Chapter 2: The Economic Problem: Scarcity and Choice

Individuals’ choices determine three key features of society:

• what gets produced

• how is it produced

• who gets what is produced

capital

Things that are produced and then used in the production of other goods and services.

factors of production (or factors)

The inputs into the process of production. Another term for resources.

production

The process that transforms scarce resources into useful goods and services.

inputs or resources

Anything provided by nature or previous generations that can be used directly or indirectly to satisfy human wants.

outputs

Goods and services of value to households.

Opportunity Cost

The best alternative that we give up, or forgo, when we make a choice or decision.

theory of comparative advantage

Ricardo’s theory that specialization and free trade will benefit all trading parties, even those that may be “absolutely” more efficient producers.

absolute advantage

A producer has an absolute advantage over another in the production of a good or service if they can produce that product using fewer resources (a lower absolute cost per unit).

comparative advantage

A producer has a comparative advantage over another in the production of a good or service if he or she can produce that product at a lower opportunity cost.

consumer goods

produced for present consumption

investment

The process of using resources to produce new capital.

production possibility frontier (PPF)

A graph that shows all the combinations of goods and services that can be produced if all of society’s resources are used efficiently

marginal rate of transformation (MRT)

slope of the production possibility frontier (PPF)

the ________ slope ells us how much society has to give up of one output to get a unit of another output.

economic growth

An increase in the total output of an economy. Growth occurs when a society acquires new resources or when it learns to produce more using existing resources.

command economy

An economy in which a central government either directly or indirectly sets output targets, incomes, and prices

laissez-faire economy

Literally from the French: “allow [them] to do.” An economy in which individual people and firms pursue their own self-interest without any central direction or regulation.

market

The institution through which buyers and sellers interact and engage in exchange.

consumer sovereignty

The idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase).

free market system

Individual producers must determine how to organize and coordinate their production.

free market economy

production decisions are made by private organizations acting in their own interest.

Income

the amount that a household earns each year. It comes in a number of forms, such as wages, salaries, and interest.