The Economizing Problem 2 C H A P T E R The Economizing Problem

The foundation of economics is the economizing problem: society’s material wants are unlimited while resources are limited or scarce. Two fundamental facts A. The first fundamental fact: Unlimited wants: Economic wants are desires of people to use goods and services that provide utility, which means pleasure, happiness, or satisfaction. Products are sometimes classified as luxuries or necessities, but the division is subjective. Services satisfy wants as well as goods. Businesses and governments also have wants. 5. Over time, wants change and multiply

B. the second fundamental fact: Scarce resources: 1. Economic resources are limited relative to wants. Economic resources are sometimes called factors of production (inputs) and include four categories: Land or natural resources Capital or investment goods which are all manufactured aids to production like tools, equipment, factories, transportation, etc., Labor or human resources, which include physical and mental abilities used in production

d. Entrepreneurial ability, a special kind of human resource that provides four important functions: Takes the initiative: combining the resources (land, capital and labor to produce a good or a service. Makes Policy Decisions: The non routine decisions that set the course of a business Combines resources needed for production Innovator: commercializes new products, new production techniques or even new forms of a business organization Bears the risk of time, effort and funds

RESOURCE PAYMENTS PROPERTY RESOURCES RENTAL LAND INCOME INTEREST CAPITAL HUMAN RESOURCES LABOR ENTREPRENEUR RENTAL INCOME INTEREST INCOME WAGES PROFIT & LOSS

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. Full employment means all available resources should be employed. 2. Full production means that employed resources are providing maximum satisfaction of our economic wants. Underemployment occurs if this is not so.

Full production implies two kinds of efficiency: Allocative efficiency means that resources are used for producing the combination of goods and services most wanted by society. Productive efficiency means that least costly production techniques are used to produce any particular mix of goods and services. Allocative efficiency requires that there be productive efficiency. Productive efficiency however, can occur without allocative efficiency. Goods can be produced in the least costly method without being the most wanted by society.

Production possibilities tables and curves are a device to illustrate and clarify the economizing problem. Assumptions: Economy produces only two types of products. Available supply of resources is fixed in quantity and quality at this point in time. Technology is constant during analysis. Economy is operating efficiently (full employment and full production).

Agricultural Products (in tons) PRODUCTION POSSIBILITIES CURVE Agricultural Products (in tons) Housings (in units) for example...

in table form PRODUCTION POSSIBILITIES TABLE Housings 0 1 2 3 4 (in thousands units) Agricultural 10 9 7 4 0 (in million tons of products)

in table form graphical form PRODUCTION POSSIBILITIES H 0 1 2 3 4 (in thousands) Ag. 10 9 7 4 0 (in million ton) graphical form Ag (tons) H (thousands)

in table form graphical form PRODUCTION POSSIBILITIES H 0 1 2 3 4 (in thousands) Ag 10 9 7 4 0 (in million tons) graphical form (million tons) Ag H (thousands)

in table form graphical form PRODUCTION POSSIBILITIES H 0 1 2 3 4 (in thousands) Ag 10 9 7 4 0 (in million ton) graphical form (million ton) Ag H(thousands)

in table form graphical form PRODUCTION POSSIBILITIES H 0 1 2 3 4 (in thousands) Ag 10 9 7 4 0 (in million ton) graphical form (million ton) Ag H(thousands)

in table form graphical form PRODUCTION POSSIBILITIES H 0 1 2 3 4 (in thousands) Ag 10 9 7 4 0 (in million tons) graphical form (million ton) Ag H (thousands)

in table form graphical form PRODUCTION POSSIBILITIES H 0 1 2 3 4 (in thousands) Ag 10 9 7 4 0 (in million tons) graphical form (million tons) Ag H(thousands)

PRODUCTION POSSIBILITIES Limited Resources means a limited output... At any point in time, a full-employment, full-production economy must sacrifice some of product Ag to obtain more of product H.

Choices will be necessary because resources and technology are fixed Choices will be necessary because resources and technology are fixed. A production possibilities table illustrates some of the possible choices. A production possibilities curve is a graphical representation of choices. Points on the curve represent maximum possible combinations of Ag. and H. given resources and technology. Points inside the curve represent underemployment or unemployment. Points outside the curve are unattainable at present.

PRODUCTION POSSIBILITIES Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Unattainable A B C W Attainable & Efficient Ag (million tons) D Attainable but Inefficient E Q 1 2 3 4 5 6 7 8 H ( thousands)

PRODUCTION POSSIBILITIES Notes... 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. LAW OF INCREASING OPPORTUNITY COSTS Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Unattainable A B C W Ag (million tons) Attainable & Efficient D Attainable but Inefficient E Q 1 2 3 4 5 6 7 8 H ( thousands)

PRODUCTION POSSIBILITIES Notes... LAW OF INCREASING OPPORTUNITY COSTS A graph of the production possibilities curve will be CONCAVE - bowed out from the origin. Economic resources are not completely adapt- able to other uses. Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Unattainable A B C W Attainable & Efficient Ag (million tons) D Attainable but Inefficient E Q 1 2 3 4 5 6 7 8 H ( thousands)

Law of increasing opportunity costs: 1. The amount of other products that must be foregone to obtain more of any given product is called the opportunity cost. 2. Opportunity costs are measured in real terms rather than money (market prices are not part of the production possibilities model). 3. The more of a product produced the greater is its (marginal) opportunity cost. 4. The slope of the production possibilities curve becomes steeper, demonstrating increasing opportunity cost. This makes the curve appear bowed out, concave from the origin.

Economic Rational Economic resources are not completely adaptable to alternative uses. To get increasing amounts of Housing Units, resources that are not particularly well suited for that purpose must be used.

Unemployment, Growth, and the Future Unemployment and productive inefficiency occur when the economy is producing less than full production or inside the curve (point U in the following figure). In a growing economy, the production possibilities curve shifts outward: 1. when resource supplies expand in quantity or quality. 2. when technological advances are occurring.

Unemployment & Underemployment Shown by Point U PRODUCTION POSSIBILITIES Q Ag (million tons) H ( 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 U

Unemployment & Underemployment Shown by Point U PRODUCTION POSSIBILITIES Notes... Economic Growth The ability to produce a larger total output - a rightward shift of the production possibilities curve caused by... Q Ag (million tons) H ( 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 More of either or both is possible U

Unemployment & Underemployment Shown by Point U PRODUCTION POSSIBILITIES Notes... Economic Growth Q Ag (million tons) H ( 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 1 – Increase in resource supplies 2 – Better resource quality 3 – Technological advances More of either or both is possible U

Economic Growth PRODUCTION POSSIBILITIES Ag (million tons) Q A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Economic Growth B’ C’ Ag (million tons) D’ E’ Q 1 2 3 4 5 6 7 8 H ( thousands)

Economic Systems Definition: A particular set of institutional arrangements and a coordinating mechanism to respond to the economizing problem. Economic systems differ as to: 1) who owns the factors of production 2) the method used to motivate, coordinate, and direct economic activity.

The Command System The government owns most property resources and economic decision making occur through a central economic plan. The central planning board determines production goals for each firm and resources to be allocated.

The Market System There is private ownership of resources. Markets and prices coordinate and direct economic activity. Each participant acts in its own self-interest. In pure capitalism the government plays a very limited role.

Characteristics of the Market System Private Property. Freedom of firms to choose. Self interest. Competition. Markets and prices. Technology and capital goods. Specialization. Use of money. Active, but limited government.