Chapter 2: The Economizing
Problem
Money and time are both scarce; making
decision in the context of scarcity always
means there are costs
The Fundamentals of Economics: Scarcity,
Choices, & Costs
The Economizing Problem focuses on Wants
& Resources
Production Possibilities Model
Circular Flow Model
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The Fundamentals of
Economics
Two facts constitute the Economizing
Problem:
1.
2.
Society’s economic wants are unlimited &
insatiable
Economic resources are limited or scarce
2
Economic Wants
Desires of consumers to obtain & use various
goods & services that provide UTILITY
Necessities  Luxuries
Over time, wants change & multiply, fueled
by new products
Business & government also try to satisfy
their economic goals
The objective of all economic activity is
to fulfill wants
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Scarce Resources
Economic resources are limited or
scarce.
Resources: all natural, human, &
manufactured resources in the
production of goods & services.
Property (Land, Raw Mats, & Capital)
Human (Labor & Entrepreneurial)
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The Factors of Production
1. Land
Includes all natural resources used in production
process (arable land, forests, mineral & oil deposits, &
water resources)
2. Capital (aka Capital/Investment Goods)

Includes all manufactured aids used in producing
consumer goods & services.

Investment is the process of producing & purchasing
capital goods
3. Labor

All physical & mental talents of individuals available &
usable in producing goods & services
4. Entrepreneurial Ability

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Full Employment
Full Employment: Use of all available
resources.


No workers should be out of work if they
are willing & able
Land or equipment is not idle
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Full Production
All employed resources should be used to
provide maximum possible satisfaction of our
wants.



Otherwise, underemployed
Productive Efficiency: Production of any particular
mix of goods & services in the least costly way
Allocative Efficiency: Production of a particular
mix of goods & services most wanted by society.
 “Right” mix of goods & services, each produced at lowest
possible unit cost.
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Production Possibilities Model
Assumptions:


Full Employment & Productive Efficiency
Factors of Production are Fixed in Quantity &
Quality
 Can be reallocated, within limits, among different uses


Fixed Technology (Short Period of Time)
Economy is Producing ONLY Two (2) Goods
At any point in time, an economy achieving full
employment & productive efficiency must
sacrifice some of one good to obtain more of
another good. Scarce resources prohibit such
an economy from having more of both goods.
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Production Possibilities Curve
Each point on the PPC represents some
maximum output of the two products.
Production Possibilities Frontier shows the
limit of attainable outputs.
To obtain the various combinations of goods
that fall ON the PPC, society MUST achieve
both Full Employment & Productive Efficiency.
Points inside are inefficient, undesirable
Points outside are unattainable w/ current
supply of resources & technology
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Increasing Opportunity Cost
Since resources are scarce relative to virtually unlimited
wants, people must choose between alternatives.
Opportunity Cost: The amount of other products that
must be forgone or satisfied to obtain 1 unit of a specific
good.
The opportunity cost of each additional unit of a good is
greater than the opportunity cost of the preceding one.
Opportunity cost is measured in real terms (goods v.
money)
The more of a product that is produced, the greater
its opportunity cost
Economic resources are not completely adaptable
to alternative uses. Lack of perfect flexibility on
the part of resources is cause of increasing OC.
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Unemployment & Productive
Inefficiency
In the presence of unemployment or
inefficiency, the economy would produce less
Represented by points inside the original PPC
A move toward full employment & productive
efficiency would yield a greater output of one
or both products.
13
A Growing Economy:
Increase in Resource Supplies
E.g.: Size of Labor Increases (Growing
Population, Immigration)
Quality of Labor improves over time
Greater abundance of resources results in
greater potential output of one or both
products at each alternative on the PPC.
Economic growth is achieved in the form of
an expanded potential output.
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A Growing Economy:
Advances in Technology
Technology progresses over time
Advanced technology brings new & better
goods AND improved ways of producing them
Technological advances allows society
to produce more goods with fixed
resources.
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A Growing Economy
When the supplies of resources increase or
there is improvement in technology, the
Production Possibilities Curve SHIFTS OUT
An outward shift of the PPC represents growth of
economic capacity
Economic Growth: The ability to produce larger
total output.
While static, no-growth economy must
sacrifice some of one product in order to
get more of another, a dynamic, growing
economy can have larger quantities of both
products
16
International Trade
Production Possibilities Model implies that an
individual nation is limited to the combinations of
output indicated by its PPC.
Through specialization & trade, the output limits
imposed by its domestic PPC can be avoided.
International Specialization: Directing domestic
resources to make what a nation is highly efficient at
producing.
International Trade: the exchange of specialized
goods for goods produced abroad.
International specialization & trade enable a nation to
obtain more goods than its PPC indicates.
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Economic Systems
Every society develops an economic system,
a particular set of institutional arrangements
and a coordinating mechanism, to respond
to the economizing problem.
Economic systems differ depending on:
1.
2.
Who owns the factors of production
The method used to coordinate & direct
economic activity
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The Market System
(Capitalism)
Characterized by the private ownership of resources
and the use of markets & prices to coordinate and
direct economic activity
Each participant acts in their own self-interest
Each individual/business seeks to maximize
satisfaction/profit
Private ownership of capital
Communicates through Prices
Coordinates activity through Markets: where buyers
& sellers come together
Competition among independent buyers & sellers of
each product
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The Command System
(Socialism/Communism)
Government owns most property
resources
Government makes economic decisions

Use of resources, composition &
distribution of output, organization of
production
Division of output between capital &
consumer goods is centrally decided
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The Circular Flow Model
Decision Makers:


Households (people) own all economic
resources directly or indirectly
Businesses buy resources necessary for
producing goods & services; Wages, rent,
interest & profit income (money) flows
back to households
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The Circular Flow Model
Markets:


Resource: where resources or services are
bought & sold
Product: where goods & services produced
by businesses are bought & sold.
 Businesses combine resources to make
products they sell
 Households use income to buy goods &
services
 Monetary flow of consumer spending yields
revenues for businesses
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Chapter 2 Study Questions
5: Productive Efficiency & Allocative
Efficiency
6: Production Possibilities Curve
9: Marginal Benefit & Cost
10: Production Possibilities Curve
12: PPC
16: Circular Flow Model
17: Women & Expanded Production
Possibilities
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