The economizing problem We defined economics as study of the efficient use of scarce resources in the production of goods and services to achieve maximum satisfaction of economic wants

Resource categories Land: all natural resources used in the production process, such as arable land, forests, water resources, mineral & oil resources Capital: all manufactured aids used in producing consumer goods & services, ex machinery, equipment, factory, storage Consumer goods satisfy wants directly Capital goods do so indirectly by aiding the prodn of consumers goods – all machinery, tools & other productive equipment Labor: all physical & mental talents of individuals available & usable in producing goods & services

Resource categories Entrepreneurial ability: a special human resource. Differs from labor in that entrepreneur performs several functions such as Takes initiative in combining resources of land, capital & labor to produce goods & services Makes basic business-policy decisions Commercialization of new products, new production techniques, etc (innovator) takes risks: rewards for his time, efforts & abilities may be profits or losses.

Efficient use of resources Full employment – use of all available resources No workers should be out of work if they are willing & able to work No capital equipment or arable land should lie idle Full production – all employed resources should be used so that they provide maximum possible satisfaction of our material wants Full production implies productive & allocative efficiency Productive efficiency: production of any particular mix of goods & services in the least costly way. Allocative efficiency: production of that particular mix of goods & services most wanted by society.

Production possibilities table Assumptions Full employment & productive efficiency Fixed resources – supplies of factors of production are fixed in quantity & quality Fixed technology – methods used to produce output does not change during our analysis The last 2 assumptions means we are looking @ the economy at a certain point in time Two goods – the economy is producing only two goods; food & tractors PPT lists the different combinations of the 2 products that can be produced with specific resources

Production alternatives Production possibilities of food & tractor with full employment & productive efficiency Production alternatives product A B C D E Food (tonnes) 1 2 3 4 tractors 100 90 70 40

Production possibility curve At alternative A, economy devotes all its available resources to the production of tractors. At E, all resources are devoted to the production of tractors. As we move from A to E, we increase production of food at the expense of tractors Plot the data on a two dimensional graph to get a production possibilities curve.

Production possibility curve tractor A unattainable 100 W B C 70 attainable Attainable, but inefficient Each point on the PPC represents some maximum combination of two products that can be produced if full employment & full production are achieved. When operating on the curve, more tractors means lesser food & vice versa. Limited resources & a fixed technology make any combination of food & tractors, lying outside the curve unattainable. D 40 E o 1 2 3 food

Opportunity cost The amount of other products that must be forgone or sacrificed to obtain 1 unit of a specific good is called the opportunity cost of that good Movement from A to B – cost of 1 additional tonne(unit) of food is 10 less tractors: B to C involves sacrificing 20 tractors to gain 1 more tonne of food. From C to D: we sacrifice 30 additional tractors for just 1 additional tonne of food

Law of increasing opportunity cost General: the opportunity cost of each additional tonne of food is greater than the opportunity cost of the one preceding it. The law of increasing opportunity costs states that the more of a product that is produced, the greater is its opportunity cost This law is reflected in the shape of the PPC – bowed out from the origin of the graph. It shows that when the economy moves from A to E, it must give up successfully larger amounts of tractors to acquire equal increments of food What is the economic rational for the law of increasing opportunity costs? Economic resources are not completely adaptable to alternative uses.

A growing economy Increases in resource supplies: increase in population increases labor supply; improved access to health care & education improves labor quality; discovery of minerals increases our productive land resources. Etc The increased supplies of factors of production enables the economy to produce more goods & services This is represented by an outward shift of the PPC

A growing economy Advances in technology: Advanced technology enables the economy to produce new & better goods & improved ways of producing them. The economy can now produce more goods with fixed resources This too shifts the PPC outwards to the right. This represents growth of economic capacity or economic growth. What are the determinants of economic growth?

Shift in the PPC tractor A1 B1 New PPC A B C1 C Initial PPC Food (tonnes/year)

Economic systems An economic system is a set of institutional arrangements & a coordinating mechanism that assist society to respond to the economizing problem Economic systems differ according to Ownership of the factors of production & The method used to coordinate & direct economic activity

Economic systems The market system (capitalism) The command system (socialim or communism) Private ownership of property resources Use markets & prices to coordinate & direct economic activity Each participant acts in his/her self-interest Each agent seeks to maximize its objective function e.g utility (consumers), profits (firms) Govt owns most property resources economic decision making occurs through a central economic plan Central planning board decides on use of resources, composition & distribution of output, & organization of production 2. Allows for private ownership of capital, communicates through prices and coordinates economic activity through markets. Markets are places where consumers and producers interact.

Mixed Economy system In mixed economy system both public sector (government) and private sector participate in the economy to produce and distribute goods and services. It has elements of capitalist economy and socialist economy. Most of the current developing countries come under this system

Five fundamental questions What goods & services to produce? How will the goods & services be produced? Who will get the goods & services? How will the system accommodate change? How will the system promote progress? All economies; market or command must address these five questions

Market system What will be produced? Pursuit profits of ensures that resources are used to produce those goods that the society needs (change in TR=change in TC) How will the goods & services be produced? Combinations of resources & technologies that minimize the cost per unit of output will be used Who will get the output? Those willing & able to pay for them at the market price; which in turn depends on incomes & preferences. How will the system accommodate change? Price changes signal the direction to which resources should be re-allocated 2. Combinations of resources & technologies that minimize the cost per unit of output will be used

Market system contd How will the system promote progress? A firm/entrepreneur that introduces a popular product will gain revenue & profits at the expense of its rivals Firms have incentives to introduce new & efficient production techniques so that they may reduce their distribution & production costs & ultimately increase their profits Firms often use part of their profits to buy capital goods, which in turn increases productivity

A simplified Model of a Market Economy Resource owners supply resource inputs (land, labor, natural resources, capital, managerial talent) to producers Resource Markets Demand Supply Producers make money payments (wages, salaries, rents, interest, dividends) to resource owners for use of their resources in the production process Income Costs Producers(Individuals, business firms & Non-profit organizations) Consumers & Resource Owners (Individuals & all organizations) Expenditures Consumers use their incomes to pay for the goods & services they buy Product markets Revenues Demand Supply Consumers buy goods & services from producers