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CHAPTER

Scarcity, Choice,
and Economic Systems

PowerPoint Slides
PowerPoint Slides prepared
prepared by:
by:
Andreea CHIRITESCU
Andreea CHIRITESCU
Eastern Illinois
Eastern Illinois University
University
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Society’s Production Choices
• Society’s choice
– How much of its resources to allocate
• National defense
• Civilian production
– Simplifying assumption
• One kind of military good (tanks)
• One kind of civilian good (wheat)

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Table 1
Production of Tanks and Wheat

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Society’s Production Choices
• Opportunity cost of producing 1,000 more
tanks
– If currently producing choice B: 100,000
bushels
– If currently producing choice D: 300,000
bushels

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The Production Possibilities Frontier
• Production possibilities frontier (PPF)
– A curve showing all combinations of two
goods that can be produced
• With the resources and technology currently
available
• Society’s choices
– Points inside or on PPF
• Unattainable
– Points outside PPF

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The Production Possibilities Frontier
• Wheat / tanks economy, PPF:
– Maximum quantity of wheat that can be
produced for each quantity of tanks
produced
– Maximum number of tanks that can be
produced for each different quantity of
wheat

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Figure 1
The Production Possibilities Frontier

Bushels of At point A, all resources


wheat per year are used for wheat.
Moving from point A to point B
requires shifting resources out of
A B wheat and into tanks.
1,000,000
950,000 C
850,000
D
700,000

E
400,000
At point F, all resources
are used for tanks.

Number of
1,000 2,000 3,000 4,000 5,000
tanks per year

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Increasing Opportunity Cost
• Law of increasing opportunity cost
– The more of something we produce
• The greater the opportunity cost of producing
even more of it
– PPF – concave shape (upside-down bowl)
– The PPF grows steeper as we move
rightward and downward
– The opportunity cost increases as we
move rightward and downward

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Figure 2
Increasing Opportunity Cost
For the first The opportunity cost is
Bushels of 1,000 tanks... 50,000 bushels of wheat.
wheat per year
For the next The opportunity cost rises to
A 1,000 tanks... 100,000 bushels of wheat.
1,000,000
950,000
B Then to 150,000 bushels,
850,000
C and so on.

700,000
D

400,000
E

F
Number of
1,000 2,000 3,000 4,000 5,000
tanks per year

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Increasing Opportunity Cost
• Reason for increasing opportunity cost
– Most resources are better suited to some
purposes than others
• Wheat / tanks economy, PPF:
– As we move rightward from A to B
• First shift resources best suited to tank
production
• PPF is flatter

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Increasing Opportunity Cost
• Wheat / tanks economy, PPF:
– As we continue moving rightward
• Must shift resources that are less and less
suited to tanks
• PPF becomes steeper
• Principle of increasing opportunity cost
– The more of something we produce, the
greater the opportunity cost of producing
still more

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The Search for a Free Lunch
• “There’s no such thing as a free lunch”
– Even if a meal is provided free of charge to
someone, society still uses up resources
to provide it
– Society pays an opportunity cost
• By not producing other things with those
resources
• Moving along a PPF
• The “free lunch”
– Possible if operating inside the PPF
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Productive Inefficiency
• Productively inefficient
– More of at least one good can be
produced
• Without sacrificing the production of any other
good
– Points inside the PPF
– Firms
• Try to eliminate productive inefficiency
• Productive efficiency
– The absence of any productive inefficiency
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Economic Growth
• Economic growth
– Produce more of everything
– The PPF shifts outward
– Economy’s productive capacity grows
• Sources of economic growth
– Increase in available resources
• Human and physical capital
– Technological change
• New ways to produce more from a given
quantity of resources
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Figure 5
Economic Growth and the PPF (a)
Wheat (bushels per year)

A’
1,200,000
H
A
1,000,000 J

700,000
D

F
3,000 5,000 Tanks per Year
All three panels show economic growth from an increase in resources or a technological
change. In panel (a), the additional resources or technological advance directly affect only
wheat production. However, society can choose to have more wheat and more tanks if it
desires, such as at point J.

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Figure 5
Economic Growth and the PPF (b)
Wheat (bushels per year)

1,000,000

5,000 6,000 Tanks per Year


All three panels show economic growth from an increase in resources or a technological
change. In panel (b), the additional resources or technological advance directly affect only tank
production. But once again, society can choose to have more of both goods.

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Figure 5
Economic Growth and the PPF (c)
Wheat (bushels per year)

1,200,000

1,000,000

5,000 6,000 Tanks per Year

All three panels show economic growth from an increase in resources or a technological
change. In panel (c), the additional resources or technological advance directly affect production
of both goods.

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Economic Growth
• Economic growth
– Due to technological change or an
increase in resources
• Even when the direct impact is to increase
production of just one type of good
• Allows us to choose greater production of all
types of goods

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Economic Growth
• Capital is a resource
– That we use to produce goods and
services
• Capital is itself a good
– Produced using resources
• Each year
– Choose how much of our available
resources to devote to producing capital

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Economic Systems
• Economic system
– The way our economy is organized
• Features of economic systems
– Specialization
• Method of production in which each person
concentrates on a limited number of activities
– Exchange
• The act of trading with others to obtain what
we desire

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Specialization and Exchange
• Specialization and exchange
– Enable us to enjoy greater production and
higher living standards
• Than would otherwise be possible
– All economies exhibit high degrees of
specialization and exchange

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Specialization and Exchange
• Gains from specialization and exchange
– Development of expertise
• Become experts at one or two things, instead
of remaining amateurs at a lot of things
– Minimizing downtime
• Less unproductive “downtime” from switching
activities
– Comparative advantage
• Allocate our resources according to their
suitability for different types of production

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Comparative Advantage
• Absolute advantage
– Produce a good or service using fewer
resources than other producers use
• Comparative advantage
– Produce a good or service at a lower
opportunity cost than other producers

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International Comparative Advantage
• A nation has comparative advantage in
producing a good
– If it can produce it at a lower opportunity
cost than some other nation
• Greatest total production of every good or
service
– When nations shift production toward their
comparative advantage goods
– And trade with each other

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Table 4
Labor Requirements for Soybeans and T-Shirts

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International Comparative Advantage
• United States
– Has an absolute advantage in producing
both goods
• U.S, opportunity cost of:
– 10 bushels of soybeans is 20 T-shirts
• China, opportunity cost of:
– 10 bushels of soybeans is 50 T-shirts
• Comparative advantage in soybeans
– Lowest opportunity cost: U.S.
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International Comparative Advantage
• U.S, opportunity cost of:
– 40 T-shirts is 20 bushels of soybeans
• China, opportunity cost of:
– 40 T-shirts is 8 bushels of soybeans
• Comparative advantage in T-shirts
– Lowest opportunity cost: China

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International Comparative Advantage
• Each nation produces more of its
comparative advantage good
– World production of both goods increases
– Each country can enjoy a higher standard
of living
• Total production of every good or service
is greatest
– When nations shift production toward their
comparative advantage goods
– And trade with each other
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Resource Allocation
• The problem of resource allocation
– Deciding how society’s scarce resources
will be divided among competing claims
and desires
– Answering three important questions:
• Which goods and services should be
produced with society’s resources?
• How should they be produced?
• Who should get them?

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Resource Allocation
• Societies determine the answers to these
questions about resources
– Tradition, Command, The market
• Traditional economy
– Resource allocation - long-lived practices
from the past
– Stable and predictable
– Little innovation and technological change
– Stagnant economies
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Resource Allocation
• Command or centrally planned economy
– Resource allocation - explicit instructions
from a central authority
– The early years: production grows rapidly
• Provide everyone with a job and basic
consumer goods
– Enforced through brute force
– The final decades: living standards
stagnated
• Political and economic dissatisfaction
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Resource Allocation
• Market economy
– Resources are allocated through individual
decision making
– Freedom of choice is constrained by the
resources one controls
– Resource allocation: markets and prices

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Markets, Ownership, Invisible Hand
• Adam Smith (1723–1790)
– Scottish social philosopher
– Often regarded as the first economist
– The Wealth of Nations, 1776
– Private resource owners are guided as if
by an invisible hand to benefit society as a
whole

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