1. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-1 Chapter 2 The economising problem

2. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-2 Learning objectives Discuss the two fundamental facts that form the bases of the economising problem Define the economising problem and expand on the definition of ‘economics’ introduced in Chapter 1 Discuss the meaning of ‘economic efficiency’ and examine the importance of specialisation to its achievement

3. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-3 Learning objectives (cont.) Illustrate, extend and modify our definition of ‘economics’ through the use of production possibilities tables and curves Introduce the concept of 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

4. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-4 Learning objectives (cont.) Survey briefly the different ways in which institutionally and ideologically diverse economies respond to the economising problem 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

5. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-5 The foundation of economics The economising problem is underpinned by two fundamental facts: Unlimited or insatiable wants of society for goods and services that give utility –‘Utility’ is the economist’s term for pleasure or satisfaction Economic resources are limited or scarce –‘Economic resources’ refers to all natural, human and manufactured resources that go into the production of goods and services

6. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-6 Economic resources Two broad categories of resources: Property resources –Land –Raw materials –Capital Human resources –Labour –Entrepreneurial ability

7. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-7 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

8. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-8 Capital All the manufactured aids to production used to produce goods and services and to distribute them to the final consumer without directly satisfying human wants ‘Capital’ as used in economics does not refer to money — money as such produces nothing, and is not considered an economic resource The process of producing and accumulating these capital goods is known as investment Payment for capital is interest

9. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-9 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

10. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-10 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

11. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-11 Relative intensity of resource use in production Land-intensive commodity is a commodity in which the production process uses a relatively large amount of land Labour-intensive product uses relatively large amounts of labour Capital-intensive product uses relatively larger amounts of capital

12. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-12 Economics and efficiency Efficiency is the use or administering of scarce resources to produce the maximum amount of desired goods and services, thereby achieving the greatest possible fulfilment of society’s wants

13. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-13 Economics and efficiency (cont.) To achieve efficiency, there must be full employment and full production Full employment –All available resources are employed Full production –The maximum amount of goods and services are produced from the employed resources of an economy Full employment implies two kinds of efficiency –Allocative efficiency –Productive efficiency

14. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-14 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

15. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-15 Economics and efficiency (cont.) Specialisation and efficiency –Specialisation enhances efficiency Two types of specialisation –Division of labour –Geographic specialisation

16. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-16 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

17. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-17 Production possibilities curve Assumptions Efficiency: The economy is operating at full employment and achieving productive efficiency Fixed resources Fixed technology Two products only: capital good and consumer good

18. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-18 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

19. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-19 Production possibilities of chocolate and tractors with full employment ___________________________________________________ Type of product Production alternatives A B C D E Chocolates (‘00000) 0 1 2 3 4 Tractors (‘000)10 9 7 4 0 ___________________________________________________

20. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-20 1 2 3 4 5 6 7 8 0 1 2 3 4 5 6 7 8 9 10 The production possibilities curve Q Q A B C D E Chocolate bars (hundred thousands) Tractors (thousands) Attainable and efficient W Unattainable Attainable but inefficient U

21. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-21 The production possibilities curve (cont.) Opportunity cost –The amount of other products that 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

22. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-22 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

23. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-23 Allocative efficiency Resources are efficiently allocated to any product when the output is such that its marginal benefit equals its marginal cost (MB = MC)

24. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-24 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

25. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-25 Chocolate bars (hundred thousands) Tractors (thousands) 1 2 3 4 5 6 7 8 0 1 2 3 4 5 6 7 8 9 10 Unemployment and underemployment Q Q A B C D E U A greater output of at least one if not both

26. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-26 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

27. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-27 Q Q Tractors (thousands) Chocolate bars (hundred thousands) 14 13 12 11 10 9 8 7 6 5 4 3 1 1 2 3 4 5 6 7 8 A′A′A′A′ B′B′B′B′ C′C′C′C′ D′D′D′D′ E′E′E′E′ Economic growth and PPC

28. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-28 Five fundamental questions 1.How much total output is to be produced? 2.What combination of outputs is to be produced? 3.How are these outputs to be produced? 4.Who is to receive/consume these outputs? 5.How can change be accommodated?

29. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-29 Alternative economic systems How the fundamental questions are answered depends on the type of economic system Economies differ on two grounds: –Ownership of the means of production – How economic activity is co-ordinated

30. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-30 Alternative economic systems (cont.) Pure capitalism (or laissez-faire) –Private ownership of property and resources –Freedom of enterprise and choice –A system of markets and prices The command economy –Characterised by public ownership of resources and property –Centralised economic planning

31. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-31 Alternative economic systems 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 The traditional economy –In the traditional or customary economies found in many less developed countries, production methods, exchange and the distribution of income are all sanctioned by custom

32. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-32 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

33. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-33 Goods for the present Goods for the future Economic growth in two countries 2003 Curve 2023 curve 2003 Curve Alphania Betania

34. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-34 Economic basis for trade Why do nations trade? What is the basis of trade between nations? 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

35. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-35 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

36. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-36 Production possibilities Clothing (K) Cereals (C) 30 25 20 15 12 10 0 30 25 20 15 10 0 5 10 15 18 20 30 5 8 10 15 20 A B AustraliaTaiwan

37. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-37 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 The terms of trade Commodity terms of trade is the rate at which one commodity can be exchanged for another, expressed in physical units of each commodity

38. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-38 Clothing (K) 4 5 4 0 3 5 3 0 2 5 2 0 1 5 1 2 1 0 5 0 30 25 20 15 10 5 0 5 10 15 18 20 25 30 5 8 10 15 20 A B Trading possibilities line Trading possibilities line Cereal (C) ′A′′A′ ′B′′B′ AustraliaTaiwan Gains from trade and trading possibilities SS’

39. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-39 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

40. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-40 The gains from trade Cereals (C) Clothing (K) 0 Australia S A E C Trade line S’ A’

41. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-41 S D B d The gains from trade (cont.) Cereals (C) Clothing (K) 0 Taiwan d’ B’ Trade line S’