中国经济管理大学
MBA课堂
《宏观经济学原理》

Chapter 2: The Economic Problem: Scarcity and Choice

Outline of Text Material
I. Introduction
 This chapter explores the questions of what, how, and for whom to produce. “Human wants are unlimited, but resources are not.” This creates scarcity. Scarcity, in turn, forces us to make choices.
??? TEACHING TIP: Stress the idea that the three fundamental questions must be answered by any society regardless of its political organization. One reason command economies don’t work well is the difficulty they have answering these questions correctly.?
A. Resources is used in its broadest sense, including everything from natural resources (timber, minerals, energy), capital (buildings, machines), labor (human capital), and entrepreneurship. Resources are also called factors of production, inputs, or simply factors. Output is what is produced. Economists usually include land, labor, and capital as factors of production.
B. The chapter then proceeds to some key definitions:
1. Factors of production (factors) are the inputs into the process of production. The text uses factors and resources interchangeably.
2. Production is the transformation of resources into goods and services.
3. Resources (inputs) are used directly or indirectly to satisfy human wants.
4. Capital includes buildings, machines, and other things that are produced in order to produce other goods and services.
??2"? TEACHING TIP: Many goods are used to produce other goods. Some of these goods are counted as intermediate goods (“parts”) while others are counted as capital. In the national income accounts, the distinction is simple: Anything that is expected to be used more than one year is capital. If it is expected to be used less than one year it is an intermediate good. This is especially useful for those teaching macroeconomics.?
5. Producers are those who transform resources into outputs (final goods and services).
6. Outputs are usable products.
II. Scarcity, Choice, and Opportunity Cost
A. Scarcity and Choice in a One-Person Economy
1. Bill must make choices about how to allocate resources, what to produce, and how to produce it. Bill’s situation is “constrained choice.” His main constraint is available time. Bill must decide what he wants to produce, what he is able to produce given the island’s resources, and how to use the resources to produce what he wants.
  TOPIC FOR CLASS DISCUSSION: 
What are some of the more useful skills Bill might want? Students will come up with things like building a fire, primitive construction, and being able to tell which berries are not poisonous. More subtle answers might include weather forecasting and knowledge of airline and shipping routes.?
???s 2" TEACHING TIP: This is a good place to follow the text’s lead and discuss the cost of leisure time. As the text notes Bill can use as much time as he wants to lie on the beach. However, the cost of that leisure time is lost production.º"Wingdings 2"
2. Opportunity Cost is the value of the best alternative that one gives up when making a choice.
??? TEACHING TIP: Instructors sometimes rush through their discussion of individual vs. societal opportunity cost because the point seems obvious. But the idea of opportunity cost makes a deep impression on students. They often find it valuable in their personal lives and remember it long after class is over.
 Students need to be reminded that opportunity cost is relevant to societal as well as individual choices. A good way to drive the concept home is to find some social goal that virtually everyone in the class thinks is “good.” (National health insurance for all? A pristine environment? Completely safe streets?) Point out that achieving the goal requires resources, which must be pulled out of producing something else. How much “other production” would class members be willing to sacrifice to accomplish the goal? A cut in their material standard of living of 10%? How about 50%? Or 90%?
 Public policy debates suffer when opportunity cost is ignored or calculated incorrectly. A major contribution of economists is to keep opportunity cost—correctly measured—part of policy debates.?
B. Scarcity and Choice in an Economy of Two or More
1. Now there are two decision makers (Bill and Colleen). Their preferences, skills, and abilities probably differ. They will have to decide how much of each good each person should produce. They will probably benefit from specialization and trade.
??? TEACHING TIP: Students often have difficulty remembering that opportunity cost and comparative advantage are intertwined. Try using the term comparative opportunity cost advantage when calculating who should specialize in what. It helps students to remember that comparative advantage is what matters when calculating who should produce which good to maximize the gains from trade.?
2. Specialization, Exchange, and Comparative Advantage: David Ricardo formulated the theory of comparative advantage. He was the first to discover that specialization and free trade will benefit all trading partners. Even if one producer can produce more of both goods, mutually beneficial trade may still be possible if the relative difference is greater for one product than the other. Ricardo’s most important point is that everyone—every individual, firm, and country—has a comparative advantage at something even if another has an absolute advantage at producing all goods and services. Trade and specialization all0w the most efficient producer to produce each good. This increases productivity. “Learning by doing” means specialization will improve each worker’s job skills leading to further productivity increases.
??? TEACHING TIP: Comparative advantage is extremely important. It is the economic motivation for exchange between individuals (roommates, workers within an office, etc.); groups of individuals (divisions within a company, firms that specialize in productive tasks within an economy); and nations (international trade). Ask students to give examples from their own experiences (for example, who does which chores in their families and why?).?
??7 \f "Wingdings 2" TEACHING TIP: Here’s an alternative example. Suppose Colleen and Bill subsist on fish and coconuts. Catching fish requires patience and good vision. Picking coconuts requires climbing ability and manual dexterity. Colleen can catch 18 fish per day or pick 36 coconuts. It costs her 36/18 = 2 coconuts per fish or 18/36 = 0.5 fish per coconut. Bill can catch 9 fish per day or pick 27 coconuts. It costs him 27/9 = 3 coconuts to catch a fish or 9/27 = 0.33 fish to pick a coconut. Colleen has a comparative advantage at fishing since one fish costs her only 2 coconuts compared to 3 for Bill. Bill has a comparative advantage at picking coconuts since it costs him 0.33 fish per coconut while it costs Colleen 0.5 fish per coconut. Colleen should specialize in fishing while Bill specializes in picking coconuts.
 Be sure the students understand how these calculations are done and why the numbers are opportunity costs.?
3. Weighing Present and Expected Future Costs and Benefits: There is a trade-off between present and future benefits and costs. The simplest example of trading present for future benefits is saving which allows us to consume more in the future.
?? TEACHING TIP: This is a good place to introduce the time value of money. Make the point that the interest rate is the marginal opportunity cost of consumption today and the marginal benefit for saving.?
4. Capital Goods and Consumer Goods: When a society devotes a portion of its resources to investment in capital it is trading present benefits for future benefits. Investment is the process of using resources to produce new capital. By giving up some production of consumer goods today in order to produce more in the future, society will be able to consume more in the future. Consumer goods are goods produced for present consumption. The process of using resources to produce new capital is called investment.
??? TEACHING TIP: Emphasize that economists are quite specific when defining investment. This is especially important when teaching macroeconomics.?ngdings 2"
  TOPIC FOR CLASS DISCUSSION: 
Introduce the idea of human capital. Explain that education is an investment in human capital. Draw on the analysis of the cost of going to college (from Chapter 1) to consider it as investment. Is it a trade-off of current benefits for future benefits? What are those benefits??
C The Production Possibility Frontier (PPF)
1. The PPF can be used to show the principles of constrained choice and scarcity.
a. A production possibilities frontier is a graph that shows all the combinations of goods and services that can be produced if all of society’s resources are used efficiently.
b. All points on the curve are combinations of output produced using full resource employment and production efficiency.
c. Production efficiency means producing a given combination of outputs at least cost. This implies producing the maximum quantities of both goods given society’s resources and technology.
d. Points inside the curve are achievable but are not efficient. Points outside the curve are unattainable.
e Different points on the PPF show the quantities of each of the two goods. At point F the economy is producing more capital goods and less consumer goods than at point F. In subsequent years, the PPF will shift out further from point F than E.
??? TEACHING TIP: The presentation of the PPF is an excellent time to reinforce the way in which one should detail and use an economic model. Lay out the assumptions being sure all variables are clearly defined, and use the model to explain what it is designed to explain (or predict). Advise students who are hesitant to work with graphs that the appendix to Chapter 1 provides a good review.?
  TOPIC FOR CLASS DISCUSSION: 
Draw a PPF for the choice between military goods and consumer goods. Use that to start a discussion about economies during the Cold War. How have things changed??
2. Unemployment
a. Every point inside the PPF is inefficient because some resources aren’t being used.
b. Inefficiency and unemployed resources mean production of either good can be increased without reducing production of the other. Along the PPF this is not possible.
c. Unemployment of labor also means unemployment of capital.
3. Inefficiency: An economy can be operating at full employment and still be inside the PPF. Although resources are being fully used they are not being allocated to their most productive uses.
??? TEACHING TIP: Suppose Shaquille O’Neal (a well-known professional basketball player) was forced to teach economics. Presumably that would not be his most productive activity.?
4. The Efficient Mix of Output: To be efficient an economy must produce what people want. This means choosing the right point on the PPF.
??? TEACHING TIP: Extreme examples can help students see the difference between these two kinds of efficiency. Suppose all of the land, labor, and capital in the country were used to produce something students might find undesirable, say Brussels sprouts or turnips. As long as the economy is producing the maximum amount possible of that good, then productive efficiency is achieved. However, the economy is not producing the best mix of outputs because the mix of goods is not allocatively efficient. Make it clear to students that points on the curve represent a productively efficient combination of resources, but not necessarily an allocatively efficient combination of resources.?
5. Negative Slope and Opportunity Cost: The negative slope of the PPF (down from left to right) illustrates opportunity cost. To have more of one good there must be a sacrifice of the other.
6. The Law of Increasing Opportunity Costs: The marginal rate of transformation (MRT) is the slope of the PPF. The slope of the PPF is not only negative, but also increasing (the curve is concave). This implies increasing opportunity cost. Since the PPF gets steeper as you move along the horizontal axis, greater quantities of the good on the vertical axis must be given up in order to produce one more unit of the good on the horizontal axis.
?"?? TEACHING TIP: Demonstrate that the absolute value of the slope of the PPF at any given point measures the opportunity cost of one more unit of what is being measured on the X-axis in terms of what is measured on the Y-axis. The reciprocal of the slope measures the opportunity cost of a unit of Y in terms of X.
 The table below shows the cost of one more bushel of corn between each pair of adjacent points in Table 2.1. Since corn output is on the vertical axis in Figure 2.5, the slope will increase as you move from point A to point E. The slope is approximately the opportunity cost. (The slope is not exactly the opportunity cost because the slope of the secant line is not the same as the slope of the PPF at either endpoint.)
 
Points Slope   
A - B -2.00   
B - C -1.29   
C - D -1.09   
D - E -0.50 

7. Economic Growth is an outward shift of the PPF caused by having more resources or better technology. Growth is an increase in the total output of an economy.
  TOPIC FOR CLASS DISCUSSION: 
This is what happens when you relax the restrictive assumptions (fixed resources and technology) used to draw the first PPF. Have students consider what happens if a change in resources or technology affects the ability to produce one product but not the other. This can lead into a discussion of how the Internet has changed productivity in different industries.?
8. Sources of Growth and the Dilemma of the Poor Countries
a. Historically the two most important sources of growth have been the accumulation of capital and technological advance.
b. For poor countries, taking resources out of the production of consumer goods is very difficult because they are living so close to subsistence levels. This lack of saving can make it difficult for them to accumulate capital and grow.
??? TEACHING TIP: There are several directions you can go from here. It appears that poor countries are destined to remain poor based on this analysis. However, recent research by Lucas and Romer seems to show that accumulation of human capital is more important than either physical capital or technology. And Lawrence Summers has estimated the rate of return on educating women in less developed countries is more than 20%.?
D. Comparative Advantage and the Gains From Trade: Specialization and voluntary exchange can make both parties to the exchange transaction better off than they were before.
E. The Economic Problem: How do different economic systems answer the three basic questions?
III. Economic Systems
 There are different types of economic systems:
A. Command Economies are those in which the central government either directly or indirectly answers the three questions.
B. Laissez-Faire (Free Market) Economies are those in which individuals and firms are free to pursue their own self-interest without central direction or regulation. The market is the institution through which buyers and sellers interact and engage in exchange. Its characteristics include:
1. Consumer Sovereignty: The mix of output produced is dictated by the tastes and preferences of consumers.
2. Individual Production Decisions: Free Enterprise: Individuals are free to start businesses. This increases output and develops new production techniques.
3. Distribution of Output: Also determined in a decentralized way.
4. Price Theory: Prices are the basic coordinating and signaling mechanism.
C. Mixed Systems, Markets, and Governments
 All real-world economies are mixed, with differing degrees of government intervention. Market systems have advantages, but are not perfect. However, remember the “law of unintended consequences.” Government intervention may make things worse instead of better.
  TOPIC FOR CLASS DISCUSSION: 
Have students research countries in transition and consider the problems and challenges faced in the process.?
IV. Looking Ahead
The next chapter discusses how markets work.

 
  Extended Applications
Application 1: The Effect of Productivity on Opportunity Cost
This example shows how an increase in productivity in one sector of the economy can actually raise the opportunity cost of production in other sectors. During the mid-1980s, the lumber industry announced that a cord of wood (a 4-by-4-by-8 foot pile) could be converted into 942 one-pound books, 2,000 pounds of paper, 61,370 number 10 envelopes, or 7,500,000 toothpicks.
Measure the opportunity cost of books in terms of “toothpicks forgone.” Given the data above, the opportunity cost of a book is 7,500,000/942 = 7,961 toothpicks per book. Suppose that a technological advance in the toothpick industry (perhaps a waste-reducing technique) enables more toothpicks, say 9,000,000, to be created from a cord of wood. What happens to the opportunity cost of producing a book? It increases! Now, one book “costs” 9,000,000/942 = 9,554 toothpicks, even though there has been no change in book-producing technology.
This insight figures importantly in the extended application on the cost of services following based on ideas originally put forward by William J. Baumol.

Application 2: The Rising Cost of Services
Consider how the cost of services tends to rise over time. Why do items like haircuts, medical care, and education keep getting more and more expensive, both absolutely (they cost more dollars) and relatively (they require a larger and larger portion of our incomes)? Using the concept of opportunity cost, the production possibilities frontier, and a little common sense, we can come up with a realistic answer.
The three items mentioned above are examples of services. A service is, by definition, provided by workers directly to consumers. (One of the fastest-growing service sectors in the United States is meals eaten away from home.) A service is always consumed the moment it is produced. It cannot be brought home in a shopping bag or resold to someone else. Services can’t be inventoried. To keep the analysis simple, let us assume that a nation can produce only one good (T-shirts) and one service (haircuts). The nation’s production possibilities frontier is shown in the following graph:
 

Initially, at Point A, the economy is producing 100 haircuts and 300 T-shirts per day. Between points A and B the opportunity of producing 50 more T-shirts (increasing from 300 to 350) requires the sacrifice of 25 haircuts (decreasing from 100 to 75). The marginal rate of transformation is thus 50/25 = 2.00. Now (as students who are taking microeconomics will see later on) relative prices in a market economy usually correspond quite closely to opportunity costs. That is, if producing 50 more T-shirts uses resources that could otherwise produce 25 haircuts, then a haircut should cost about two times the cost of a T-shirt. Let us suppose that for this economy at Point A, each T-shirt costs $5 and each haircut costs $10.
Many economists believe that the growth of productivity (output per hour) is much slower for services than for goods. This is easy to see in the case of T-shirts versus haircuts. Over the past 50 years, the number of T-shirts a worker can produce in an hour has increased dramatically due to technological advances in cotton-picking, weaving, and assembly-line production techniques. Over the same period, however, the number of haircuts a barber could perform in an hour has probably increased very little, if at all.
The effect of this asymmetrical change in productivity is illustrated in the diagram. Note that the vertical (T-shirt) intercept of the production possibilities frontier has increased, reflecting an increase in the maximum quantity of T-shirts that could be produced—after the productivity change—if all resources were devoted to T-shirt production. But the horizontal (haircut) intercept remains the same, as there has been no productivity change in this industry.
Suppose that the economy ends up at Point C on the new PPF. The economy is producing more T-shirts (160) and more haircuts (400). In addition, the opportunity cost has increased. As the economy moves from Point C to Point D (after the productivity change) it could produce 100 additional T-shirts with a sacrifice of 25 haircuts. The opportunity cost is now 4.00 instead of 2.00. In other words, even though there has been no change in haircut technology or productivity, the opportunity cost of haircuts has risen! One haircut should now cost the same as 10 T-shirts. If T-shirts continue to cost $5 each, then haircuts should rise in price to $50. Alternatively, if T-shirts fall to $1.50 each, haircuts should remain priced at $15. Either way, the relative price of haircuts will rise, as the opportunity cost of haircuts has risen.
This simple analysis has far-reaching implications. It explains why college tuition rises faster than the general price level, as providing an education relies heavily on services (teaching, building maintenance, administrative services) rather than goods. Similarly, it suggests that ongoing efforts to reform health care may be only partially successful. We can certainly choose, as a nation, to provide better health care to more of our population. But if manufacturing productivity continues to increase faster than productivity in medical services, then the relative price of health care like the relative price of haircuts, will rise.