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
1

Economizing problem:
Society’s material wants are unlimited while resources are limited or scarce.
• Suppose you have $50 and are deciding how to spend it.
• Should you buy a new pair of jeans or three compact discs?
3
1. Economic wants - desires of people to use goods and services that provide utility
2. Luxuries or necessities
– Food and race cars
3. Services satisfy wants as well as goods
4. Businesses and governments also have wants
– Business – equipment; government - schools
5. Over time, wants change and multiply
– DVD, digital cameras
4
2

• 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
Entrepreneurial ability
1. Takes initiative - Combines resources needed for production
2. Makes strategic business decisions
3. Innovator for new products, production techniques, organizational forms
4. Bears the risk of time, effort, and funds
6
3

Resource payments
Property resources:
LAND
CAPITAL
RENTAL INCOME
INTEREST INCOME
Human resources:
LABOR
ENTREPRENEUR
WAGES
PROFITS
7
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
8
4

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
– for example, producing computers with word processors rather than manual typewriters
2. Productive efficiency - least costly production techniques are used
9
• Full production means producing the “right” goods (allocative efficiency) in the “right” way
(productive efficiency)
• Allocative efficiency requires productive efficiency
• Productive efficiency can occur without allocative efficiency
– Goods can be produced in the least costly method without being the most wanted by society
10
5

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
11
Production Possibilities
10,000 Robots or
400,000 Pizzas
Using all of our resources, to get some pizza, we must give up some robots!
12
6

Production Possibilities in table form
PIZZA
(in hundred thousands)
0 1 2 3 4
ROBOTS
(in thousands)
10 9 7 4 0
13
Production Possibilities
PIZZA
(in hundred thousands)
0 1 2 3 4
ROBOTS
(in thousands)
10 9 7 4 0 graphical form
Pizzas
(hundred thousands)
14
7

Production Possibilities
PIZZA
(in hundred thousands)
0 1 2 3 4
ROBOTS
(in thousands)
10 9 7 4 0 graphical form
Pizzas
(hundred thousands)
15
Production Possibilities
PIZZA
(in hundred thousands)
0 1 2 3 4
ROBOTS
(in thousands)
10 9 7 4 0 graphical form
Pizzas
(hundred thousands)
16
8

Production Possibilities
PIZZA
(in hundred thousands)
0 1 2 3 4
ROBOTS
(in thousands)
10 9 7 4 0 graphical form
Pizzas
(hundred thousands)
17
Production Possibilities
PIZZA
(in hundred thousands)
0 1 2 3 4
ROBOTS
(in thousands)
10 9 7 4 0 graphical form
Pizzas
(hundred thousands)
18
9

Production Possibilities
PIZZA
(in hundred thousands)
0 1 2 3 4
ROBOTS
(in thousands)
10 9 7 4 0 graphical form
Pizzas
(hundred thousands)
19
Production Possibilities
A
B
C
Attainable but
Inefficient
D
E
W
Pizzas
(hundred thousands)
20
10

Production Possibilities
• Points on the curve represent maximum possible combinations of goods given resources and technology
• Points inside the curve represent underemployment or unemployment
• Points outside the curve are unattainable
• Optimal or best product-mix:
– a point on the curve;
– the exact point depends on society (a normative decision) 21
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.
– the curve is bowed out,
– concave from the origin
22
11

Economic Rationale:
• Economic resources are not completely adaptable to alternative uses
For example:
– 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
23
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
24
12

P
MC
$15
MB=MC
10
5
1 2 3
Quantity of Pizzas
MB
Q
25
• 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
26
13

Production Possibilities
Q
7
6
9
8
13
12
11
10
3
2
5
4
1
U
U
More of either or both is possible
1 2 3 4 5 6 7 8
Pizzas
(hundred thousands)
Q
27
Production Possibilities
Q
4
3
6
5
2
1
10
9
8
7
14
13
12
11
A’
B’
C’
D’
1 2 3 4 5 6 7 8
Pizzas
(hundred thousands)
E’
Q
28
14

Shifts of production Possibilities Curve:
• Increases in the quality and quantity of female participation in the labor force
• Technological advances
29
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
30
15

Economic Systems
31
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.
32
16

Economic Systems
• Command economy, socialism or communism:
– There is public (state) ownership of resources.
– Economic activity is coordinated by central planning.
33
The Circular Flow Model
• Two groups of decision makers in the private economy: households and businesses
• The market system coordinates these decisions.
• In the resource markets :
– Households sell resources
– Businesses buy resources in order to produce goods and services
34
17

The Circular Flow Model
• Interactions determine the price of each resource
• Flow of payments from businesses for the resources constitutes business costs and resource owners’ incomes .
35
The Circular Flow Model
• In the product markets:
– Households purchase goods and services
– Businesses offer products for sale
– Interactions determine the price of each product
– Flow of consumer expenditures constitutes sales receipts for businesses
Circular flow model illustrates this complex web of decision-making and economic activity that give rise to the real and money flows.
36
18

The Circular Flow Model
RESOURCE
MARKET
BUSINESSES HOUSEHOLDS
PRODUCT
MARKET
37
The Circular Flow Model
RESOURCE
MARKET
RESOURCES INPUTS
BUSINESSES HOUSEHOLDS
PRODUCT
MARKET
38
19

The Circular Flow Model
$ COSTS $ INCOMES
RESOURCE
MARKET
RESOURCES INPUTS
BUSINESSES HOUSEHOLDS
PRODUCT
MARKET
39
The Circular Flow Model
$ COSTS $ INCOMES
RESOURCE
MARKET
RESOURCES INPUTS
BUSINESSES
GOODS &
SERVICES
PRODUCT
MARKET
GOODS &
SERVICES
HOUSEHOLDS
40
20

The Circular Flow Model
$ COSTS $ INCOMES
RESOURCE
MARKET
RESOURCES INPUTS
BUSINESSES
GOODS &
SERVICES
$ REVENUE
PRODUCT
MARKET
GOODS &
SERVICES
HOUSEHOLDS
$ CONSUMPTION
41
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
42
21

• ECONOMIC RESOURCES
• FACTORS OF
PRODUCTION
• FULL EMPLOYMENT
• FULL PRODUCTION
• PRODUCTIVE EFFICIENCY
• ALLOCATIVE EFFICIENCY
• PRODUCTION
POSSIBILITIES TABLE
• PRODUCTION
POSSIBILITIES CURVE
Key Terms
• OPPORTUNITY COST
• LAW OF INCREASING
OPPORTUNITY COST
• ECONOMIC GROWTH
• ECONOMIC SYSTEM
• MARKET SYSTEM
• CAPITALIZM
• COMMAND SYSTEM
• RESOURCE MARKET
• PRODUCT MARKET
• CIRCULAR FLOW MODEL
43
22