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Economics of Resources: Scarcity, Trade-offs, and Allocation, Study notes of Economics

Virginia Polytechnic Institute and State University (Virginia Tech)Economics

An introduction to the economics of resources, focusing on scarcity, trade-offs, and allocation. It covers the concepts of scarce goods, limited resources, and the importance of making trade-offs. The document also discusses the role of price in rationing goods and services, the concept of opportunity cost, and the importance of considering secondary effects. Additionally, it touches upon the impact of trade restrictions and the role of microeconomics in understanding resource allocation.

Typology: Study notes

2019/2020

Uploaded on 04/19/2022

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GS Reading Notes
Chapter 1
Economics is about scarcity and the choices we have to make because our desire for good and
services is far greater than their availability from nature.
- Scarcity: Fundamental concept of economics that indicates that there is less of a good
freely available than people would like.
- Choice: The act of selecting among alternatives.
- Resource: An input used to produce economic goods. Land, labor, skills, natural
resources, and human-made tools and equipment provide examples. Throughout history,
people have struggled to transform available, but limited, resources into things they
would like to have – economic goods.
- Capital: Human-made resources (such as tools, equipment, and structures) used to
produce other goods and services. They enhance our ability to produce in the future.
Trade-off (scarcity and choice)
Scarce Goods:
Food
Clothing
Household goods
Education
National defense
Leisure time
Entertainment
Clean air
Pleasant environment
Pleasant working conditions
Limited Resources:
Land
Natural resources
Machines and other human-made physical resources
Nonhuman animal resources
Technology
Human resources
Three General Categories of Resources:
Human resources
Physical resources (capital)
Natural resources
- Objective: A fact based on observable phenomena that is not influenced by differences in
personal opinion.
- Subjective: An opinion based on personal preferences and value judgements.
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GS Reading Notes Chapter 1 Economics is about scarcity and the choices we have to make because our desire for good and services is far greater than their availability from nature.

  • Scarcity: Fundamental concept of economics that indicates that there is less of a good freely available than people would like.
  • Choice: The act of selecting among alternatives.
  • Resource: An input used to produce economic goods. Land, labor, skills, natural resources, and human-made tools and equipment provide examples. Throughout history, people have struggled to transform available, but limited, resources into things they would like to have – economic goods.
  • Capital: Human-made resources (such as tools, equipment, and structures) used to produce other goods and services. They enhance our ability to produce in the future.  Trade-off (scarcity and choice) Scarce Goods:  Food  Clothing  Household goods  Education  National defense  Leisure time  Entertainment  Clean air  Pleasant environment  Pleasant working conditions Limited Resources:  Land  Natural resources  Machines and other human-made physical resources  Nonhuman animal resources  Technology  Human resources Three General Categories of Resources:  Human resources  Physical resources (capital)  Natural resources
  • Objective: A fact based on observable phenomena that is not influenced by differences in personal opinion.
  • Subjective: An opinion based on personal preferences and value judgements.
  • Rationing: Allocating a limited supply of a good or resource among people who would like to have more of it. When price performs the rationing function, the good or resource is allocated to those willing to give up the most “other things” in order to get it. Scarcity = objective Poverty = subjective In a market economy, price is generally used to ration goods and services only to those who are willing and able to pay the prevailing market price. If you have to pay for something, it is scarce. Price-rationing benefit: Encourages individuals to engage in the production of goods and services. [COMPETITION]
  • Economic theory: A set of definitions, postulates, and principles assembled in a manner that makes clear the “cause-and-effect” relationships.
  • Opportunity cost: The highest valued alternative that must be sacrificed as a result of choosing an option. **Eight Guideposts to Economic Thinking
  1. The use of scarce resources is costly, so decision-makers must make trade-offs.**
  • Opportunity cost: The highest valued alternative that must be sacrificed as a result of choosing an option.  No option is free of cost.  Opportunity cost ex: If you use 1 hour to study, then you lose 1 hour to watch TV or listen to music. Whichever option you would have preferred to choose if you didn’t study is highest value option forgone. If you would have watched TV, the opportunity cost of this hour of studying is a forgone hour of TV.  In economics: The opportunity cost of an action is the highest valued option given up when a choice is made. 2. Individuals choose purposefully – they try to get the most from their limited resources. - Economizing behavior: Choosing the option that offers the greatest benefit at the least possible cost. - Utility: The subjective benefit or satisfaction a person expects from a choice or course of action. 3. Incentives matter – Changes in incentives influence human choices in a predictable way. Both monetary and nonmonetary incentives matter.  If the personal cost of an option increases, people will be less likely to choose it.  “Basic postulate of economics”

8. The test of a theory is its ability to predict.

  • Scientific thinking: Developing a theory from basic principles and testing it against events in the real world. Good theories are consistent with and help explain real-world events. Theories that are inconsistent with the real world are invalid and must be rejected.  If the events in the real world are consistent with a theory, we say that the theory has predictive value and is therefore valid. Positive and Normative Economics
  • Positive economics: The scientific study of “what is” among economic relationships.
  • Includes potentially verifiable or refutable propositions.  A positive economic statement need not be correct; it simply must be testable.  Although positive economics does not tell us which policy is best, it can provide evidence about the likely effects of a policy.
  • Normative economics: Judgements about “what ought to be” in economic matters. Normative economic views cannot be confirmed nor proven false because they are based on value judgements. **Pitfalls to Avoid in Economic Thinking
  1. Violation of the** Ceteris paribus condition can lead one to draw the wrong conclusion.
  • Ceteris paribus: Latin tern meaning “other things constant” that is used when the effect of one change is being described, recognizing that if other things changed, they also could affect the results. Economists often describe the effects on one change, knowing that in the real world, other things might change and also exert an effect.
  • Ceteris paribus ex: “ Ceteris paribus , an increase in the price of housing will cause buyers to reduse their purchases of housing.”  We live in a dynamic world. Things are rarely constant. 2. Good intentions do not guarantee desirable outcomes.  Adverse secondary effects. Particularly when they are indirect and observable only over time.  Politicians MAY tie their arguments to objectives that are widely supported by the general populace. Meaning: The claims of this program MAY not be accurate. 3. Association is not causation.  Ex: A witch casts a spell each November to the weather gods, then the weather turns cold. While the weather can be associated with the spell, it isn’t the true cause.  Post hoc propter ergo hoc : Logical fallacy describing an argument that a causal relationship exists simply because of the presence of statistical association. 4. The fallacy of composition: What’s true for one might not be true for all.

- Fallacy of composition: Erroneous view that what is true for the individual (or the part) will also be true for the group (or the whole). - Microeconomics: The branch of economics that focuses on how human behavior affects the conduct of affairs within narrowly defined units, such as individual households or business firms.  Focuses on decision-making. - Macroeconomics: the branch of economics that focuses on how human behavior affects out comes in highly aggregated markets, such as the markets for labor or consumer products.  Aggregates markets; combines all 123 million households in the country. Chapter 2 Because of scarcity, we can’t have everything we want. As a result, we constantly face choices that involve trade-offs between our competing desisres. Opportunity Cost The choice to do one thing is, at the same time, a choice not to do something else.  Subjective; depend on the value the decision-maker places on alternative options.  Can never be measure by anyone outside of the decision-maker.  Monetary cost reflect opportunities forgone, and can be measured objectively in dollars and cents. Opportunity Cost and the Real World  Ex: Paying to attend colleges means you forego any salary you could have earned while in-school.  Failure to consider opportunity cost often leads to unwise decision-making.  Thomas Sowell – “the rules of the game” **Trade Creates Value

  1. When individuals engage in a voluntary exchange, both parties are made better off.**  One only agrees to an exchange if they will be made better off.  Janet loves tomatoes, but hates onions. Brad loves onions, but hates tomatoes. Brad offers Janet his tomatoes for her onions. Janet voluntarily agrees because she believes she will be better off. On the other side, Brad has voluntarily made this offer because he also believes that he will be better off. 2. By channeling goods and resources to those who value them most, trade creates value and increases the wealth created by a society’s resources.  Preferences – The value of an item varies from person to person.
  1. Private owners have an incentive to conserve for the future – particularly if the property is expected increase in value.  When more than one individual has the right to drill for oil, the incentive is to extract as much as possible, as quickly as possible. Any oil conserved for the future will probably be taken by someone else. Private-owned property would slow the extract.  Someone who owns land, a house, or a factory has a strong incentive to bear costs now, if necessary, to preserve the asset’s value for the future.
  2. Private owners have an incentive to lower the chance that their property will cause damage to the property of others.  Private owners can be held accountable for damage done to others through the misuse of their property. Private Ownership and Markets  If you want to use a good or resource, you must either buy or lease it from the owner.  “The extended order” – The tendency for markets to lead perfect strangers from different backgrounds around the world to cooperate with one another. (Friedrich Hayek)  The Mystery of Capital – The lack of well-defined and enforced property rights explains why some underdeveloped countries (despite being market based) have made little economic process. (Hernando de Soto) *  Endangered species ex: Because cattle are privately owned, the market demand creates the incentive for suppliers to maintain herds of cattle and to protect them under a system of private ownership. Production Possibilities Curve
  • Production possibility curve: A curve that outlines all possible combinations of total output that could be produced, assuming (1) a fixed amount of productive resources, (2) a given amount of technical knowledge, and (3) full and efficient use of those resources. The slope of the curve indicates the amount of one product that must be given up to produce more of the other.  The slope of the production possibilities curve reflects increasing opportunity costs.  All output possibilities on the curve are efficient. Points inside the curve are inefficient. Points outside the curve are unattainable.  Able to show all maximum combinations of two goods that an economy will be able to produce: (1) given a fixed quantity of resources, (2) holding the level of technology constant, (3) assuming that all resources are used efficiently. **Shifting the Production Possibilities Curve Outward Four Factors:
  1. An increase in the economy’s resource base would expand our ability to produce goods and services. -** Investment: The purchase, construction, or development of resources, including physical assets, such as plants and machinery, and human assets, such as better education.

Investment expands an economy’s resources. The process of investment is sometimes called capital formation.  The production possibilities curve of a high-investment economy will tend to shift outward by a larger amount over time than a low-investment economy’s will.

2. Advancements in technology can expand the economy’s production possibilities.

  • Technology: The technological knowledge available in an economy at any given time. The level of technology determines the amount of output we can generate with our limited resources.
  • Invention: The creation of a new product or process, often facilitated by the knowledge of engineering and science.
  • Innovation: The successful introduction and adoption of a new product or process; the economic application of inventions and marketing techniques.
  • Entrepreneur: A person who introduces new products or improved technologies and decides which projects to undertake. A successful entrepreneur’s actions will increase the value of resources and expand the size of the economic pie.
  • Creative destruction: The replacement of old products and production methods by innovative new ones that consumers judge to be superior. The process generates economic growth and higher living standards. (Joseph Schumpeter) 3. An improvement in the rules under which the economy functions can also increase output.  The legal system of a country influences the ability of people to cooperate with one another and produce goods.  Poor institutions can lead to reduction of resources used (shifting the curve inward), and efficiency (causing the economy to operate inside its production possibilities curve). 4. By working harder and giving up current leisure, we could increase our production of goods and services.  Working more inherently moves the production possibilities curve outward. Production Possibilities and Economic Growth  Economic growth is simply an outward shift in the curve through time.  More rapid outward shifts = more rapid growth. Trade, Output, and Living Standards  Trade makes it possible for people to generate more output through specialization and division of labor, large-scale production processes, and the dissemination of improved products and production methods.
  • Division of labor: A method that breaks down the production of a product into a series of specific tasks, each performed by a different worker.

Market Organization

  • Market organization: A method of organization in which private parties make their own plans and decisions with the guidance of unregulated market prices. The basic economic questions of consumption, production, and distribution are answered through these decentralized decisions. (aka capitalism)
  • Capitalism: An economic system in which productive resources are owned privately and goods and resources are allocated through market prices.  Government plays a “limited role” of rulemaker and referee. *Not an active player in the economy.  The three questions are answered by buyers and sellers. Political Organization
  • Collective decision-making: The use of the political process (voting, taxes, government spending, regulations, political bargaining, lobbying, and so on) to make decisions and allocate resources. In a democratic setting, the votes of citizens and their representative will determine the actions undertaken.  Government makes decisions for buyers and sellers in an attempt to solve basic problems facing the economy.
  • Socialism: A system of economic organization in which (1) the ownership and control of the basic means of production rest with the state and (2) resource allocation is determined by centralized planning rather than by market forces. Market system relies on voluntary exchange, price signals, and freedom of entry. Result: Wider variety of products, a more competitive environment, and more dynamic change. Political system responds primarily to the votes of the majority.