Chapter 3
Scarcity, Trade-Offs and Economic Growth

3.1 The Three Economic Questions
Every Society Faces

n Because of scarcity, certain economic questions must be answered regardless of the level of affluence of the society or its political structure.

3.1 The Three Economic Questions
Every Society Faces

n Three fundamental questions that inevitably must be faced in a world of scarcity are:

n What is to be produced?

n How are these goods to be produced?

n For whom are the goods produced?

3.1 The Three Economic Questions
Every Society Faces

n In market-oriented economies, people “vote” on economic affairs with their dollars.

n Consumer sovereignty describes how individual consumers in market economies determine what and how much is to be produced.

3.1 The Three Economic Questions
Every Society Faces

n Economies are organized in different ways to answer the question of what is to be produced.

3.1 The Three Economic Questions
Every Society Faces

n Command economies rely on central planning; decisions about what and how many are largely determined by a government official associated with the central planning organization.

n Note that decisions are not made by “organizations” but rather by individuals within them; the incentives those individuals face will impact decisions regardless of the economic system.

3.1 The Three Economic Questions
Every Society Faces

n Market economies, on the other hand, largely rely on a decentralized decision-making process, in which literally millions of individual producers and consumers of goods and services determine what goods, and how many of them, will be produced.

3.1 The Three Economic Questions
Every Society Faces

n Most countries, including the United States, have mixed economies in which the government and private sector determine the allocation of resources together.

Exhibit 1: Government Spending as a Percentage of GDP

3.1 The Three Economic Questions
Every Society Faces

n All economies, regardless of political structure, must decide how to produce the goods and services that they want.

n For example, when digging a ditch, a contractor must decide between many workers using their hands, a few workers with shovels, or one person with a backhoe.

n A decision must be made as to which method is appropriate.

n The best method = least-cost method.

3.1 The Three Economic Questions
Every Society Faces

n The best or "optimal" form of production will vary from one economy to the next.

n The production processes is used that conserves the relatively scarce (thus relatively more expensive) resources and uses more of the relatively abundant resources.

n Labor-intensive methods will be used where capital is relatively scarce

n Capital-intensive methods will be used where labor is relatively scarce.

3.1 The Three Economic Questions
Every Society Faces

n In every society, some mechanism must exist to determine how goods and services are to be distributed among the population.

n Who gets what?

n The distribution of income is an issue that always arouses strong emotional responses.

3.1 The Three Economic Questions
Every Society Faces

n In a market economy, with private ownership and control of the means of production, the amount of output one is able to obtain depends on one's income, which in turn, depends on the quantity and quality of the scarce resources that the individual controls.

n Tiger Woods' income is very large because his skills are very scarce.

3.2 The Production Possibilities Curve

n The economic concepts of scarcity, choice, and trade-offs can be illustrated by the use of a production possibilities curve, which represents the potential total output combinations of any two goods for an economy.

n It illustrates an economy's potential for allocating its limited resources for producing various combinations of goods, in a given time period.

3.2 The Production Possibilities Curve

n The production possibilities curve discussion begins with a straight-line production possibilities curve, with the goods being one's grade in economics and one's grade in history.

Exhibit 1: Production Possibilities Curve: “Producing” Grades in Economics and History

3.2 The Production Possibilities Curve

n On a production possibilities curve, we assume that the economy has a given quantity and quality of resources and technology available to use for production.

3.2 The Production Possibilities Curve

n Using an example involving food and shelter we can see a nonlinear production possibilities curve.

n Each point represents the potential amounts of food and shelter that can be produced in a given time period, given the quantity and quality of resources available.

Exhibit 2: Production Possibilities Curve: The Trade-Off Between Shelter and Food

3.2 The Production Possibilities Curve

n The economy cannot produce beyond the levels indicated by the production possibilities curve during a given time period, because there are not enough resources to produce that output.

n However, it is possible to operate inside the production possibilities curve.

3.2 The Production Possibilities Curve

n If an economy is operating inside its production possibilities curve, it is not at full capacity and is operating inefficiently.

n The economy is not getting the most it can from its scarce resources.

n As a result, actual output is less than potential output.

3.2 The Production Possibilities Curve

n Most modern economies have resources that are idle, at least for some period of time.

n If those resources were not idle, people would have more scarce goods and services available for their use.

3.2 The Production Possibilities Curve

n Unemployed resources create a serious problem, not just for labor but for all resources entering into production, such as plant capacity.

n All resources must be used effectively for efficient production.

3.2 The Production Possibilities Curve

n Social concern about unemployed resources focuses on labor.

n First, labor costs are the largest share of production costs.

n Second, unemployed or underemployed laborers (whose resources are not being used to their full potential) may have mouths to feed at home, while an unemployed machine does not (although the owner of the unemployed machine may).

3.2 The Production Possibilities Curve

n Underutilized resources or those not being put to their best uses are illustrated by output combinations inside the production possibilities curve.

n By putting unemployed resources to work or by putting already employed resources to better uses, we could expand output.

3.2 The Production Possibilities Curve

n Increasing or improving the utilization of resources can lead to greater output of all goods.

n That is why we all have an interest in the efficient use of all of society's resources:

n There can be more of everything we care about available for our use.

3.2 The Production Possibilities Curve

n Efficiency requires society to use its resources to the fullest extent—getting the most we can out of our scarce resources.

n If resources are being used efficiently, at a point along a production possibilities curve, more of one good or service requires the sacrifice of another good or service as its cost.

3.2 The Production Possibilities Curve

n The production possibilities curve is not a straight line.

n It is concave from below (that is, bowed outward from the origin), reflecting increasing opportunity costs of producing additional amounts of a good.

Exhibit 3: Increasing Opportunity Cost and the Production Possibilities Curve

3.2 The Production Possibilities Curve

n The basic reason for increasing opportunity cost is that some resources and skills cannot be easily adapted from their current uses to alternative uses.

n Easily adaptable resources are soon exhausted and resources and workers that are less well-suited or appropriate (those with a relatively greater opportunity cost) must then be employed to increase output further.

Exhibit 4: Opportunity Costs
for Cattle and Wheat

3.3 Economic Growth and the Production Possibilities Curve

n Some nations have been able to rapidly expand their output of goods and services over time.

n Others have been unable to increase their standard of living at all.

3.3 Economic Growth and the Production Possibilities Curve

n To generate economic growth, a society must produce fewer consumer goods and more capital goods in the present.

n They must sacrifice some consumption of consumer goods in the present in order to experience growth in the future.

3.3 Economic Growth and the Production Possibilities Curve

n Investing in capital goods will increase the future production capacity of the economy.

n So an economy that invests more and consumes less now will be able to produce and consume more in the future.

3.3 Economic Growth and the Production Possibilities Curve

n An economy can only grow with qualitative or quantitative changes in the factors of production—land, labor, capital, and entrepreneurship.

n outward shifts of the production possibilities curve result from

n advancements in technology,

n improvements in labor productivity, or

n new natural resource finds.

3.3 Economic Growth and the Production Possibilities Curve

n Economic growth means an outward shift in the “menu” of possible bundles of output illustrated by the production possibilities curve.

n With growth comes the possibility to have more of both goods than were previously available.

Exhibit 1: Economic Growth
and Production Possibilities

3.3 Economic Growth and the Production Possibilities Curve

n It is important to remember that increases in a society's output do not make scarcity disappear.

n Even when output has grown more rapidly than population, so people are made better off, they still face trade-offs.

n At any point along the production possibilities curve, in order to get more of one thing, you must give up something else.

3.3 Economic Growth and the Production Possibilities Curve

n An economy that invests more of its resources for the future devotes a larger share of its productive capacity to capital goods rather than consumption goods.

n Economies that choose to invest more of their resources for the future will grow faster than those that don't, other things equal.

Exhibit 2: Economic Growth
and the Production Possibilities Curve

Exhibit 2: Economic Growth
and the Production Possibilities Curve

3.3 Economic Growth and the Production Possibilities Curve

n The production possibilities curve can be used to illustrate the economic concepts of scarcity, choice, opportunity costs, efficiency, and economic growth.

n Scarcity is represented by the fact that resource combinations outside the production possibility curve are unattainable.

3.3 Economic Growth and the Production Possibilities Curve

n Choice is the fact that one must choose among the alternative bundles available along the production possibilities curve.

n Opportunity costs are how much of one good you give up to get another unit of the second good as you move along the production possibilities curve.

3.3 Economic Growth and the Production Possibilities Curve

n Efficiency would mean being on the production possibilities curve rather than inside it.

n Economic growth is represented by shifting out the production possibilities curve.

Exhibit 3: Production Possibilities Curve

Exhibit 4: Correlation
of Investment and Growth