESOURCE
O
O
C
M
MARKET
$
ES
RESOURCES INPUTS
GOODS & GOODS &

SERVICES SERVICES
N
OI
PT
PRODUCT
$
M
R
SU
MARKET
EV
N
EN
O
C
U
E
$

The Economic Problem: Scarcity, Wants, and Choices

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The Economic Problem: Scarcity, Wants, and Choices

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The

• All manufactured aid to INVESTMENT

using all our resources?

To get some pizza, we must

1 (hundred thousand) pizzas “cost” 1

1 (hundred thousand) pizzas “cost” 2

1 (hundred thousand) pizzas “cost” 3

1 (hundred thousand) pizzas “cost” 4

the more pizzas we make, the more each

too few too many

Goods for the Present

Goods for the Future

Goods for the Present Goods for the Present

GOODS & GOODS &

GOODS & GOODS &

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