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Chapter 2: The Economizing Problem

Money and time are both scarce; making decision in the context of scarcity always means there are costsThe Fundamentals of Economics: Scarcity, Choices, & CostsThe Economizing Problem focuses on Wants & Resources

Production Possibilities Model

Circular Flow Model

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The Fundamentals of Economics

Two facts constitute the Economizing Problem:

1. Society’s economic wants are unlimited & insatiable

2. Economic resources are limited or scarce

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Economic Wants

Desires of consumers to obtain & use various goods & services that provide UTILITYNecessities LuxuriesOver time, wants change & multiply, fueled by new productsBusiness & government also try to satisfy their economic goalsThe objective of all economic activity is to fulfill wants

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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)

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The Factors of Production

1. Land Includes all natural resources used in production

process (arable land, forests, mineral & oil deposits, & water resources)

2. Capital (aka Capital/Investment Goods) Includes all manufactured aids used in producing

consumer goods & services. Investment is the process of producing &

purchasing capital goods3. Labor

All physical & mental talents of individuals available & usable in producing goods & services

4. Entrepreneurial Ability

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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

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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.

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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.

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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, undesirablePoints outside are unattainable w/ current supply of resources & technology

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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 costEconomic resources are not completely adaptable to alternative uses. Lack of perfect flexibility on the part of resources is cause of increasing OC.

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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.

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A Growing Economy: Increase in Resource Supplies

E.g.: Size of Labor Increases (Growing Population, Immigration)Quality of Labor improves over timeGreater 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.

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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.

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A Growing Economy

When the supplies of resources increase or there is improvement in technology, the Production Possibilities Curve SHIFTS OUTAn outward shift of the PPC represents growth of economic capacityEconomic 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

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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.

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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:1. Who owns the factors of production2. The method used to coordinate & direct

economic activity

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The Market System (Capitalism)

Characterized by the private ownership of resources and the use of markets & prices to coordinate and direct economic activityEach participant acts in their own self-interestEach individual/business seeks to maximize satisfaction/profit Private ownership of capitalCommunicates through PricesCoordinates activity through Markets: where buyers & sellers come togetherCompetition among independent buyers & sellers of each product

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The Command System (Socialism/Communism)

Government owns most property resourcesGovernment makes economic decisions Use of resources, composition &

distribution of output, organization of production

Division of output between capital & consumer goods is centrally decided

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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

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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 sellHouseholds use income to buy goods &

servicesMonetary flow of consumer spending yields

revenues for businesses

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Chapter 2 Study Questions

5: Productive Efficiency & Allocative Efficiency6: Production Possibilities Curve9: Marginal Benefit & Cost10: Production Possibilities Curve12: PPC16: Circular Flow Model17: Women & Expanded Production Possibilities