Chapter 2: Scarcity and Choice

Three Economic Questions

1) What gets produced? 2) How is it produced? 3) Who gets it?

theory of comparative advantage

David Riccardo's theory that specialization and free trade between people and countries leads to increase in wealth for both people and countries (some are more efficient producers than others)

price theory

Factors that influence and determine prices. Basic coordinating mechanism in a free market system is price ( amount that a product sells per unit)- reflects what society is willing to pay. Prices of inputs determine how much it costs to produce a product (Prices coordinate the laissez faire economy). Usually it is a good indicator of scarcity but in cases of subsidizing pollution for example, it is not (CO2 emissions) in market failure the price is lower than the cost to make product.

Laissez-faire economy

Free market. French "allow them to do" an economy in which individual people and firms pursue their own self interest without any central direction or regulation. Answers basic economic questions through the market.

free enterprise

The freedom of individuals to start and operate private businesses in search of profits. How new products and new production techniques find their way into use. Proponents argue that it leads to more efficient production and a better response to changing consumer preference. Competition forces producers to use efficient techniques of production. Competition dictates how output is produced.

consumer sovereignty

The idea that consumers ultimately what will or will not be produced by choosing what or what not to purchase. Business rise and fall in response to consumer demands. No central or directive plan is necessary.

marginal rate of transformation

The rate at which one goods must be sacrificed in order to produce a single extra unit (marginal unit) of another good- assuming that both goods require the same scarce inputs. The value of the slope of a societies PPF. The slope of the curve (the ratio of change in capital goods to the change in consumer goods) is negative. (one cannot go up unless the other goes down)

factors of production/factors

basic resources available to a society. Three key factors are- land, labor and capital.

outputs of the process of production

goods and services of value to households

consumer goods

goods for present consumption Ex) food, clothing, toys etc

production possibilities frontier (PPF)

graphic device which illustrates the principle of constrained choice, opportunity cost and scarcity. Graph that shows all the combinations of goods and services that can be produced if all of societies resources are used efficiently. Y-axis is quantity of capital goods produced, X-axis quantity of consumer goods. -points above to the right of curve= combinations that cannot be reached. - points at top left would produce no consumer goods and all resources used to produce capital goods -points at bottom right would produce no consumer goods and all resources would go to formation of capital - points ON the ppf are points of both full resource employment and production efficiency (state in which given mix of outputs is produced at least cost) resources are not going unused and none is wasted. -points below and to left of curve= combo of capital and consumer goods that are possible for a society given available resources and existing technology- however represent unemployment of resources or production inefficiency

economic growth

increase in the total output of an economy. Happens when a society acquires new resources or learns to produce more using existing resources. (technological change and innovation)

market

institution through which buyers and sellers interact and engage in exchange

Law of increasing opportunity cost

opportunity cost increases as the quantity of a good produced increases. This is because you reallocate resources to produce one good that was better suited to produce the original good. Negative slope of the PPF indicates the trade-off a society faces between two goods.

investment

process of using resources to produce new capital. A wise investment in capital would be one that yields future benefits that are more valuable than the present cost. Ex) buying a house- the benefit of living in it is worth more than the things you could buy today with the same money.

production

process that transforms scarce resources into useful goods and services

absolute advantage

producer can produce goods and services using fewer resources including time.

comparative advantage

producer can produce goods or services at a lower opportunity cost than the other producer.

Inputs of process of production

resources or factors

command economy

the basic economic questions are answered by a central government. Combo of government ownership of state enterprises and central planning, government directly or indirectly sets output targets, incomes, and prices. Requires too much collection and assimilation of info and opens many opportunities for waste and corruption.

capital resources

things that are produced and then used in the production of other goods and services (factors of production) Ex) roads, machinery, factories, education