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Unformatted text preview: Chapter 2 Scarcity, Opportunity Cost, Specialization and Trade Preparation. The ideas introduced and discussed in this lecture note are: Why have markets? Scarcity. Production possibility frontiers. Production possibility sets. Opportunity costs. Comparative advantage. Specialization in production. Mutual gains from free trade. The terms-of-trade. You should use the index of your textbook to review what your book has to say on these subjects before you come to class. There is little point to browsing the lecture note since it will not be completed until the end of the lectures on these topics. Motivation. In our economy we see everywhere people trading in markets. You might sell some labor in the labor market ( i.e. you work for somebody in exchange for wages) and then use those wages to purchase goods or services produced by others ( e.g. oranges produced by an orange grower and a book produced by an author and a publisher). Such trading would not be necessary if every individual produced 15 16 CHAPTER 2. SCARCITY, OPP. COST, SPECIALIZATION &amp; TRADE everything he needed, growing his own food, making his own clothes, producing his own tools and vehicles, and so on. But we do not. Instead, we choose to specialize in just a few productive skills that provide income to be used for purchases of goods and services produced by others. In doing so we rely upon people specialized in other skills to bring to market the items that we wish to purchase. Put briefly, we have chosen to specialize in production and to generalize in consumption. Why has this come about? And when somebody chooses a specialization, why is it that particular specialization and not some other craft? Any practical, useful model of an economy has to be able to give a convincing explanation of at least these obvious, important features of an economy. What are the answers? An economy is a very complex system so you should not be surprised that the answers are quite complex. This complexity exists because in an economy most things are related to almost everything else. Lets think about this for a brief moment. Household incomes depend mainly upon the demands that firms make for the labor services supplied by members of the household. Firms demands for labor depend upon the demands that households make for the firms products. And households demands depend upon household incomes, which depend upon firms demands for labor supplied by households. We have come full circle in an economy almost everything depends upon everything else. To begin to disentangle this intricate web of interconnections we will start with the most basic of economic ideas, which is that almost everything is scarce. This is the most fundamental idea in economics. After all, if nothing was scarce then why would you bother to economize?...
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- Spring '08
- Opportunity Cost