CHAPTER 3

THE FUNDAMENTAL ECONOMIC PROBLEM:

SCARCITY AND CHOICE

TEST YOURSELF

2.   Figure 1 shows the production possibilities frontier. The principle of increasing cost holds, because the curve is concave. For example, begin at the point of producing 20 pizza ovens and 0 pizzas. To produce 15 pizzas we must give up the production of 2 pizza ovens; this brings us the point of 18 pizza ovens and 15 pizzas. To gain another 15 pizzas, we must now give up the production of 3 pizza ovens. As we continue to produce more pizzas we must give up increasing quantities of pizza ovens. There are diminishing returns as resources are shifted from pizzas to pizza ovens, or vice versa.

Figure 1 (Pizza numbers are in millions, ovens are in thousands)

4.   Figure 2 shows the production possibilities frontier. It is a straight line rather than a curve, because for each additional box of brand X that Jasmine buys, no matter how many boxes she already has, she must cut her purchases of Brand Y by the same amount, 3/5 of a bag. The production possibilities frontier in this question is really like a budget constraint.  Brand X is $0.60, Brand Y is $1.00.

            Figure 2

DISCUSSION QUESTIONS

4. Under the former communist regime, the farmer was allocated a certain amount of each type of feed, at a fixed cost, and was also given a quota for the number of chickens to be produced. The farmer did as he was told, and took few if any risks or innovations. Under private enterprise now, the farmer can get richer by producing more chickens. He is free to buy any combination of feed grains, subject only to the limit of his budget, at the going market prices. Through a process of trial and error, he will select the combination of feed grains that maximizes his profit—and if the price of soy meal rises, he will shift toward corn. The price of soy meal will in fact rise if soy meal becomes scarcer in the economy as a whole. Thus the market system leads the farmer to economize in his use of a resource that is becoming increasingly scarce—a task that used to be the responsibility of the central planning agency.

5.   There are countless good answers to this question. An increase in defense purchases, for example, may require a reduction in educational expenditures. For some students, it may also be important to note that a larger deficit now may lead to a decrease in expenditures in the future.

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