The Economic Problem: Scarcity and Choice

The Main Content

I. II.

The economic problem Scarcity and choice (the production possibility frontier)

What is Production?

Production is the process by which resources are transformed into useful forms. Resources, or inputs, refer to anything provided by nature or previous generations that can be used directly or indirectly to satisfy human wants.
Capital

resources Human resources Natural resources

Three Basic Questions

The mechanics of decision making in a larger economy are more complex, but the type of decisions that must be made are nearly identical.

All societies must decide:

What to produce?
How to produce? For whom to produce?

Three Basic Questions

Factors of Production

The basic resources that are available to a society are factors of production: 1. Land (natural resource) 2. Labor 3. Capital Capital refers to the things that are themselves produced and then used to produce other goods and services. Production is the process that transforms scarce resources into useful goods and services.

I. Scarcity and Choice

Capital goods are goods used to produce other goods and services. Consumer goods are goods produced for present consumption.

Investment is the process of using resources to produce new capital. Capital is the accumulation of previous investment.
capital is forgone present consumption.

The opportunity cost of every investment in

The Production Possibility Frontier

A

The production possibility frontier (ppf) is a graph that shows all of the combinations of goods and services that can be produced if all of societys resources are used efficiently.

Inefficiency

Points inside of the curve are inefficient.

At point H, resources are either unemployed, or are used inefficiently.

Unattainable Point

Point F is desirable because it yields more of both goods, but it is not attainable given the amount of resources available in the economy.

Efficiency

Point C is one of the possible combinations of goods produced when resources are fully and efficiently employed.

Negative Slope and Opportunity Cost

A move along the curve illustrates the concept of opportunity cost. The production possibility frontier curve has a negative slope, which indicates a trade-off between producing one good or another. From point D, an increase the production of capital goods requires a decrease in the amount of consumer goods.

The Law of Increasing Opportunity Cost

Cloth

Wheat

15

14

12

The slope of the ppf curve is also called the marginal rate of transformation (MRT). The negative slope of the ppf curve reflects the law of increasing opportunity cost. As we increase the production of one good, we sacrifice progressively more of the other. Why is it so ?
suited or adaptable for alternative uses.(a given resource is more suited to the production of one good than the other.

Because economic resources are not completely

economy foregoes increasing amounts of one good when producing more of the other. Essentially, this law states that, as additional units of a good are manufactured, the opportunity cost associated with that production will also increase. Understanding this phenomenon can help businesses determine if choosing to increase production is worth the effort, or if the increasing opportunity costs mean that the benefits of doing so are reduced sufficiently to merit maintaining production at a lower level.

Economic Growth

Economic growth is an increase in the total output of the economy. It occurs when a society acquires new resources, or when it learns to produce more using existing resources. The main sources of economic growth are capital accumulation and technological advances, human resources

Economic Growth
Outward shifts of the curve represent economic growth.

An outward shift means that it is possible to increase the production of one good without decreasing the production of the other. Scientists ,engineers discover new and innovative ways of producing things Technological progress by improving productive efficiency allows society to produce goods at given and fixed amount of resources

Economic Growth

Not every sector of the economy grows at the same rate.

In this historic example, productivity increases were more dramatic for corn than for wheat over this time period.

Capital Goods and Growth in Poor and Rich Countries

Rich countries devote more resources to capital production than poor countries. As more resources flow into capital production, the rate of economic growth in rich countries increases, and so does the gap between rich and poor countries.