Chapter 2
The Foundation of Economics
Economizing problem – based on two fundamental facts:
 Society’s economic wants – the economic wants of its
citizens and institutions are virtually unlimited and
insatiable.
 Economic resources – the means of producing goods and
services are limited or scarce.
Unlimited Wants
Economic wants – the desires of consumers to obtain and
use various goods and services that provide utility
Utility – satisfaction or enjoyment from a choice
These wants extend over a wide range of products from
necessities to luxuries.
Over time wants change and multiply – fueled by new
products
All these wants are insatiable or unlimited, meaning that
our desires for goods and services cannot be completely
satisfied.
Scarce Resources
The second fundamental fact is that economic resources are
limited and scarce.
Economic resources – all natural, human, and manufactured
resources that go into the production of goods and services.
Resources categories
 Land – includes minerals found in the land
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 Capital – includes all manufactured aids
used in producing consumer goods and
services.
o Such as tools, machinery, equipment,
factory, storage, transportation, and
distribution facilities.
o The process of producing and
purchasing capital goods is known as
investment
o Capital goods differ from consumer
goods in that consumer goods satisfy
wants directly, while capital goods do
s indirectly by aiding the production
of consumer goods.
o Capital is not money but real goods
o
 Labor – a broad term for all the physical and
mental talents of individuals available and
usable in producing goods and services.
o Entrepreneurial ability
- Takes the initiative in
combining the resources of
land, capital, and labor to
produce a good or service
- Makes basic business policy
decisions
- Is an innovator
- Risk bearer
 Called Factors of Production
o Used to produced goods and services
Resources payments
 Land – rents
 Capital – interest
 Labor – wages
 Entrepreneurial income – profits
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Relative Scarcity
The fours types of economic resources or factors
of production or inputs have one significant
characteristic in common:
They are scarce or limited in supply
Employment and Efficiency
Economics is the social science concerned with the problem of using
scarce resources to attain the maximum fulfillment of society’s
unlimited wants.
Concerned with doing the best with what we have
Full employment – to realize the best use of scarce resources, a society
must achieve both full employment and full production.
 Full employment means that the use of all available
resources.
o No workers should be out of work if they are
willing and able to work. Remember all those
willing and able to work
o Nor should capital equipment or arable land sit idle
The employment of all available resources is not enough to achieve
efficiency. Full production must also be realized.
Full production – all employed resources should be used so that they
provide maximum possible satisfaction of our material wants.
 If we fail to use all resources then we are underemployed.
 Two types of efficiency
o Productive efficiency – is the production of any
particular mix of goods and services in the least
costly way.
o Allcative efficiency – is the production of that
particular mix of goods and services most wanted
by society.
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o This means apportioning limited resources among
firms and industries in such a way that society
obtains the combination of goods and services it
wants the most.
Production Possibilities Table
Assumptions
1. Full employment and productive efficiency
2. Fixed resources
3. Fixed technology
4. Two goods
a. Consumer goods
b. Capital goods
Society must choose among alternative
It is a list of the different combination of two products, which can be
produced, with a specific set of resources.
Good A
0
1
2
3
4
Good B
10
9
7
4
0
At any point in time, an economy achieving full employment and
productive efficiency must sacrifice some of one good to obtain more
of another good.
Scarce resources prohibit scarce an economy from having more of
both good.
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Law of increasing Opportunity Cost
 Because resources are scarce relative to the virtually
unlimited wants they can be used to satisfy, people must
choose among alternatives.
 Opportunity cost – the amount of other products that
must be forgone or sacrificed to obtain 1 unit of a
specific good
 When more of a good is produced the greater is the
opportunity cost of producing that good
o Why?
 Economic resources are not completely
adaptable to alternative uses
Allocative Efficiency Revisited
Resources are being efficiently allocated to any product when
the marginal benefit and marginal cost of its output are equal .
MB = MC
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Unemployment, Growth, and the Future
 Unemployment and Productive inefficiency
o Producing inside the curve.
o Inefficient use of resources and unemployment
occur
o We are producing at less than each alternative
shown on the table
o A move toward full employment and productive
efficiency would yield a greater output of one or
both parties
 Growing economy
o When we drop the assumption that the quantity
and quality of resources and technology are fixed,
the production possibilities curve shifts positions
that is, the potential maximum output of the
economy changes.
o Increases in Resource Supplies
 They can and do change over time
 Examples
 The net result of these increased supplies of
the factors of production is the ability to
produce more of both goods
 Society will have achieved economic growth
o Advances in Technology
 Adavancing technology brings both new and
better goods and improved ways of
producing them
 Shifts the curve outward
o Economic growth occurs
 It is the ability to produce a larger
total output
 Increase in resources or change in
technology
 While a static, no growth economy
must sacrifrice some of one product in
order to get more of another; a
dynamic, growing economy can have
larger quantities of both products.
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Qualification: International Trade
 Production possibilities analysis implies that an individual
nation is limited to the combinations of output indicated by its
production possibilities curve
 Must be modified when international trade occurs
 International specialization means directing domestic resources
to output that a nation is highly efficiency at producing
 International trade involves the exchange of these goods for
goods produced abroad.
 Specialization and trade enable a nation to get more of a desired
good at less sacrifice of some other good
Economic Systems –
A particular set of institutional arrangements and a coordinating
mechanism to respond to the economizing problem.
Economic systems differ:
 Who owns factors of production
 The method used to coordinate and direct economic
activity.
Pure Capitalism or market system  Each participant acts in his or her own self interest; each
individual or business seeks to maximize its satisfaction
or profit through its own decisions regarding
consumption or production.
 Private ownership of resources
 Coordinates economic activity through markets
 Goods and services are produced and resources are
supplied by whoever is willing and able to do so
 Competition among independently acting buyers and
sellers of each product and resource.
 No government intervention
 Laissez-faire
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Command Economy
 Public ownership of virtually all property resources and
economic decision making through central economic
planning.
 Communism
 Government owns all the resources
 Planning board determines production goals for each
enterprise and specifies the amount of resources to be
allocated to each enterprise so that it can reach its
production goals
Mixed economy
 Government actively participates in the economy by
promoting economic stability and growth.
 Private and government owned resources
 Some planning and regulation
 Called socialism

Circular Flow Model
Resource market - the place where resources or the services of
resource suppliers are bought and sold
Product market – the place where goods and services produced by
business are bought and sold
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