Scarcity and Opportunity
Costs
CHAPTER 2
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Opportunity Costs
◦ Opportunity cost: the value of the highest-valued
alternative that must be forgone when a choice is made.
It is the evaluation of a trade-off
◦ Marginal benefits and costs: the benefits and
opportunity costs associated with one additional unit of
the good
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Decision Making
◦ Principle: Decision making involves trade-offs
◦ A trade-off means a sacrifice - giving up one good or
activity in order to obtain some other good or activity
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Production Possibilities Curve
◦ The production possibilities curve shows the maximum
quantity of goods and services that can be produced
when the existing resources are used fully and efficiently.
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Production Possibilities
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Growth
◦ The PPC moves outward (growth occurs) as the
result of:
◦ Increased resources
◦ Larger labor force
◦ Change in labor force participation
◦ Chance in labor-leisure decision
◦ Improved technology (innovation)
◦ Expansion of capital stock
◦ An improvement in the rules (laws, institutions, and
policies) of the economy
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A Shift of the PPC
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Marginal Cost
◦ The Production Possibilities Curve (PPC) illustrates the concept of
opportunity cost. Each point on the PPC means that every other
point is a forgone opportunity.
◦ The PPC bows outward because there are ever-increasing marginal
costs to the production of any good.
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Output and Resources
◦Resources are the elements needed to
produce goods. Resources are also called
◦ factors of production
◦ inputs
◦They are:
◦ Land (includes natural resources)
◦ Labor (physical and intellectual services of people)
◦ Capital (plant, machinery, equipment used in production)
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Resources
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Income Creation
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Resources and Income Flows
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Gains from Trade
◦ Economic agents (individuals, firms, nations) will be
better off if they choose to produce those things for
which they have the lowest opportunity costs, and trade
for those with higher costs.
◦ Agents do this because such choices involve giving up the
least amount of other things.
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Specialization and Trade
Comparative Advantage: the ability to produce a good or
service at a lower opportunity cost than someone else
Gains from Trade: the difference between what can be
produced and consumed without specialization and trade
and with specialization and trade
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Allocation Systems
An allocation system is the process of determining who gets
the goods and services and who does not.
◦
◦
◦
◦
Government
First-come, first-served
Lottery
Market or price system
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Which System Works?
Fairness--none of the systems are fair, scarcity means
someone gets left out.
Incentives increase supplies and raise standards of living in
a market system.
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Arbitrage
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An Arbitrage Opportunity?
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