Lecture 3 & 4
Dominika Milczarek-Andrzejewska
The Economizing Problem
Economic Systems
Outline of Lecture 3 and 4
•
•
•
•
•
•
Unlimited Wants
Scarce Resources
Resource Categories
Employment and Efficiency
Production Possibilities Curve
Economic Systems (Market and Command
System)
• Circular Flow Model
2
Economizing problem:
Society’s material wants are unlimited
while resources are limited or scarce.
3
1
Unlimited Wants
(The First Fundamental Fact)
1. Economic wants - desires of people to
use goods and services that provide
utility
2. Luxuries or necessities
3. Services satisfy wants as well as goods
4. Businesses and governments also have
wants
5. Over time, wants change and multiply
4
Scarce Resources
(The Second Fundamental Fact)
• Economic resources - limited relative to
wants
• Economic resources - sometimes called
factors of production
• Four categories:
– Land or natural resources,
– Capital or investment goods (tools,
equipment, factories, etc.)
– Labor or human resources
– Entrepreneurial ability
5
Employment and Efficiency
• Economics is a science of efficiency in
the use of scarce resources.
• Efficiency requires:
– full employment of available resources and
– full production
6
2
Allocative and Productive Efficiency
Full production: employed resources are providing
maximum satisfaction of our economic wants.
Full production implies two kinds of efficiency:
1. Allocative efficiency - resources are used for
producing the combination of goods and services
most wanted by society
2. Productive efficiency - least costly production
techniques are used
7
Allocative and Productive Efficiency
• Allocative efficiency requires productive
efficiency
• Productive efficiency can occur without
allocative efficiency
8
Production Possibilities
Assumptions:
1. Economy is operating efficiently
2. Available supply of resources is fixed in
quantity and quality at this point in time
3. Technology is constant during analysis
4. Economy produces only two types of products
• Choices will be necessary because resources
and technology are fixed
• A production possibilities curve is a graphical
representation of choices
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3
Production Possibilities
cars
(thousands)
Q
13
12
11 A
B
10
9
C
8
7
D
6
5
Attainable
4
but
3
Inefficient
2
1
1
2
3
TV sets
Unattainable
W
Attainable
& Efficient
E
4
5
6
7
(hundred thousands)
8
Q
10
Law of Increasing Opportunity Costs
Opportunity cost - the amount of other
products that must be foregone to obtain
more of any given product
• The more of a product produced the
greater is its opportunity cost
• The slope of the production possibilities
curve becomes steeper, demonstrating
increasing opportunity cost.
11
Allocative Efficiency Revisited
How does society decide its optimal point on
the production possibilities curve?
– It is advantageous to have the additional
product if
MB > MC
– It is not “worth” it to society to produce the
extra unit if
MB < MC
12
4
Allocative Efficiency: MB=MC
Marginal Benefit & Cost
P
MC
$15
MB=MC
10
5
MB
1
2
Q
3
Quantity of TV sets
13
Unemployment and Growth
• Unemployment and productive inefficiency
– the economy is producing less than full
production or
– inside the curve
• In a growing economy, the production
possibilities curve shifts outward
– when resource supplies expand in quantity or
quality
– when technological advances are occurring
14
Production Possibilities
cars
(thousands)
Q
Unemployment &
Underemployment
Shown by Point U
13
12
11
10
9
8
7
6
5
4
3
2
1
More of either or
both is possible
U
1
2
3
4
5
6
TV sets (hundred thousands)
7
8
Q
15
5
Production Possibilities
cars
(thousands)
Q 14
A’
13
12
11
10
9
8
7
6
5
4
3
2
1
Economic
Growth
C’
B’
D’
E’
1
2
3
4
5
6
7
TV sets (hundred thousands)
8
Q
16
International Trade
• A nation can avoid the output limits of its
domestic Production Possibilities through
international specialization and trade
• Specialization and trade have the same
effect as having more and better
resources of improved technology
17
Economic Systems
• Differences:
– Who owns the factors of production
and
– The method used to coordinate
economic activity
18
6
Economic Systems
• The market system:
– There is private ownership of resources;
– Markets and prices coordinate and direct
economic activity;
– Each participant acts in his or her own selfinterest;
– In pure capitalism the government plays a
very limited role;
– In the European version of capitalism, the
government plays a substantial role.
19
Economic Systems
• Command economy, socialism or
communism:
– There is public (state) ownership of
resources.
– Economic activity is coordinated by central
planning.
20
The Circular Flow Model
• Two groups of decision makers in the private
economy: households and businesses
• The market system coordinates these
decisions.
21
7
The Circular Flow Model
$ COSTS
$ INCOMES
RESOURCE
MARKET
RESOURCES
INPUTS
BUSINESSES
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
$ REVENUE
$ CONSUMPTION
22
The Circular Flow Model
Limitations of the model:
• No transactions between households and
businesses
• Lack of government and the “rest of the
world”
• Lack of explanation how prices of
products and resources are determined
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Key Terms
• ECONOMIC RESOURCES
• FACTORS OF
PRODUCTION
• FULL EMPLOYMENT
• FULL PRODUCTION
• PRODUCTIVE EFFICIENCY
• ALLOCATIVE EFFICIENCY
• PRODUCTION
POSSIBILITIES TABLE
• PRODUCTION
POSSIBILITIES CURVE
• OPPORTUNITY COST
• LAW OF INCREASING
OPPORTUNITY COST
• ECONOMIC GROWTH
• ECONOMIC SYSTEM
• MARKET SYSTEM
• CAPITALIZM
• COMMAND SYSTEM
• RESOURCE MARKET
• PRODUCT MARKET
• CIRCULAR FLOW MODEL
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