THE ECONOMIC PROBLEM: SCARCITY AND CHOICE

• Scarcity is the fundamental economic problem of having humans who have unlimited wants and needs in a world of limited resources
• Choice consists of the mental process of judging the merits of multiple options and selecting one of them.

Types of choices

• Command decisions
• Delegated decisions
• Avoided decisions
• "No-brainer" decisions

Three basic questions must be answered in order to understand an economic system:

• What gets produced?
• How is it produced?
• Who gets what is produced?

Capital refers to the things that are themselves produced and then used to produce other goods and services.

According to Adam Smith and David , factors of production:

• Land :naturally-occurring goods such as water, air, soil, minerals, flora and fauna that are used in the creation of products
• Labor : human effort used in production which also includes technical and marketing expertise
• Capital: human-made goods (or means of production), which are used in the production of other goods.

Production

Production is a process, and as such it occurs through time and space. There are three aspects to production processes:

• The quantity of the good or service produced,
• The form of the good or service created,
• The temporal and spatial distribution of the good or service produced.

Resources or factors of production are the inputs into the process of production; goods and services of value to households are the outputs of the process of production

Scarcity and Choice in a One-Person Economy

• Nearly all the basic decisions that characterize complex economies must also be made in a single-person economy.
• Constrained choice and scarcity are the basic concepts that apply to every society.
• Opportunity cost is that which we give up or forgo, when we make a decision or a choice.

Scarcity and Choice in an Economy of Two or More

• A producer has an absolute advantage over another in the production of a good or service if it can produce that product using fewer resources
• A producer has a comparative advantage in the production of a good or service over another if it can produce that product at a lower opportunity cost.

Specialization, Exchange and Comparative Advantage

• According to the theory of competitive advantage, specialization and free trade will benefit all trading parties, even those that may be absolutely more efficient producers

Capital Goods and Consumer Goods

• Capital goodsare goods used to produce other goods and services.
• Consumer goodsare goods produced for present consumption
• Investment is the process of using resources to produce new capital. Capital is the accumulation of previous investment.
• The opportunity cost of every investment in capital is forgone present consumption

The Production Possibility Frontier

• The production possibility frontier (ppf)is an expository figure for representing scarcity, cost, and efficiency. In the simplest case an economy can produce just two goods (say "guns" and "butter")

The Law of Increasing Opportunity Cost

• The slope of the ppf curve is also called the marginal rate of transformation (MRT).
• The negative slope of the ppf curve reflects the law of increasing opportunity cost. As we increase the production of one good, we sacrifice progressively more of the other.

Economic Growth

• Economic growth is defined as the increasing capacity of the economy to satisfy the wants of the members of society. Economic growth is enabled by increases in productivity, which lowers the inputs (labor, capital, material, energy, etc.)
• The main sources of economic growth are capital accumulation and technological advances
• Outward shifts of the curve represent economic growth
• An outward shift means that it is possible to increase the production of one good without decreasing the production of the other.
• From point D, the economy can choose any combination of output between F and G.

Measuring economic growth : Economic growth is measured as a percentage change in the Gross Domestic Product (GDP) or Gross National Product (GNP)
Capital Goods and Growth in Poor and Rich Countries

• Rich countries devote more resources to capital production than poor countries.
• As more resources flow into capital production, the rate of economic growth in rich countries increases, and so does the gap between rich and poor countries.

Economic Systems

• The economic problem: Given scarce resources, how, exactly, do large, complex societies go about answering the three basic economic questions?
• Economic systems are the basic arrangements made by societies to solve the economic problem. They include:Command economies, Laissez-faire economies, Mixed systems
• In a command economy, a central government either directly or indirectly sets output targets, incomes, and prices.
• In a laissez-faire economy,individuals and firms pursue their own self-interests without any central direction or regulation. 
• The central institution of a laissez-faire economy is the free-market system.
• A market is the institution through which buyers and sellers interact and engage in exchange.
• Consumer sovereignty is the idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase
• Free enterprise: under a free market system, individual producers must figure out how to plan, organize, and coordinate the production of products and services.
• In a laissez-faire economy, the distribution of output is also determined in a decentralized way. The amount that any one household gets depends on its income and wealth.
• The basic coordinating mechanism in a free market system is price. Price is the amount that a product sells for per unit. It reflects what society is willing to pay.

Mixed Systems, Markets, and Governments

Since markets are not perfect, governments intervene and often play a major role in the economy. Some of the goals of government are to:

1. Minimize market inefficiencies
2. Provide public goods
3. Redistribute income
4. Stabilize the macroeconomic:

• Promote low levels of unemployment
• Promote low levels of inflation