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The Economic
Economic Problem:
Problem:
Scarcity,
Scarcity, Wants,
Wants, and
and Choices
Choices
Chapter 2
Chapter 2 S M Khan 1
Chapter
Chapter 22 Topics
Topics
Chapter 2 S M Khan 2
The
The Foundation
Foundation of
of Economics
Economics
■ Society has virtually unlimited
wants…
■ But resources are limited or scarce
Chapter 2 S M Khan 3
UNLIMITED
UNLIMITED WANTS
WANTS
■ Goods & services provide utility.
■ Desire for a particular good can be
satisfied, but not desire for goods in
general.
Chapter 2 S M Khan 4
Utility
Utility and
and it’s
it’s types
types
■ Utility – ability of a product to satisfy
one’s need.
Types of utility
■ Form utility
■ Time utility
■ Place utility
■ Possession utility
Chapter 2 S M Khan 5
RESOURCE
RESOURCE CATEGORIES
CATEGORIES (1)
(1)
Property Resources
– Land
– Capital
Human Resources
– Labor
– Entrepreneurial Ability
Chapter 2 S M Khan 6
RESOURCE
RESOURCE CATEGORIES
CATEGORIES (2)
(2)
Property Resources
■ Land –
refers to
all natural resources
“gift of nature”
Usable in the productive process
As land, forests, mineral & oil etc
Chapter 2 S M Khan 7
RESOURCE
RESOURCE CATEGORIES
CATEGORIES (3)
(3)
Property Resources
Notes....
■ Capital
INVESTMENT
• All manufacturing aid to
production MONEY
• Capital goods vs. consumer CAPITAL
goods; REAL
• Capital as here does not refer to CAPITAL
money;
Chapter 2 S M Khan 8
RESOURCE
RESOURCE CATEGORIES
CATEGORIES (4)
(4)
Property Resources
■ Land
■ Capital
Human Resources
■ Labour
Chapter 2 S M Khan 9
RESOURCE
RESOURCE CATEGORIES
CATEGORIES (5)
(5)
Property Resources
■ Land
■ Capital
Human Resources
■ Labour
■ Entrepreneurial Ability
Chapter 2 S M Khan 10
RESOURCE
RESOURCE CATEGORIES
CATEGORIES (6)
(6)
■ Entrepreneurial Ability
– Takes initiative
– Makes basic business policy decisions
– Source of innovation
– Bears the risk
Chapter 2 S M Khan 11
Resource
Resource Payments
Payments
PROPERTY RESOURCES
LAND RENT
CAPITAL INTEREST
HUMAN RESOURCES
LABOUR WAGES
PROFIT &
ENTREPRENEUR
LOSS
Chapter 2 S M Khan 12
Relative
Relative Scarcity
Scarcity
■ Resources are scarce or limited in
supply
■ Ultimate constraints on production
Chapter 2 S M Khan 13
Basic
Basic problems
problems of
of an
an economy
economy
■ What to produce
■ How to produce
■ For whom to produce
Chapter 2 S M Khan 14
Chapter
Chapter 22 Topics
Topics
✓ The Foundation of Economics
■ Getting the Most From Available
Resources
■ Unemployment, Growth & the
Future
■ Economic Systems
■ The Circular Flow Model
Chapter 2 S M Khan 15
Definition
Definition of
of Economics
Economics
■ Social science concerned with using
scarce resources to attain maximum
fulfillment of society’s unlimited
wants
■ Doing the best with what we have
Chapter 2 S M Khan 16
Getting
Getting the
the Most
Most from
from Available
Available
Resources
Resources
Chapter 2 S M Khan 17
Production
Production Possibilities
Possibilities
Assumes:
■ full employment & productive efficiency
■ fixed resources
■ fixed technology
■ two goods
– pizzas symbolize consumer goods
– industrial robots symbolize capital goods
Chapter 2 S M Khan 18
PRODUCTION POSSIBILITIES
What if we could only produce ...
10,000 Robots
Chapter 2 S M Khan 19
PRODUCTION POSSIBILITIES
What if we could only produce ...
10,000 Robots
or
400,000 Pizzas
10,000 Robots
or
400,000 Pizzas
ROBOTS 10 9 7 4 0
(in thousands)
Chapter 2 S M Khan 22
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3 4
(in hundred thousands)
ROBOTS 10 9 7 4 0
(in thousands)
Production Possibilities
12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
pizza (hundred thousands)
Chapter 2 S M Khan 23
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3 4
(in hundred thousands)
ROBOTS 10 9 7 4 0
(in thousands)
Production Possibilities
12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
pizza (hundred thousands)
Chapter 2 S M Khan 24
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3 4
(in hundred thousands)
ROBOTS 10 9 7 4 0
(in thousands)
Production Possibilities
12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
pizza (hundred thousands)
Chapter 2 S M Khan 25
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3 4
(in hundred thousands)
ROBOTS 10 9 7 4 0
(in thousands)
Production Possibilities
12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
pizza (hundred thousands)
Chapter 2 S M Khan 26
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3 4
(in hundred thousands)
ROBOTS 10 9 7 4 0
(in thousands)
Production Possibilities
12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
pizza (hundred thousands)
Chapter 2 S M Khan 27
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3 4
(in hundred thousands)
ROBOTS 10 9 7 4 0
(in thousands)
Production Possibilities
12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
pizza (hundred thousands)
Chapter 2 S M Khan 28
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3 4
(in hundred thousands)
ROBOTS 10 9 7 4 0
(in thousands)
Production Possibilities
12
robots (thousands)
10
PRODUCTION 8
POSSIBILITIES 6
4
CURVE 2
0
0 1 2 3 4 5
pizza (hundred thousands)
Chapter 2 S M Khan 29
PRODUCTION POSSIBILITIES
Figure 2-1
Q Unattainable
A B
10 C
9 Robots (thousands) W
Robots (thousands)
8
7 D
6 Attainable and
5 attainable efficient
4 but
3
2 inefficient
1 E
Q
1 2 3 4 5 6 7 8
Pizzas (hundred thousands)
Chapter 2 S M Khan 30
Production
Production Possibilities
Possibilities
■ the production possibilities curve
(frontier) marks the boundary between
attainable & unattainable production
levels
■ points on the curve are attainable &
efficient
■ points above the curve are unattainable
■ points below the curve are attainable &
inefficient
Chapter 2 S M Khan 31
Production
Production Possibilities
Possibilities
Opportunity Costs:
■ The cost of passing up the next best choice
when making a decision. For example, if an
asset such as capital is used for one purpose,
the opportunity cost is the value of the next
best purpose the asset could have been used
for.
Chapter 2 S M Khan 32
Production
Production Possibilities
Possibilities
Law of Increasing Opportunity Costs:
■ opportunity cost increases with
amount produced
■ as we make more pizzas, the
robots we have to give up (per
pizza) increases
illustrated...
Chapter 2 S M Khan 33
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3
4
ROBOTS
(in hundred thousands) 10 9 7 4
0
(in thousands)
■ Opportunity Cost 1st Pizza unit
=1 Robot unit
Chapter 2 S M Khan 34
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3
4
ROBOTS
(in hundred thousands) 10 9 7 4
0
(in thousands)
■ Opportunity Cost 2nd Pizza unit
=2 Robot units
Chapter 2 S M Khan 35
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3
4
ROBOTS
(in hundred thousands) 10 9 7 4
0
(in thousands)
■ Opportunity Cost 3rd Pizza unit
= 3 Robot units
Chapter 2 S M Khan 36
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3
4
ROBOTS
(in hundred thousands) 10 9 7 4
0
(in thousands)
■ Opportunity Cost 4th Pizza unit
= 4 Robot units
Chapter 2 S M Khan 37
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3
4
ROBOTS
(in hundred thousands) 10 9 7 4
■
0Opportunity Cost 1st Pizza Unit = 1 Robot Unit
(in thousands)
■ Opportunity Cost 2nd Pizza Unit = 2 Robot Units
■ Opportunity Cost 3rd Pizza Unit = 3 Robot Units
■ Opportunity Cost 4th Pizza Unit = 4 Robot Units
Chapter 2 S M Khan 38
P ro d u c tio n P o s s ib ilitie s
12
10
1st pizza unit 8
robots (thousands)
6
costs 1 robot
unit 4
2
0
0 1 2 3 4 5
p i z z a (h u n d re d th o u sa n d s)
Chapter 2 S M Khan 39
P ro d u c tio n P o s s ib ilitie s
12
10
2nd pizza unit 8
robots (thousands)
6
costs 2 robot
units 4
2
0
0 1 2 3 4 5
p i z z a (h u n d re d th o u sa n d s)
Chapter 2 S M Khan 40
P ro d u c tio n P o s s ib ilitie s
12
10
3rd pizza unit 8
robots (thousands)
6
costs 3 robot
units 4
2
0
0 1 2 3 4 5
p i z z a (h u n d re d th o u sa n d s)
Chapter 2 S M Khan 41
P ro d u c tio n P o s s ib ilitie s
the more
12
pizza
we make, the 10
more robots 8
we have robots (thousands)
to give up 6
➜ the steeper 4
the curve
2
0
0 1 2 3 4 5
p i z z a (h u n d re d th o u sa n d s)
Chapter 2 S M Khan 42
LAW
LAW OF
OF INCREASING
INCREASING
OPPORTUNITY
OPPORTUNITY COSTS
COSTS
■ Means a graph of the production
possibilities curve will be
CONCAVE — bowed out from the
origin
■ Economic resources are not
completely adaptable to other uses
Chapter 2 S M Khan 43
Production
Production Possibilities
Possibilities
■ which point on the frontier is BEST?
■ need more informatiom to decide on
allocative efficiency
Chapter 2 S M Khan 44
Allocative
Allocative Efficiency
Efficiency Revisited
Revisited
■ decide on allocative efficiency by
comparing Marginal (extra) Cost (MC)
to Marginal Benefit (MB).
■ Marginal Benefit is the extra benefit
associated with consuming one more
unit.
■ Marginal Cost is the extra opportunity
cost of that extra unit.
Chapter 2 S M Khan 45
Allocative
Allocative Efficiency
Efficiency Revisited
Revisited
Figure 2-2 MB > MC
➜under allocation of
resources
MC
Marginal benefit and
15
marginal cost
10
5
MB
0
0 1 2 3
Quantity of pizza (hundred thousands)
Chapter 2 S M Khan 46
Allocative
Allocative Efficiency
Efficiency Revisited
Revisited
Figure 2-2 MB < MC
➜over allocation of
resources
MC
Marginal benefit and
15
marginal cost
10
5
MB
0
0 1 2 3
Quantity of pizza (hundred thousands)
Chapter 2 S M Khan 47
Allocative
Allocative Efficiency
Efficiency Revisited
Revisited
Figure 2-2
MC
Marginal benefit and
15 MB=MC
marginal cost
5
MB
0
0 1 2 3
Quantity of pizza (hundred thousands)
Chapter 2 S M Khan 48
Production Possibilities Curve
Q
Unemployment &
10 Underemployment
Robots (thousands)
9
Shown by Point U
Robots (thousands)
8
7
6
5 U
4
3
2
1
Q
1 2 3 4 5 6 7 8
Pizzas (hundred thousands)
Chapter 2 S M Khan 49
Production Possibilities Curve
Figure 2-3
Q
Unemployment &
10 Underemployment
Robots (thousands)
9
Shown by Point U
Robots (thousands)
8
7
6
5
4 U More of either or
3
2 both is possible
1
Q
1 2 3 4 5 6 7 8
Pizzas (hundred thousands)
Chapter 2 S M Khan 50
Production
Production Possibilities
Possibilities Curve
Curve
■ Economic Growth: a rightward
shift of the production
possibilities curve caused by....
1. Increases in resource supplies
2. Advances in technology
Chapter 2 S M Khan 51
PRODUCTION POSSIBILITIES
A’ Figure 2-4
Q 14 Economic Growth
13 B’
12
11
10
Robots (thousands)
C’
9
8
7
6 D’
5
4
3
2
1 E’
1 2 3 4 5 6 7 8 Q
Pizzas (hundred thousands)
Chapter 2 S M Khan 52
PRODUCTION POSSIBILITIES
Two Examples of Economic Growth
Figure 2-5
FAVOURING
PRESENT GOODS
Goods for the Future
FUTURE
CURVE
Chapter 2 S M Khan 53
PRODUCTION POSSIBILITIES
Two Examples of Economic Growth
Figure 2-5
FAVOURING FAVOURING
PRESENT GOODS FUTURE GOODS
Goods for the Future
Chapter 2 S M Khan 54
Qualification:
Qualification: International
International Trade
Trade
■ an individual nation is limited by the
production possibilities curve
■ but NOT when there is international
specialization and trade!
– possible to consume ABOVE the
production possibilities curve
Chapter 2 S M Khan 55
Examples
Examples &
& Applications
Applications
■ Unemployment & Productive
Inefficiency
– the Great Depression
– discrimination
■ Tradeoffs & Opportunity Costs
– logging or wilderness?
■ Shifts in Production Possibilities
Curves
– cell phones, the Internet
Chapter 2 S M Khan 56
Chapter
Chapter 22 Topics
Topics
✓ The Foundation of Economics
✓ Getting the Most From Available
Resources
✓ Unemployment, Growth & the
Future
■ Economic Systems
■ The Circular Flow Model
Chapter 2 S M Khan 57
Economic
Economic Systems
Systems
■ Market economy
■ Command economy
■ Mix economy
■ Islamic economy
Chapter 2 S M Khan 58
Economic
Economic Systems
Systems
■ Resource allocation methods
differ according to:
– resource ownership
– co-ordination method
Chapter 2 S M Khan 59
The
The Market
Market System
System
■ private ownership of capital
■ prices & markets co-ordinate activity
■ independent actions of buyers
& sellers
■ limited role for government
Chapter 2 S M Khan 60
The
The Command
Command System
System
■ socialism, communism
■ government owns most resources
■ central planning
Chapter 2 S M Khan 61
Mixed
Mixed economy
economy
■ Both Govt. and private
Chapter 2 S M Khan 62
Islamic
Islamic economy
economy
■ As stated of holy Quran ……
Chapter 2 S M Khan 63
Chapter
Chapter 22 Topics
Topics
✓ The Foundation of Economics
✓ Getting the Most From Available
Resources
✓ Unemployment, Growth & the
Future
✓ Economic Systems
■ The Circular Flow Model
Chapter 2 S M Khan 64
Circular
Circular Flow
Flow Model
Model
Figure 2-6
BUSINESSES
Chapter 2 S M Khan 65
Circular
Circular Flow
Flow Model
Model
Figure 2-6
BUSINESSES HOUSEHOLDS
Chapter 2 S M Khan 66
Circular
Circular Flow
Flow Model
Model
Figure 2-6
RESOURCE
MARKET
RESOURCES INPUTS
BUSINESSES HOUSEHOLDS
Chapter 2 S M Khan 67
Circular
Circular Flow
Flow Model
Model
Figure 2-6
$I
NC
S
ST
OM
RESOURCE
O
E
C
S
MARKET
$
RESOURCES INPUTS
BUSINESSES HOUSEHOLDS
Chapter 2 S M Khan 68
Circular
Circular Flow
Flow Model
Model
Figure 2-6
$
IN
S
C
ST
O
RESOURCE M
O
ES
C
MARKET
$
RESOURCES INPUTS
BUSINESSES HOUSEHOLDS
PRODUCT
MARKET
Chapter 2 S M Khan 69
Circular
Circular Flow
Flow Model
Model
Figure 2-6
$
IN
S
C
ST
O
RESOURCE M
O
ES
C
MARKET
$
RESOURCES INPUTS
BUSINESSES HOUSEHOLDS
N
O
$
I
PT
R
EV PRODUCT
M
SU
EN MARKET
N
U
O
E
C
$
Chapter 2 S M Khan 70