Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Chapter 2 RESOURCE UTILIZATION

2-2 Learning Objectives After this chapter you should be able to: 1. Define economics. 2. Identify the central fact of economics and explain how it related to the economic problem. 3. Name the four economic resources and explain how they are used by the entrepreneur. 4. Explain and apply the concept of opportunity cost. 5. Describe and distinguish among the concepts of full employment, full production, and underemployment. 6. Describe the concept of the production possibilities curve and how it is used. 7. Identify and explain the three concepts upon which the law of increasing costs is based. 8. Define and explain productive efficiency. 9. Identify and explain the factors which enable an economy to grow.

2-3 Economics Defined Economics studies the efficient allocation of the scarce means of production toward the satisfaction of human wants. o Efficiency, as a goal, emphasizes the need to maximize our material output; given the amount of resources. o Means of production includes our resources and our technological ability to use them to produce output. Resources are the things used to produce goods and services. These resources are scarce (limited). o Satisfaction of human wants is the purpose of an economy. Economists assume people know their wants. Definition does not distinguish between wants and needs. Goods and services fulfill our material wants.

2-4 The Central Fact of Economics: SCARCITY This definition assumes that scarcity is the fundamental economic problem: o There are never enough resources to produce all of the goods and services that people want. Why is there an economic problem? o The means of production (resources) are limited. o Economists assume that human wants are unlimited. An economy is a system for organizing the allocation of resources to produce and distribute the goods and services that satisfy human wants. o The more efficient the economy is, the more wants we can satisfy.

2-5 Four Economic Resources There are four categories of economic resources: o Land - natural resources o Labor - work o Capital - produced goods used to produce other goods and services o Entrepreneurial ability - effort to organize the production process In a market economy, each of these resources is exchanged in markets for a type of income. o We sell our resources to earn income to purchase goods and services to satisfy our wants.

2-6 Land Earns Rents Land (a broader meaning than our normal understanding of the word). o Land includes natural resources like timber, oil, coal, iron ore, soil, water, as well as the ground in which these resources are found. How is land used in an economy? o Extraction of minerals (mining) and farming (agriculture) o It provides the site for factories, office buildings, shopping centers, homes, etc. Owners of land receive rent. o Economic rent is money received from something that is given by nature, rather than produced by human effort. o Rent is earned by establishing ownership over resources.

2-7 Labor Earns Wages. Labor: o is work and time for which one is paid. o involves human effort. Income received for one’s labor is called wages and/or salaries o About two-thirds of the total resource cost is the cost of labor. o Unpaid labor (housework, volunteer work) can also contribute to the satisfaction of human wants.

2-8 Capital Earns Interest. Capital: o “human-made” goods used to produce other goods or services. o includes office buildings, stores, and factories (physical plant), equipment, and software. o This is a different use of the term capital than when it means the money a business uses to buy plant and equipment. The income owners of capital receive what is called interest. o The purchase of new capital equipment is often funded through loans, so the lender earns interest from its productivity.

2-9 Entrepreneur Ability Earns Profits. The entrepreneur: o sets up a business. o assembles the needed resources. o risks his/her own (or borrowed) money. o is central to the American economy. An entrepreneur earns a profit (or a loss) depending upon his or her ability to run a business. There are over 30 million businesses in the U.S., most are owned by entrepreneurs. o The vast majority work for themselves or have one or two employees.

2-10 Questions for Thought and Discussion Why are the means of production scarce? The text has a quote by F.V. Meyer that says “Economics is the science of greed.” What does he mean? Do you agree or disagree with the quote? Which is the only category of resources that cannot be increased over time? What is the difference between an entrepreneur and an inventor?

2-11 Our Economic Problem Revisited Our economic problem is that we have limited resources available to satisfy relatively unlimited wants. There are NOT enough resources to produce everything that everyone wants. Therefore, CHOICES must be made! The wood used to build a table cannot be used to make paper. The time a nurse spends filling out forms cannot be used in patient care.

2-12 Opportunity Cost: A Fundamental Concept in Economics Opportunity cost is the foregone value of the next best alternative. o The value of things we give up (our second-best choice). People weigh the costs and benefits of various options, including opportunity costs. o Economists assume that we choose the option we find more valuable. In the economic world, “both” is not an admissible answer to a choice of “which one.”

2-13 Choosing the Highest Valued Alternative Because time is linear, we must make choices. Here are your options: o spend time on social networking site. o play video games. o go to movies with friends. o study economics. Whichever option is chosen, you will miss the value of the other options. o If you go to the movie with friends, the direct cost is the movie ticket and any transportation costs. o The opportunity cost is the value of the alternatives use of your time (for example, the benefit of the improvement in your grade from studying). o Opportunity cost may or may not have a dollar value. But you implicitly place a value when you make a decision.

2-14 You inherit $40,000. Two choices: Buy your dream car or go to college. Suppose you bought the car (paid $40,000): What was the value of the foregone option? College graduate (lifetime earnings) $1,300,000 High School graduate (lifetime earnings) $800,000 Opportunity Cost$500,000

2-15 Businesses and Government Face Also Opportunity Costs. A large corporation has to choose between using profits to pay shareholder dividends (boosting stock value) or to purchase additional capital equipment (which might increase profits at a later date). A small store has to choose which items get more shelf space and which get less shelf space. Governments have to choose how much to spend on education, military, food inspections, environmental protection, medical research, etc. Some local governments are not paving local roads so they do not have to raise taxes on residents.

2-16 Questions for Thought and Discussion Do Bill Gates and other wealthy persons face scarcity? Do they have to weigh opportunity costs? The direct costs of the wars in Iraq and Afghanistan have been approximately $150 per year. What are some of the opportunity cost of the wars in Iraq and Afghanistan? What are the opportunity costs of raising taxes to fund government programs? What are the opportunity costs of lowering taxes?

2-17 Full Employment and Full Production Full employment is when a society’s human resources are being used with maximum efficiency. o Generally, a 4 – 6% unemployment rate is considered full employment. o There will always be a small percentage of the labor force who are between jobs. Full Production is when a society’s resources are being allocated in the most efficient manner possible. o Full production can include physical resources (land and capital) and human resources (labor and entrepreneurial ability). o Generally, a 85–90% capacity utilization rate is considered full production of a nation’s capital.

2-18 Underemployment of Resources Underemployment of resources lowers the productive output of the nation as a whole. o It is an economic problem, not just a personal problem. o Unemployment and low capacity utilization mean that society is not allocating its resources efficiently in order to maximize output. o An unemployment rate greater than 5% is considered underemployment of our labor resources. o A capacity utilization rate less than 85% is considered underemployment of our capital resources. Underemployment of resources occurs during recessions.

2-19 Employment Discrimination Causes Underemployment of Society’s Resources. Employment discrimination excludes members of particular groups from particular jobs. o Society loses out when people are kept from being fully productive. o Discrimination has diminished but has not been eliminated entirely. Example: African Americans were kept out of major league baseball until o Great baseball players like Satchel Paige played in the separate Negro Leagues. o Society lost generations of contributions to records in Major League Baseball.

2-20 The Production Possibilities Curve The Production Possibilities Curve represents our economy at: o full employment. o full production. Productive efficiency occurs only when we are operating on the production possibilities curve. o Productivity efficiency means that the output of one good cannot be attained with out reducing the output of some other good. Guns versus Butter example focuses on government’s choice between military spending or spending on social programs. o Remember: businesses and consumers face trade-offs too!

2-21 The Production Possibilities Curve Points A, B, C, D, E, and F are efficient with full employment and full production. Points X, Y, and Z are points where economy is producing below efficiency since either capital is being under utilized or the workforce is underemployed. You can produce more guns without sacrificing butter, or vice versa. Any point above the production possibility curve, such as W, is not achievable.

Production Possibilities Curve Hypothetical Production Schedule Point Units of Butter Units of Guns A150 B141 C122 D93 E54 F05 This Production Possibilities Curve shows the range of possible combinations of guns and butter extending from 15 units of butter and no guns at point A to 5 units of guns and no butter at point F 2-22

Production Possibilities Curve Hypothetical Production Schedule Point Units of Butter Units of Guns A150 B141 C122 D93 E54 F05 When you are on the curve, to get more of one thing you have to give up some of the other thing. The opportunity cost of gaining 1 unit of guns was 1 unit of butter To gain 1 unit of Guns Had to give up 1 unit of butter 2-23

2-24 Law of Increasing Costs As we shift from butter to guns, we have to give up increasing units of butter for each additional unit of guns. Law of Increasing Cost: As the output of one good expands, the opportunity cost of producing additional units of this good increases. You give up fewer units of butter to get 1 unit of guns up top. From A to B you give up 1 unit of butter to get 1 unit of guns. You give up more units of butter to get 1 unit of guns at the bottom. From E to F you have to give up 5 units of butter.

2-25 Questions for Thought and Discussion Explain how unemployment and discrimination are problems for society as a whole, not just those individuals who experience it. Give an example that was not mentioned in your text. Explain how the concept of opportunity costs is illustrated on the Production Possibilities Curve. In the Law of Increasing Costs, are we talking about direct costs or opportunity costs increasing as we produce more of one good or service?

2-26 Economic Growth Economic growth enables a society to produce more guns AND more butter – or whatever goods and services are allocated resources. What causes economic growth? o More or better trained labor More or improved plant and equipment (capital) Technological change (new fertilizer, shift from typewriter to computer) Economic growth can be illustrated by a new Production Possibilities Curve. o The curve moves to up and to the right

2-27 Economic Growth Illustrated PPC PPC after economic growth PPC after more growth

2-28 Investing in Future Growth Note that investment in capital equipment today can lead to economic growth in the future. Choosing Point B in Year 1 gives us greater production possibilities in the future than choosing Point A. Look! The axes have new labels!

2-29 Questions for Thought and Discussion Given limited resources, is growth always good? o Why do most mainstream economists embrace growth? Is our economy in a period of full employment and full production? What are the implications for you when you look for a job after college? Choose a trade-off between any two goods or services and illustrate it on a Production Possibilities Curve. Try to explain how the Law of Increasing Costs would operate as you move along the curve. Does the PPC move out in a recession year?