Chapter 2: The Economizing Problem

1. Chapter 2: The Economizing Problem • Money and time are both scarce; making decision in the context of scarcity always means there are costs • The Fundamentals of Economics: Scarcity, Choices, & Costs • The Economizing Problem focuses on Wants & Resources • Production Possibilities Model • Circular Flow Model

2. The Fundamentals of Economics • Two facts constitute the Economizing Problem: • Society’s economic wants are unlimited & insatiable • Economic resources are limited or scarce

3. Economic Wants • Desires of consumers to obtain & use various goods & services that provide UTILITY • Necessities  Luxuries • Over time, wants change & multiply, fueled by new products • Business & government also try to satisfy their economic goals • The objective of all economic activity is to fulfill wants

4. Scarce Resources • Economic resources are limited or scarce. • Resources: all natural, human, & manufactured resources in the production of goods & services. • Property (Land, Raw Mats, & Capital) • Human (Labor & Entrepreneurial)

5. The Factors of Production • Land • Includes all natural resources used in production process (arable land, forests, mineral & oil deposits, & water resources) • Capital (aka Capital/Investment Goods) • Includes all manufactured aids used in producing consumer goods & services. • Investment is the process of producing & purchasing capital goods • Labor • All physical & mental talents of individuals available & usable in producing goods & services • Entrepreneurial Ability

6. Full Employment • Full Employment: Use of all available resources. • No workers should be out of work if they are willing & able • Land or equipment is not idle

7. Full Production • All employed resources should be used to provide maximum possible satisfaction of our wants. • Otherwise, underemployed • Productive Efficiency: Production of any particular mix of goods & services in the least costly way • Allocative Efficiency: Production of a particular mix of goods & services most wanted by society. • “Right” mix of goods & services, each produced at lowest possible unit cost.

8. Production Possibilities Model • Assumptions: • Full Employment & Productive Efficiency • Factors of Production are Fixed in Quantity & Quality • Can be reallocated, within limits, among different uses • Fixed Technology (Short Period of Time) • Economy is Producing ONLY Two (2) Goods • At any point in time, an economy achieving full employment & productive efficiency must sacrifice some of one good to obtain more of another good. Scarce resources prohibit such an economy from having more of both goods.

9. Production Possibilities Curve • Each point on the PPC represents some maximum output of the two products. • Production Possibilities Frontier shows the limit of attainable outputs. • To obtain the various combinations of goods that fall ON the PPC, society MUST achieve both Full Employment & Productive Efficiency. • Points inside are inefficient, undesirable • Points outside are unattainable w/ current supply of resources & technology

10. Increasing Opportunity Cost • Since resources are scarce relative to virtually unlimited wants, people must choose between alternatives. • Opportunity Cost: The amount of other products that must be forgone or satisfied to obtain 1 unit of a specific good. • The opportunity cost of each additional unit of a good is greater than the opportunity cost of the preceding one. • Opportunity cost is measured in real terms (goods v. money) • The more of a product that is produced, the greater its opportunity cost • Economic resources are not completely adaptable to alternative uses. Lack of perfect flexibility on the part of resources is cause of increasing OC.

11. Unemployment & Productive Inefficiency • In the presence of unemployment or inefficiency, the economy would produce less • Represented by points inside the original PPC • A move toward full employment & productive efficiency would yield a greater output of one or both products.

12. A Growing Economy: Increase in Resource Supplies • E.g.: Size of Labor Increases (Growing Population, Immigration) • Quality of Labor improves over time • Greater abundance of resources results in greater potential output of one or both products at each alternative on the PPC. • Economic growth is achieved in the form of an expanded potential output.

13. A Growing Economy: Advances in Technology • Technology progresses over time • Advanced technology brings new & better goods AND improved ways of producing them • Technological advances allows society to produce more goods with fixed resources.

14. A Growing Economy • When the supplies of resources increase or there is improvement in technology, the Production Possibilities Curve SHIFTS OUT • An outward shift of the PPC represents growth of economic capacity • Economic Growth: The ability to produce larger total output. • While static, no-growth economy must sacrifice some of one product in order to get more of another, a dynamic, growing economy can have larger quantities of both products

15. International Trade • Production Possibilities Model implies that an individual nation is limited to the combinations of output indicated by its PPC. • Through specialization & trade, the output limits imposed by its domestic PPC can be avoided. • International Specialization: Directing domestic resources to make what a nation is highly efficient at producing. • International Trade: the exchange of specialized goods for goods produced abroad. • International specialization & trade enable a nation to obtain more goods than its PPC indicates.

16. Economic Systems • Every society develops an economic system, a particular set of institutional arrangements and a coordinating mechanism, to respond to the economizing problem. • Economic systems differ depending on: • Who owns the factors of production • The method used to coordinate & direct economic activity

17. The Market System (Capitalism) • Characterized by the private ownership of resources and the use of markets & prices to coordinate and direct economic activity • Each participant acts in their own self-interest • Each individual/business seeks to maximize satisfaction/profit • Private ownership of capital • Communicates through Prices • Coordinates activity through Markets: where buyers & sellers come together • Competition among independent buyers & sellers of each product

18. The Command System (Socialism/Communism) • Government owns most property resources • Government makes economic decisions • Use of resources, composition & distribution of output, organization of production • Division of output between capital & consumer goods is centrally decided

19. The Circular Flow Model • Decision Makers: • Households (people) own all economic resources directly or indirectly • Businesses buy resources necessary for producing goods & services; Wages, rent, interest & profit income (money) flows back to households

20. The Circular Flow Model • Markets: • Resource: where resources or services are bought & sold • Product: where goods & services produced by businesses are bought & sold. • Businesses combine resources to make products they sell • Households use income to buy goods & services • Monetary flow of consumer spending yields revenues for businesses

21. Chapter 2 Study Questions • 5: Productive Efficiency & Allocative Efficiency • 6: Production Possibilities Curve • 9: Marginal Benefit & Cost • 10: Production Possibilities Curve • 12: PPC • 16: Circular Flow Model • 17: Women & Expanded Production Possibilities