The Economizing Problem part 1 Please listen to the audio as you work through the slides.

An Exercise in Connecting the Dots Today, over 1 billion people in the world go hungry while over 1 billion people are overweight. How do you explain this?

Connecting more dots How do you explain the relationship between the previous problem and the 3 features of the economic way of thinking: Scarcity and Choice Rational behavior Marginal analysis

The Economizing Problem part 1 Learning Objectives: Students will thoroughly and completely explain: The 4 basic input factors of production, The individual’s economizing problem, Society’s economizing problem. The basic types of economic systems, The circular flow model.

The Foundations of Economics SOCIETY HAS VIRTUALLY UNLIMITED WANTS... The economic wants of citizens, firms, and governments

The Foundations of Economics SOCIETY HAS VIRTUALLY UNLIMITED WANTS... BUT LIMITED OR SCARCE PRODUCTIVE RESOURCES! The means of producing goods and services

Goods & Services Provide... UTILITY A measure of satisfaction or pleasure.

Goods & Services Provide… UTILITY Individuals want luxuries – goods and services

UTILITY Goods & Services Provide... As well as necessities The objective of all economic activity Is to fulfill wants.

Scarce Resources Types of Economic Resources PROPERTY RESOURCES LAND - including ecosystem services

Scarce Resources Economic Resources Property Resources - LAND - CAPITAL Real Capital: Equipment, tools, machinery, buildings - Used to produce final goods! Financial Capital: Funds available for acquiring real capital!

Scarce Resources Economic Resources Property Resources LAND CAPITAL HUMAN RESOURCES

SCARCE RESOURCES ECONOMIC RESOURCES PROPERTY RESOURCES LAND CAPITAL HUMAN RESOURCES - LABOR – physical & Mental talents of individuals, Available and useable in the production of goods and services

Entrepreneurial Ability The Entrepreneur: Takes the Initiative in combining resources Makes Strategic Business Decisions that set the course of the business Is an Innovator The Risk Bearer – success is not guaranteed

Also known as the SCARCE RESOURCES Input Factors of Production ECONOMIC RESOURCES PROPERTY RESOURCES Also known as the Input Factors of Production LAND CAPITAL HUMAN RESOURCES LABOR ENTREPRENEURIAL ABILITY

Resource Payments PROPERTY RESOURCES LAND CAPITAL HUMAN RESOURCES LABOR ENTREPRENEUR RENTAL INCOME INTEREST INCOME WAGES PROFIT & LOSS

The Individual’s Economizing Problem Characteristics: Limited income Unlimited wants A budget line – aka budget constraint Tradeoffs & opportunity costs Make best choice possible What happens when there is a change in income?

Budget Line (constraint) for the Individual 12 10 8 6 4 2 DVDs $20 Books $10 6 5 4 3 2 1 2 4 6 8 10 12 Income = $120 Pdvd = $20 = 6 Unattainable Quantity of DVDs Income = $120 Pb = $10 = 12 Attainable 2 4 6 8 10 12 14 Quantity of Paperback Books 1-18

Society’s Economizing Problem Introducing the Production Possibility Model. A Production Possibilities Model illustrates the tradeoffs and output that are possible given a limited amount of input. It is important to understand because it can help display which options might allow a country to use their resources in the most efficient way possible.

Make sure you understand this: Key Point: Make sure you understand this: To realize the best use of scarce resources, A society must achieve both full employment and full production! What does this mean?

Key Concepts of the model Full Employment – the use of all available resources. Be Careful here! Full production – all employed resources are used so they provide the maximum satisfaction of our economic wants. This implies two kinds of efficiency. Productive Efficiency – Production of any particular mix of goods and services in the least cost way. Allocative Efficiency – least cost production of the 1 set of outputs that society wants most.

The Production Possibilities model Assumptions Full Employment and Full Production Fixed resources – in both quantity and quality Fixed technology Two Goods – a consumer good and a capital good

PIZZA Assumes... Full Employment and Productive Efficiency Production Possibilities Assumes... A Consumer Good Full Employment and Productive Efficiency PIZZA Fixed Resources Fixed Technology Two Goods for example...

Assumes... Full Employment and Productive Efficiency Fixed Resources Production Possibilities A Capital Good Assumes... Full Employment and Productive Efficiency Robots Fixed Resources Fixed Technology Two Goods for example...

for example... 10,000 Robots 400,000 Pizzas Production Possibilities What if we could only produce ... 10,000 Robots or 400,000 Pizzas Using all of our resources, to get some more pizza, we must give up some more robots! for example...

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

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

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

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

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

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

Limited Resources means a limited output... 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.

Production Possibilities Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Unattainable A B C W Attainable & Efficient Note: Every point on the curve represents productive efficiency Robots (thousands) D Attainable but Inefficient E Q 1 2 3 4 5 6 7 8 Pizzas (hundred thousands)

Law of Increasing Opportunity Costs The amount of other products that must be forgone or sacrificed to obtain 1 unit of a specific product is called the opportunity cost of that good. The Law of Increasing Opportunity Costs says: that in order to produce more of one good, more of some other good must be sacrificed.

Production Possibilities * Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Explain the Law of Increasing Opportunity Costs using the PPC. A B C Robots (thousands) D Attainable but Inefficient E Q 1 2 3 4 5 6 7 8 Pizzas (hundred thousands)

To find the point of allocative efficiency, you can use Marginal analysis, which involves: Comparing marginal benefits and marginal costs Here’s how to think about marginal analysis: Any economic activity should be expanded as long as Marginal benefits exceed Marginal costs. The optimal amount of activity occurs at MB=MC No resources beyond the MB=MC point should be allocated to the production of that good. In fact, you should reduce the use of resources until you get back to MB=MC.

Note: every point on the PPC consists of pizza – robot pairs! Production Possibilities Note: every point on the PPC consists of pizza – robot pairs! * Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Where on the curve will the Point of Allocative Efficiency be found? A B C Here’s How to Figure it out! Two Step Process: Find the allocatively efficient quantity of Pizzas. Then find the quantity of Robots that correspond to that quantity of Pizzas. Robots (thousands) D Attainable but Inefficient E Q 1 2 3 4 5 6 7 8 Pizzas (hundred thousands)

Allocative Efficiency: MB=MC Production Possibilities Allocative Efficiency: MB=MC P Q Marginal Benefit & Cost Quantity of Pizzas $15 10 5 1 2 3 MC Two Step Process Step One! Find the allocatively efficient quantity of Pizzas. You are looking at the MB and MC associated with the production of different quantities of pizzas. The quantity of pizzas where MB=MC is the allocatively efficient quantity of pizzas. 200,000! MB=MC MB

Point of Allocative Efficiency Production Possibilities Point of Allocative Efficiency Q Step Two! 2. Then find the quantity of Robots that correspond to that quantity of Pizzas (200,000). At 200,000, go up to the PPC, then go left, horizontally to the Robot axis. The point on the PPC where the vertical and horizontal lines intersect identifies the one point of allocative efficiency. Allocative efficiency means – 200,000 pizzas and 9000 robots will maximize the satisfaction of the society. But we must be able to product that combo at least cost! 14 13 12 11 10 9 8 7 6 5 4 3 2 1 A B C Robots (thousands) D E Q 1 2 3 4 5 6 7 8 Pizzas (hundred thousands)

Pizzas (hundred thousands) Production Possibilities Q Robots (thousands) Pizzas (hundred thousands) 14 13 12 11 10 9 8 7 6 5 4 3 2 1 1 2 3 4 5 6 7 8 Unemployment & Underemployment Shown by Point U Sort of like today! More of either or both is possible U

Economic Growth This is a BIG Deal! The ability to produce a larger total output - a rightward shift of the Production Possibilities curve caused by... 1 – Increase in resource supplies 2 – Better resource quality 3 – Technological advances

Pizzas (hundred thousands) Production Possibilities Q A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Economic Growth B’ C’ Robots (thousands) D’ E’ Q 1 2 3 4 5 6 7 8 Pizzas (hundred thousands)

Two Examples of Economic Growth Production Possibilities Two Examples of Economic Growth And the importance of today’s decisions on our future! Presentville - FAVORS PRESENT GOODS CURRENT CURVE FUTURE CURVE Goods for the Future CONSUMPTION Goods for the Present Presentville

Two Examples of Economic Growth Production Possibilities Two Examples of Economic Growth And the importance of today’s decisions on our future! Presentville - FAVORS PRESENT GOODS Futureville- FAVORS FUTURE GOODS CURRENT CURVE CONSUMPTION FUTURE CURVE FUTURE CURVE Goods for the Future Goods for the Future CONSUMPTION CURRENT CURVE Goods for the Present Goods for the Present Presentville Futureville

Applications... Production Possibilities Unemployment and Productive inefficiency The Great Depression of the 1930’s Nations experiencing significant unemployment and unused / under used production capacity. Economies that allow discrimination of any kind

Applications... Production Possibilities Unemployment and Productive Inefficiency Tradeoffs and Opportunity Costs Should land be used for oil production or preserved as wilderness? Farming or waste disposal, Should corn be used for fuel or food? Should society devote more resources to homeland security or education?

Applications... Production Possibilities Unemployment and Productive Inefficiency Tradeoffs and Opportunity Costs Shifts in the Production Possibilities Curves More resources – increase in number of women in the workforce. Better quality resources – women becoming better educated and professionally trained. New technologies.

Practice constructing answers Please thoroughly and completely explain The Production Possibility Model Step 1 – write down the key points to include, in outline format Step 2 – add detail to each of the key points Step 3 – construct your response based on this outline

You should at least have these items Description of the model Assumptions of the model – list and explain! full production and full employment fixed resources fixed technology two goods – capital and consumer goods Key concepts – list and explain! productive efficiency, define, relate to the curve allocative efficiency - define, how to find and tool to use Economic Growth What’s it mean, 3 prereqs, the futureville / presentville case, how to represent graphically. Law of increasing opportunity cost Draw picture of the model