Chapter 2 The economising problem

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

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

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

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

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

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

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

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 asinvestment • Payment for capital is interest Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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 Uwill entail a greater output of at least one, ifnot both, products Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

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

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

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

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

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

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

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

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

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

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

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

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

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 whichone commodity can be exchanged for another, expressed in physical units of each commodity Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

38. Trading possibilities line Trading possibilities line A′ B′ Gains from trade and trading possibilities 45 40 35 30 25 20 15 12 10 5 0 Australia Taiwan 30 25 20 15 10 5 0 Clothing (K) Clothing (K) A S S’ B 5 10 15 18 20 25 30 5 8 10 15 20 Cereal (C) Cereal (C) Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal

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

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

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