Lesson 1. Scarcity, Choice, Opportunity Cost and Production Possibilities
Any given country in the world has been endowed by nature with a given quantity and quality of resources (land, labor, natural resources). Differences in resources endowments leads countries to decide between different combination of resources to produce the goods and services necessary for the society.
Scarcity is the condition that countries (and also individuals) have to face because productive resources (or factors of production) are insufficient to satisfy people’s unlimited wants and desires.
The level of production and the type of products in a country are related to the opportunity cost associated with this decision. Opportunity cost is defined as the ratio of what is given up divided by what is gained. Thus, in a situation of producing more of X and less of Y, the trade off that a country faces has a numerical value defined by the reduced production of good Y divided by the increased production of X. If the ratio is above unity, let us say equal to 20.9, the choice of acquiring that additional amount of X is expensive. On the other hand, if the ratio is equal to .3, the cost of acquiring that specific amount of X is low.
A very visual representation of scarcity and the implications for choice and opportunity cost is available in the Production Possibilities Model. It describes the different combinations of output of any two goods (X and Y, for example) that can be produced given different combinations of the scarce inputs. The position of the PP curve illustrates the idea of the maximum amount of any combination of outputs that are available. A PP curve that occupies a position close to the origin signifies that resources are very scarce, whereas a PP curve displaced at a significant distance from zero signifies less scarcity. In this sense, the PP curve is a boundary, or a frontier.
Imagine a Country A that has a given amount of capital and a fixed quantity of labor. Both resources are used as production inputs. On the other hand, Country B has a different amount of both factors. Quantities are described in Visual 1.1.1.
Visual 1.1.1. Production Possibilities Frontiers
Country A has a higher number of units of labor. Country B has a higher number of units of Capital. If both countries decide to use only one factor for producing, Country A would use 300 units of labor and Country B would use 300 units of Capital.
Both PPF curves (Production Possibilities Frontier) show the trade off in the use of factors of production. It means that to achieve the same level of output, country A and B have to decide the number of labor units and capital units to use. Along the PPF, level of output does not change. What actually suffers a change along the PPF is the use of factors of production.
Opportunity cost under this assumption would represent the number of units of labor/capital each country decide to leave using in order to employ more units of the other factor. This change is known as the technical rate of transformation, and it represents the technology available in a country that permits the changes in the use of factors of production because an increase in the use of other.
For an individual, the opportunity cost would represent the value of the best alternative passed up for the chosen item or activity.
Many choices involve analysis of opportunity costs. For instance, the decision to attend college requires spending funds that could be used for other purposes as well as forgoing income that could have been earned from other uses of scare time.
Once introduced the concept of opportunity cost to your students, ask them to estimate the amount of money they could earn if they take a job immediately after finishing High School.
Ask them to estimate the income they would earn in the following 5 years if they had a full time job.Ask them to estimate the income they would earn in the following 5 years if they had a full time job.
Then ask them to estimate the costs of attending University:
Compute the expenses they would incur to earn a four-year college degree.
Ask them to discuss the opportunity costs they might pay if they decide not to attend college after high school. Also, ask them to compute the estimated income they would earn with a College degree and compare it with the earnings of just having a High School Diploma.
Make sure they understand what they might be giving up- higher salaries, knowledge, and college experience-. Continue the discussion by asking your students to think about what they would decide to do after finishing High School under these assumptions.
Draw a general conclusion.
Based on information provided in Visual 1.1.2 calculate the following:
Visual 1.1.2. Production Possibilities Frontier of Country X
The number of units of capital that country X has to give up in order to increase the use of more labor from 200 units to 300 units.
What would the change in capital over the change in labor represent? (Change Capital/Change in Labor). (Hint: TRT)
What would be the level of output in the new Point B?
Suppose that the factor of labor has increased because an increase in population in country X, from 400 units to 500 units, as shown in Visual 1.1.3.
Visual 1.1.3. Changes in PPF of Country X
If the units of capital do not vary, what it is expected to happen to the level of output? Does it increase or decrease? Why the PPF has shift to the right?
What would be the opportunity cost in terms of units of capital (units of capital to be given up) if country X decides to specialize production by using the 500 units of labor disposable in the country? (i.e. to go from point C to point F) What would be the level of output of country X in point F? Hint: Remember what the PPF represents.
What would happen with the use of resources if the PPF if production is set up in point D? (i.e. 100 units of capital and 100 units of labor)
What would happen with the use of resources if the PPF if production is set up in point E? It is possible to have that level of production? Why not? What would be necessary to do in Country X in order to achieve the level of output described in point E?