2
C HAPTE R
The
Economizing
Problem
The foundation of economics is the economizing
problem: society’s material wants are unlimited while
resources are limited or scarce.
Two fundamental facts
A. The first fundamental fact: Unlimited wants:
1. Economic wants are desires of people to use goods and
services that provide utility, which means pleasure,
happiness, or satisfaction.
2. Products are sometimes classified as luxuries or
necessities, but the division is subjective.
3. Services satisfy wants as well as goods.
4. Businesses and governments also have wants.
5. Over time, wants change and multiply
B. the second fundamental fact: Scarce resources:
1. Economic resources are limited relative to wants.
2. Economic resources are sometimes called factors of
production (inputs) and include four categories:
a. Land or natural resources
b. Capital or investment goods which are all
manufactured aids to production like tools, equipment,
factories, transportation, etc.,
c. Labor or human resources, which include physical and
mental abilities used in production
d. Entrepreneurial ability, a special kind of human
resource that provides four important functions:
i.
Takes the initiative: combining the resources (land,
capital and labor to produce a good or a service.
ii. Makes Policy Decisions: The non routine decisions
that set the course of a business Combines resources
needed for production
iii. Innovator: commercializes new products, new
production techniques or even new forms of a business
organization
iv. Bears the risk of time, effort and funds
RESOURCE PAYMENTS
PROPERTY RESOURCES
LAND
CAPITAL
HUMAN RESOURCES
LABOR
ENTREPRENEUR
RENTAL
INCOME
INTEREST
INCOME
WAGES
PROFIT &
LOSS
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.
1. Full employment means all available resources should
be employed.
2. Full production means that employed resources are
providing maximum satisfaction of our economic
wants. Underemployment occurs if this is not so.
Full production implies two kinds of efficiency:
1. Allocative efficiency means that resources are used for
producing the combination of goods and services most
wanted by society.
2. Productive efficiency means that least costly
production techniques are used to produce any
particular mix of goods and services.
Allocative efficiency requires that there be productive
efficiency.
Productive efficiency however, can occur without
allocative efficiency. Goods can be produced in the
least costly method without being the most wanted by
society.
Production possibilities tables and curves are a
device to illustrate and clarify the economizing
problem.
Assumptions:
1. Economy is operating efficiently (full employment
and full production).
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.
PRODUCTION POSSIBILITIES
A Consumer Good
for example...
PRODUCTION POSSIBILITIES
A Capital Good
PRODUCTION POSSIBILITIES
What if we could only produce ...
10,000 Robots
or
400,000 Pizzas
Using all of our resources, to
get some pizza, we must give
up some robots!
for example...
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
(in thousands)
10
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
Limited Resources means a limited output...
At any point in time,
a full-employment, full-production
economy must sacrifice some of
product X to obtain more of product Y.
 Choices will be necessary because resources and
technology are fixed. A production possibilities table
illustrates some of the possible choices.
 A production possibilities curve is a graphical
representation of choices.
 Points on the curve represent maximum possible
combinations of robots and pizza given resources and
technology.
 Points inside the curve represent underemployment or
unemployment.
 Points outside the curve are unattainable at present.
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
13
12
11
10
9
8
7
6
5
4
3
2
1
Unattainable
A
B
C
W
Attainable
& Efficient
D
Attainable
but
Inefficient
E
1
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
13
12
11
10
9
8
7
6
5
4
3
2
1
Notes...
Unattainable
LAW OF INCREASING
A OPPORTUNITY
COSTS
B
The amount
of other
C
W
products that must be
forgone or D
sacrificed to
Attainable
obtain 1 unit of a specific
product is called the & Efficient
Attainable
opportunity
cost of that
but
good.
Inefficient
E
1
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
13
12
11
10
9
8
7
6
5
4
3
2
1
Notes...
Unattainable
LAW OF INCREASING
A OPPORTUNITY
COSTS
B
A graph of the production
C
possibilities curve W
will be
CONCAVE - bowed out from
D
Attainable
the origin.
&
Attainable
Economic resources are
but
not completely adaptInefficient
able
to other uses.
Efficient
1
7
E
2
3
4
5
6
Pizzas (hundred thousands)
8
Q
Law of increasing opportunity costs:
1. The amount of other products that must be foregone to
obtain more of any given product is called the
opportunity cost.
2. Opportunity costs are measured in real terms rather than
money (market prices are not part of the production
possibilities model).
3. The more of a product produced the greater is its
(marginal) opportunity cost.
4. The slope of the production possibilities curve becomes
steeper, demonstrating increasing opportunity cost. This
makes the curve appear bowed out, concave from the
origin.
Economic Rational
 Economic resources are not completely
adaptable to alternative uses.
 To get increasing amounts of pizza, resources
that are not particularly well suited for that
purpose must be used.
 Workers that are accustomed to producing
robots on an assembly line may not do well as
kitchen help.
Unemployment, Growth, and the Future
Unemployment and productive inefficiency occur
when the economy is producing less than full
production or inside the curve (point U in the
following figure).
In a growing economy, the production possibilities
curve shifts outward:
1. when resource supplies expand in quantity or quality.
2. when technological advances are occurring.
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
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
7
Pizzas (hundred thousands)
8
Q
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
13
12
11
10
9
8
7
6
5
4
3
2
1
Notes...Unemployment
Economic Growth
&
Underemployment
The ability to produce
by- Point U
a largerShown
total output
a rightward shift of
the production
More
of
either
or
U
possibilities curve
caused by...both is possible
1
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
13
12
11
10
9
8
7
6
5
4
3
2
1
Notes...Unemployment
Economic Growth
&
Underemployment
1 – Increase
in
resource
supplies
Shown
by Point U
2 – Better resource
U quality More of
either or
both is possible
3 – Technological
advances
1
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
A’
13
12
11
10
9
8
7
6
5
4
3
2
1
Economic Growth
B’
C’
D’
E’
1
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
Economic Systems
• Definition: A particular set of institutional
arrangements and a coordinating mechanism
to respond to the economizing problem.
• Economic systems differ as to:
1) who owns the factors of production
2) the method used to motivate, coordinate, and
direct economic activity.
The Command System
• The government owns most property
resources and economic decision making
occur through a central economic plan.
• The central planning board determines
production goals for each firm and resources
to be allocated.
The Market System
• There is private ownership of resources.
• Markets and prices coordinate and direct
economic activity.
• Each participant acts in its own self-interest.
• In pure capitalism the government plays a
very limited role.
Characteristics of the Market System
•
•
•
•
•
•
•
•
•
Private Property.
Freedom of firms to choose.
Self interest.
Competition.
Markets and prices.
Technology and capital goods.
Specialization.
Use of money.
Active, but limited government.
The Circular Flow Model
• There are two groups of decision makers in
the private economy: households (resource
owners) and businesses (resource users)
• The market system (resource markets and
product markets) coordinates these decisions.
What happens in the resource markets?
a. Households sell resources directly or indirectly
(through ownership of corporations) to businesses.
b. Businesses buy resources in order to produce
goods and services.
c. Interaction of these sellers and buyers
determines the price of each resource, which in
turn provides income for the owner of that
resource.
d. Flow of payments from businesses for the
resources constitutes business costs and resource
owners’ incomes.
What happens in the product markets?
a. Households are on the buying side of these
markets, purchasing goods and services.
b. Businesses are on the selling side of these markets,
offering products for sale.
c. Interaction of these buyers and sellers determines
the price of each product.
d. Flow of consumer expenditures constitutes sales
receipts for businesses.
CIRCULAR FLOW MODEL
RESOURCE
MARKET
BUSINESSES
HOUSEHOLDS
PRODUCT
MARKET
CIRCULAR FLOW MODEL
RESOURCE
MARKET
RESOURCES
INPUTS
BUSINESSES
HOUSEHOLDS
PRODUCT
MARKET
CIRCULAR FLOW MODEL
$ COSTS
$ INCOMES
RESOURCE
MARKET
RESOURCES
INPUTS
BUSINESSES
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
CIRCULAR FLOW MODEL
$ COSTS
$ INCOMES
RESOURCE
MARKET
RESOURCES
INPUTS
BUSINESSES
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
CIRCULAR FLOW MODEL
$ COSTS
$ INCOMES
RESOURCE
MARKET
RESOURCES
INPUTS
BUSINESSES
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
$ REVENUE
$ CONSUMPTION
More Realistic Circular Flow