Scarcity, Choice, and Opportunity Cost
Scarcity, Choice, and Opportunity Cost
The concepts of scarcity, choice, and opportunity cost provide the chance to explore the questions of what, how, and for who are products and services produced. In general terms, human wants are unlimited, but resources are limited. This scenario creates scarcity. Scarcity, in turn, forces us to make choices. Scarcity means that society does not have enough resources to produce all the goods and services that its members want to consume. Opportunity cost is the value of the best alternative that one gives up when making a choice between the resources that are available and the way in which they will be used for a given society.
In understanding economics, resources is used in its broadest sense, including everything from natural resources (timber, minerals, energy); capital (buildings, machines); labor (human capital); and entrepreneurship, or the ability to start a business. Resources are also called factors of production, inputs, or simply factors. Output is what is produced. Economists usually include land, labor, and capital as factors of production. To understand how these concepts interact with the economy, it is important to define them specifically:
- Factors of production (factors) are the inputs into the process of production.
- Production is the transformation of resources into goods and services.
- Resources (inputs) are used directly or indirectly to satisfy human wants.
- Capital includes buildings, machines, and other things that are produced in order to produce other goods and services.
Many goods are used to produce other goods. Some of these goods are counted as intermediate goods, whereas others are counted as capital. In the national income accounts, the distinction is simple: Anything that is expected to be used more than one year is capital. If it is expected to be used less than one year it is an intermediate good. Producers are those who transform resources into outputs that include final goods and services.
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Specialization, Exchange, and Comparative Advantage
Specialization means to focus energy, time, and resources toward a specific endeavor rather than spread out limited resources over a broad range of projects. Exchange is simply the process of obtaining good or services through a mutually agreed transfer. Comparative advantage, which is extremely important, is the ability of a country to produce a specific good or service at a lower opportunity cost than its trading partners. Comparative advantage is the basis for specialization and trade between countries. It is the economic motivation for exchange between individuals, groups of individuals, and nations (international trade).
Economists have discovered that specialization and free trade will benefit all trading partners. Even if one producer can produce more of both goods, mutually beneficial trade may still be possible if the relative difference is greater for one product than the other. Every individual, firm, or nation has a comparative advantage at something, even if another has an absolute advantage at producing all goods and services. Trade and specialization allow the most efficient producer to produce each good. This increases productivity.
There is a trade-off between present and future benefits and costs. The simplest example of trading present for future benefits is simply the act of saving, which allows us to consume more in the future. When a society devotes a portion of its resources to investment in capital, it is trading present benefits for future benefits. Investment is the process of using resources to produce new capital. By giving up some production of consumer goods today in order to produce more in the future, society will be able to consume more in the future. Consumer goods are goods produced for present consumption. The process of using resources to produce new capital is called investment.
Overall, the process of comparative advantage creates specialization and opportunity for production. Specialization and voluntary exchange can make both parties to the exchange transaction better off than they were before.
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