1. 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

2. The Fundamentals of Economics
Two facts constitute the Economizing Problem:
Society’s economic wants are unlimited & insatiable
Economic resources are limited or scarce

3. 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

4. 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)

5. The Factors of Production
Land
Includes all natural resources used in production process (arable land, forests, mineral & oil deposits, & water resources)
Capital (aka Capital/Investment Goods)
Includes all manufactured aids used in producing consumer goods & services.
Investment is the process of producing & purchasing capital goods
Labor
All physical & mental talents of individuals available & usable in producing goods & services
Entrepreneurial Ability

6. 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

7. 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.

8. 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.

9. 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

10. 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.

11. Allocative Efficiency
Allocative Efficiency requires economy produce at most valued or optimal point on the PPC.
Economic decisions center on weighing marginal benefits v. marginal costs.
Any economic activity should be expanded as long as MB > MC
An economic activity should be reduced if MC > MB
The optimal amount of activity occurs when MB = MC

12. Allocative Efficiency (cont’d)
The optimal quantity of production is indicated by the intersection of the MB & MC curves.
When MB = MC, the benefits of producing a good or an alternative product w/ the available resources are equal
Allocative efficiency is achieved when MB = MC
Resources are being efficiently allocated to any product when MB = MC.

13. 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.

14. 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.

15. 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.

16. 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

17. Present Choices & Future Possibilities
An economy’s current choice of positions on its PPC helps determine the curve’s future location

18. 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.

19. 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:
Who owns the factors of production
The method used to coordinate & direct economic activity

20. 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

21. 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

22. 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

23. 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

24. The Circular Flow Model (p. 35)
Complex, interrelated web of decision making & economic activity involving businesses & households
Decision makers are buyers & sellers
Counterclockwise real flow of economic resources & finished goods & services
Clockwise money flow of income & consumption expenditures
Flows are simultaneous & repetitive

25. 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