Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 1 Chapter 2 The Economising Problem

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 2 Learning Objectives Discuss the two fundamental facts that form the bases of the economising problem. Define the economising problem and expand upon the definition of economics introduced in Chapter 1.

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 3 Learning Objectives (cont.) Discuss the meaning of economic efficiency and examine the importance of specialisation to its achievement. Illustrate, extend and modify our definition of economics through the use of production possibilities tables and curves.

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 4 Learning Objectives (cont.) Introduce the concept of the opportunity cost, the law of increasing opportunity costs, and the law of comparative advantage. Restate and discuss the economising problem in terms of five fundamental questions.

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 5 Learning Objectives (cont.) Survey briefly the different ways in which institutionally and ideologically diverse economies respond to the economising problem. Briefly discuss the roles of markets and money within the economic systems of industrially advanced economies.

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 6 Learning Objectives (cont.) Use the production possibilities curve model to examine the trade-off between current and future consumption, and the importance of comparative advantage as a basis for trade between nations. Review the volume and pattern of Australia’s trade.

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 7 The Foundation of Economics The economising problem is underpinned by two fundamental facts: 1. Unlimited or insatiable wants of society for goods and services that give utility Utility is the economist’s term for pleasure or satisfaction 2. Economic resources are limited or scarce

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 8 Economic Resources Two broad categories: Property resources – Land – Raw materials – Capital Human resources – Labour – Entrepreneurial ability

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 9 Land Broader than commonly understood An economic resource which includes all the natural resources that go into the production of goods and services Income received by land is rent

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 10 Capital All the manufactured aids to production used to produce goods and services and distribute them to the final consumer without directly satisfying human wants The process of producing and accumulating these capital goods is known as investment Payment for capital is interest

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 11 Labour Broader than commonly used All human physical and mental talents (excluding entrepreneurial talent) that can be used in producing goods and services Income accruing to labour is wage

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 12 Entrepreneurial Ability A specialised form of human resource Involves the combining of the other resources to produce a product, make non-routine decisions, innovate, and bear risk Profit is the reward for entrepreneurship

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 13 Economics and Efficiency Efficiency is the use or administering of scarce resources to produce the maximum amount of the desired goods and services, thereby achieving the greatest possible fulfilment of society’s wants

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 14 Economics and Efficiency (cont.) Full employment: When all available resources are employed Full production: When the maximum amount of goods and services are produced from the employed resources of an economy – Two kinds of efficiency  Allocative efficiency  Productive efficiency

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 15 Economics and Efficiency (cont.) Allocative efficiency – Occurs when all available resources are devoted to the combination of goods most wanted by society Productive efficiency – Occurs when goods or services are produced using the lowest cost production methods

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 16 The Economising Problem Illustrated The Production Possibilities Curve (PPC) can be used to illustrate the concept of choice and opportunity cost Demonstrates that society must make choices about which goods and services to produce and which to go without

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 17 Production Possibilities Curve Assumptions Efficiency: Full employment and productive efficiency Fixed resources Fixed technology Two products only: capital good and consumer good

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 18 Production Possibilities Curve (cont.) Points on the PPC represent a maximum output of the two products Points inside the PPC are attainable, but are inefficient and undesirable Points outside the curve are superior but unobtainable given the assumptions of fixed technology and resources

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 19 Production possibilities of chocolate and tractors with full employment ___________________________________________________ Type of product Production alternatives A BCDE Chocolates (‘00000) Tractors (‘000) ___________________________________________________

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 20 Q Q Tractors (thousands) Chocolate bars (hundred thousands) The Production Possibilities Curve A B C D E W UnattainableAttainable and efficient Attainable but inefficient U

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 21 Production Possibilities Curve (cont.) Opportunity cost: – The amount of other products that must must be sacrificed to obtain an additional unit of a good The PPC is concave to the origin because of the law of increasing opportunity costs: – more and more of a good must be given up to obtain additional units of the other good

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 22 Law of Increasing Opportunity Costs Based on the fact that economic resources are not completely adaptable to alternative uses; they are imperfect substitutes Resources lack perfect flexibility or interchangeability

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 23 Allocative Efficiency Resources are efficiently allocated to any product when the output is such that its marginal benefit equals its marginal cost (MB = MC)

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 24 The Production Possibility Curve Points inside the production possibility curve illustrate unemployment or productive inefficiency A movement towards full employment and productive efficiency from a point such as U will entail a greater output of at least one, if not both, products

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 25 Q Q Tractors (thousands) Chocolate bars (hundred thousands) Unemployment and Underemployment A B C D E U More of either or both is possible U

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 26 Economic Growth and the PPC Economic growth can be represented as an outward shift (to the right) of the PPC Economic growth results from: – expanding resource supplies – technological advances

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 27 Q Q Tractors (thousands) Chocolate bars (hundred thousands) A′A′A′A′ B′B′B′B′ C′C′C′C′ D′D′D′D′ E′E′E′E′ Economic Growth and PPC

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 28 Five Fundamental Questions How much total output is to be produced? What combination of outputs is to be produced? How are these outputs to be produced? Who is to receive/consume these outputs? How can change be accommodated?

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 29 Economic Systems How the fundamental questions are answered depends on the type of economic system Economies differ on two grounds: – ownership of resources – how economic activity is co-ordinated

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 30 The ‘isms’ Pure capitalism (or laissez-faire): – private ownership of property – freedom of enterprise – a system of markets and prices The command economy: – characterised by public ownership of resources and property – centralised economic planning

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 31 The ‘isms’ (cont.) Mixed systems – a mixture of pure capitalism and command economy – authoritarian capitalism refers to a regime with a high degree of government control, with privately owned property – market socialism is characterised by public ownership of property, with markets playing a significant role

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 32 Present Choice and Future Possibilities The PPC can be used to: illustrate the importance of society’s choice between current and future consumption demonstrate the economic basis for trade between nations

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 33 Goods for the Present Goods for the Future Economic Growth in Two Countries 2003 Curve 2023 Curve 2003 Curve Alphania Betania

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 34 Economic Basis for Trade Why do nations trade? Distribution of economic resources differs between nations Different technologies and/or resources are required for production: – labour-intensive commodities – land-intensive commodities – capital-intensive commodities

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 35 Specialisation and Comparative Advantage Two isolated nations Constant costs – Straight line production possibilities curve Different opportunity costs – Different resource mix and different levels of technology Self sufficiency

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 36 Production Possibilities Clothing (K) Cereals (C) A B AustraliaTaiwan

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. Principles of Comparative Advantage Total output will be greatest when each good is produced by that nation which has the lower domestic opportunity cost. Australia has a comparative advantage in cereal Terms of trade is the rate at which Australia and Taiwan will exchange 37

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 38 Clothing (K) A B Trading possibilities line Trading possibilities line Cereal (C) ′A′′A′ ′B′′B′ AustraliaTaiwan Gains from Trade and Trading Possibilities

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 39 Gains from Trade Under Increasing Cost Increasing costs impose limits upon the gains from specialisation and trade The primary effect of increasing costs is to make specialisation less than complete

Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 40 Next Chapter: Demand and Supply