Economic systems The way a society organizes to produce, distribute, and consume goods. Economic systems try to prevent surpluses (having too much of a good or service) Economic systems try to avoid shortages (having too little of a good or a service) The four types of economic systems are: traditional, market, command, and mixed.

The Production Possibilities Frontier/Curve (PPF/PPC) The production possibilities frontier is a graph that shows the combinations of output that an economy can possibly produce given: The available resources -factors of production. Fully employed and used efficiently The available production technology.

Law of Increasing Opportunity Costs Resources do not transfer perfectly from the production of one good to another. Increasing quantities of any good can be obtained only by sacrificing ever-increasing quantities of other goods. Resources used to produce trucks aren’t ideally suited for producing tanks.

Efficiency Efficiency means getting the maximum output of a good from the resources used in production. Full Employment. Allocative efficiency- production is such that marginal benefit is equal to marginal cost. Goods and services that are most highly valued. Every point on a production possibilities frontier curve is efficient.

Inefficiency A production possibilities frontier curve shows potential output, not necessarily actual output. If we are inefficient- attainable, actual output will be less than the potential output.

Inefficiency Countries may end up inside their production possibilities frontier curve if resources are inefficiently combined. Such inefficiencies plagued centrally planned economies.

Unemployment Countries may end up inside their production possibilities frontier curve if all available resources are not used.

PPF Graph Law of Increasing Opportunity Costs Step 1: give up one truck 5 B 4 Step 3: give up another truck Step 2: get two tanks C 3 OUTPUT OF TRUCKS Step 4: get one more tank D 2 E 1 F 1 2 3 4 5 OUTPUT OF TANKS

PPF Graph Unemployment 5 B 4 Y C 3 OUTPUT OF TRUCKS Unemployment 2 1 1 2 3 4 5 OUTPUT OF TANKS

Economic Growth A X 5 Currently not attainable B 4 C 3 OUTPUT OF TRUCKS 2 1 1 2 3 4 5 OUTPUT OF TANKS

Economic Growth A point outside the production possibilities frontier curve suggests that we could get more goods than we are capable of producing! Economic growth is an increase in output (real GDP) – an expansion of production possibilities.

Production Possibilities Model Society uses scarce resources to produce goods and services. Illustrates production choices Assumptions: Full employment- use of all resources Unemployment – Not using all resources Fixed resources (# of factors of production-land, labor, capital, is fixed). Change can cause a shift inward. Natural disaster. Fixed technology Two goods (hypothetical; economy is producing only two goods, one consumer, one capital. Cell phone - Factory The production possibilities model shows the maximum combinations of two goods that can be produced with the resources available today. Full-employment means that we are using all available resources, and they are being used to their potential. Using two goods is a simplification. You will still see the concepts shown by the PPC without making it any more complicated. Often times, the two goods are general categories of two goods rather than specific goods, so that the PPC shows the tradeoff between choosing those goods. LO5 1-13

Externalities An externality is a cost or benefit accruing to a third party external to the market transaction Positive externalities Too little is produced Demand-side market failures Negative externalities Too much is produced Supply-side market failures Positive externalities occur when a third person, or persons, is affected by the transaction in a positive way. The good is underproduced when positive externalities are present. The equilibrium output will be smaller than the efficient output because the consumer is willing to pay a price equal to the consumer’s individual marginal benefit, but no more. Since social benefits exist in addition to the private benefit, the government must either aid the producer to encourage more output, or engage in its own production of the item with the external benefits. Negative externalities occur when a third person, or persons, external to the transaction is affected from the transaction in a negative way. The good is overproduced and the equilibrium output will be greater than the efficient output. This is because the producer, who is not bearing the full cost of production, will be able to produce more at a lower price than the efficient level, which would exist if true costs were reflected in the production decision. LO4

Economic Growth Economic growth results in an outward shift of the PPF because production possibilities are expanded.

Trade-offs: The Production Possibility Frontier X

Production Possibilities Model Production Alternatives Type of Product A B C D E Pizzas (in hundred thousands) 1 2 3 4 Industrial Robots (in thousands) 10 9 7 4 Plot the Points to Create the Graph… LO5 1-17

Production Possibilities Model 14 13 12 11 10 9 8 7 6 5 4 3 2 1 The law of increasing opportunity costs makes the PPC concave. A B Unattainable C Industrial Robots U D Attainable E 0 1 2 3 4 5 6 7 8 9 Pizzas LO5 1-18

Test # 2 End of notes

A Growing Economy Economic Growth Now Attainable Unattainable 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable A Economic Growth B C’ C Industrial Robots D’ D Now Attainable Attainable E E’ 0 1 2 3 4 5 6 7 8 9 Pizzas LO6 1-22

Present Choices, Future Possibilities Compare Two Hypothetical Economies Future Curve Future Curve F Goods for the Future Goods for the Future P Current Curve Current Curve Goods for the Present Goods for the Present Presentville Futureville LO6 1-23

Set of institutional arrangements in response to economizing problem. Economic Systems Set of institutional arrangements in response to economizing problem. Differences in systems exist by: Who owns the factors of production? What method is used to motivate, coordinate, and direct economic activity? Economic systems are a set of institutional arrangements and a coordinating mechanism to solve economic problems. Economic systems differ in two important ways: Who owns the factors of production and the method used to coordinate economic activity. 2-24 LO1

Externalities An externality is a cost or benefit accruing to a third party external to the market transaction Positive externalities Too little is produced Demand-side market failures Negative externalities Too much is produced Supply-side market failures Positive externalities occur when a third person, or persons, is affected by the transaction in a positive way. The good is underproduced when positive externalities are present. The equilibrium output will be smaller than the efficient output because the consumer is willing to pay a price equal to the consumer’s individual marginal benefit, but no more. Since social benefits exist in addition to the private benefit, the government must either aid the producer to encourage more output, or engage in its own production of the item with the external benefits. Negative externalities occur when a third person, or persons, external to the transaction is affected from the transaction in a negative way. The good is overproduced and the equilibrium output will be greater than the efficient output. This is because the producer, who is not bearing the full cost of production, will be able to produce more at a lower price than the efficient level, which would exist if true costs were reflected in the production decision. LO4

1. The Command System Known as socialism or communism Government ownership of means to production. Decisions made by a central planning board. Include production goals, resource usage, consumer vs. capital goods production, etc. North Korea and Cuba. Resources are owned by government and economic activity is coordinated by a central planning board. This means that what is produced, how much is produced and the prices that are charged for the output are determined by the central planning board. 2-32 LO1