Chapter Two - Chapter Two Models of Scarcity and Choice The...

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Models of Scarcity and Choice The first chapter explored two basic themes: (1) economics is the study of choices that arise from scarcity, and (2) economics uses a process of model-building to simplify the world so that we can understand it. In one sense, economics consists of a toolkit of models that can be used to help solve many types of problems, from social issues to personal finance. In another sense, economics provides a paradigm for understanding the world. In this chapter, we begin to examine some of the models in the economists’ arsenal. We will look at the ideas of opportunity cost, production possibilities curves, and comparative advantage. Opportunity Cost Every time you make a decision that arises from scarcity, you give up the opportunity to make a different choice. You give up the next best alternative uses of the resources devoted to your choice. What you sacrifice is known as the opportunity cost. Opportunity cost is the benefit foregone from not choosing the next best alternative. Every action that uses scarce resources has an opportunity cost. If we return to the examples in the first chapter, what is the opportunity cost of studying economics on a Friday night? Opportunity costs are different for different people, which is why we make different choices. For some, the opportunity cost of studying economics on a Friday night might be not seeing a movie. For others it may be a date or video games. For some it may be drinking or smoking. Some students may have such low opportunity costs that they actually do study economics on a Friday night. But for most of us, the opportunity cost is too high. We are better off doing other things on a Friday night besides studying economics. Using our other examples, what is the opportunity cost of the lollipop purchased by the little boy in the candy store? It is the quantity of bubble gum that cannot be purchased with the same amount of money. If bubble gum is 5¢ and lollipops are 10¢, then the opportunity cost of a lollipop is the two pieces of bubble gum that could have been purchased instead. For Microsoft, the opportunity cost of using computer engineers to develop new browser software is the media player software that never gets developed. Once employees are put to work on one project, a company gives up other projects that the employees might be working on instead. The federal government faces many opportunity costs. The opportunity costs of the War on Iraq, for example, are many. National Guard troops stationed in Iraq cannot be used for disaster relief at home. Soldiers killed in Iraq will no longer produce goods and services at home. The raw materials used to produce bombs and tanks could be devoted to building hospitals, schools, mass transit, or space exploration. In analyzing public policy choices, it is important to be aware of the opportunity costs of government actions. 13
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Chapter Two - Chapter Two Models of Scarcity and Choice The...

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