chapter 2 confronting scarcity: choices in production

Chapter 2Chapter 2Confronting Scarcity: Choices in Confronting Scarcity: Choices in

ProductionProduction

ReviewReview

What is the economic way of thinking?What is the economic way of thinking?– Scarcity forces us to choose and economists Scarcity forces us to choose and economists

analyze opportunity costs when analyzing analyze opportunity costs when analyzing choiceschoices

– People are motivated to maximize their self People are motivated to maximize their self interestinterest

– Individuals maximize choices by engaging in Individuals maximize choices by engaging in marginal decision makingmarginal decision making

Factors of ProductionFactors of Production

Definition: resources available to an Definition: resources available to an economy for the production of goods and economy for the production of goods and servicesservices

Factors of production (FOP) create utility.Factors of production (FOP) create utility. Utility is the value or satisfaction that people Utility is the value or satisfaction that people

derive from the goods or services they derive from the goods or services they consumeconsume


Land (natural resources)-resources of Land (natural resources)-resources of nature that can be used in the production of nature that can be used in the production of goods and servicesgoods and services– Must be found in natureMust be found in nature– Expansion occurs through:Expansion occurs through:

Discovery of moreDiscovery of more Discovery of new useDiscovery of new use New ways of extractionNew ways of extraction


Labor-human factor in productionLabor-human factor in production– Natural abilityNatural ability– Human capital Human capital – Increase labor through Increase labor through

Increasing number of people availableIncreasing number of people available Increasing human capitalIncreasing human capital


Capital-resources produced for use in the Capital-resources produced for use in the production of goods and servicesproduction of goods and services– Resource must have been producedResource must have been produced– Resource can be used to produce other goods Resource can be used to produce other goods

and servicesand services– THIS DOES NOT MEAN FINANCIAL CAPITAL THIS DOES NOT MEAN FINANCIAL CAPITAL

(money)(money)


Entrepreneurs change the way that the Entrepreneurs change the way that the factors of production are used by putting factors of production are used by putting new technologies to worknew technologies to work

EntrepreneurEntrepreneur person who seeks to earn person who seeks to earn profits by finding new ways to organize the profits by finding new ways to organize the factors of production (sometimes classified factors of production (sometimes classified as the fourth factor of production)as the fourth factor of production)

TechnologyTechnology knowledge that can be knowledge that can be applied to production of goods and servicesapplied to production of goods and services

Case in Point: Technology Cuts Case in Point: Technology Cuts Costs, Boosts Productivity and Costs, Boosts Productivity and

ProfitsProfits Read p. 41Read p. 41 Who are the winners and losers from Who are the winners and losers from

technology?technology?– ConsumersConsumers– ProducersProducers– WorkersWorkers

Land, labor or capital?Land, labor or capital?

An unemployed factory workerAn unemployed factory worker A college professorA college professor The SMCHS libraryThe SMCHS library Yellowstone National ParkYellowstone National Park An untapped deposit of natural gasAn untapped deposit of natural gas The White HouseThe White House A power plantA power plant

Production Possibilities CurveProduction Possibilities Curve

CSU Monterey Bay built on site of Fort OrdCSU Monterey Bay built on site of Fort Ord Shift from military use to civilian useShift from military use to civilian use Definition: Model that shows goods and Definition: Model that shows goods and

services that an economy is capable of services that an economy is capable of producing given the factors of production producing given the factors of production and technology it has availableand technology it has available


Assumes that only two goods can be Assumes that only two goods can be producedproduced

Any increase in one good means you can Any increase in one good means you can produce less of the otherproduce less of the other

Assumes that factors of production are fixed Assumes that factors of production are fixed


The PPC is downward slopingThe PPC is downward sloping– Reflects scarcityReflects scarcity

The PPC is bowed outThe PPC is bowed out– Curve gets steeper as we move from left to rightCurve gets steeper as we move from left to right– ““Producing an additional good on horizontal axis Producing an additional good on horizontal axis

requires a greater sacrifice of the good on the requires a greater sacrifice of the good on the vertical axis than did previous units produced” vertical axis than did previous units produced” (Tregarthen & Rittenberg, 2000, p. 57)(Tregarthen & Rittenberg, 2000, p. 57)


The PPC is bowed outThe PPC is bowed out– The absolute value of the slope of any The absolute value of the slope of any

production possibilities curve (PPC) = the production possibilities curve (PPC) = the opportunity cost of an additional unit of a good opportunity cost of an additional unit of a good on the horizontal axison the horizontal axis

– Steeper the slope, the greater the opportunity Steeper the slope, the greater the opportunity cost of producing that goodcost of producing that good

– Illustrates the law of increasing opportunity costIllustrates the law of increasing opportunity cost

Calculating Opportunity CostCalculating Opportunity Cost

Opportunity cost = what is given up/what is Opportunity cost = what is given up/what is obtainedobtained

Economy can produce either 40 houses or 20 Economy can produce either 40 houses or 20 office buildingsoffice buildings

OC of houses = 20 office buildings/40 houses=.5 OC of houses = 20 office buildings/40 houses=.5 office buildingsoffice buildings

OC of office buildings = 40 houses/20 office OC of office buildings = 40 houses/20 office buildings = 2 housesbuildings = 2 houses

Try “Try It Yourself” 2-2 on p. 49Try “Try It Yourself” 2-2 on p. 49


Law of increasing opportunity costLaw of increasing opportunity cost– As an economy moves along its PPC in the As an economy moves along its PPC in the

direction of increased production of one good, direction of increased production of one good, the opportunity cost of additional units of that the opportunity cost of additional units of that good increasegood increase

– Law applies because as one moves closer to Law applies because as one moves closer to one end of the curve, resources transferred one end of the curve, resources transferred from one use to the other had greater and from one use to the other had greater and greater comparative advantagegreater comparative advantage


Comparative advantage is when the Comparative advantage is when the opportunity cost of producing that good or opportunity cost of producing that good or service is lower for a particular economy service is lower for a particular economy than any otherthan any other

– International trade theory is based on International trade theory is based on comparative advantagecomparative advantage


Specialization implies that an economy is Specialization implies that an economy is producing goods and services in which it has a producing goods and services in which it has a comparative advantagecomparative advantage– People work and use the income they earn to People work and use the income they earn to

buy goods and services from people who have buy goods and services from people who have a comparative advantage in doing other thingsa comparative advantage in doing other things

– What would life be like without specialization? What would life be like without specialization? Hong Kong vs. United StatesHong Kong vs. United States


Movement along the PPC means that all Movement along the PPC means that all factors of production are being maximized factors of production are being maximized (point A)(point A)

Production within the curve means that Production within the curve means that factors of production are being used factors of production are being used inefficiently (point B)inefficiently (point B)– Idle factors of productionIdle factors of production– Inefficient productionInefficient production– Could increase production of both goodsCould increase production of both goods


Production outside of the PPC is impossible Production outside of the PPC is impossible without economic growthwithout economic growth– Increased educational levelsIncreased educational levels– Change in technologyChange in technology– Increased quality or quantity of labor and capitalIncreased quality or quantity of labor and capital

Applications of the PPC ModelApplications of the PPC Model

In order to allocate resources efficiently, then each In order to allocate resources efficiently, then each nation should specialize in producing products for nation should specialize in producing products for which they have a comparative advantagewhich they have a comparative advantage

Nations should trade in order to get the goods and Nations should trade in order to get the goods and services they needservices they need– Trade results in more productionTrade results in more production

Failure to specialize means that the world Failure to specialize means that the world economy would be producing inside the global economy would be producing inside the global PPCPPC

Production Possibilities and Production Possibilities and Economic GrowthEconomic Growth

An outward shift of the PPC indicates An outward shift of the PPC indicates economic growth.economic growth.

Economic growth raises standards of living, Economic growth raises standards of living, even in the continuing face of scarcity.even in the continuing face of scarcity.

Economic growth is a sustained increase in Economic growth is a sustained increase in a nation’s production of goods and services.a nation’s production of goods and services.


The history of world economic growth raises The history of world economic growth raises important questions about the ability of important questions about the ability of nations to deal with the ever-present nations to deal with the ever-present problem of scarcity.problem of scarcity.– Rich versus poor nationsRich versus poor nations– Conditions that favor growthConditions that favor growth– How can growth be promoted? How can growth be promoted? – How can poverty be reduced?How can poverty be reduced?


Economic growth occurs throughEconomic growth occurs through– Increases in educational levelsIncreases in educational levels– Changes in technologyChanges in technology– Increases in quantity or quality of labor and Increases in quantity or quality of labor and

capitalcapital– InnovationInnovation

Institutions Matter for Economic Institutions Matter for Economic GrowthGrowth

chapter 2 confronting scarcity: choices in production

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