Chapter 2

A CLOSER LOOK AT THE

ECONOMIC PROBLEM
 Central Economic Questions

• 3 central economic questions

- Output Q: what & in what quantities?
- Input Q: How & how much of scarce resources?
- Distribution Q: For whom & where?

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2.1 What should be produced?
Non-durable
Capital goods goods

Semi-durable
Consumer goods
goods

Final goods & Durable goods

intermediate
goods

Economic Private goods &

goods public goods

Free goods Homogenous &

heterogeneous
goods

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Figure 2-1 The production possibilities curve once
again

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Figure 2-2 Improved technique for producing
capital goods

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Figure 2-3 Improved technique for producing
consumer goods

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Figure 2-4 Increase in the quantity or productivity
of the available resources

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2.2 Factors of production
Secondary
Primary factors
factors of
of production
production

Natural resources Capital

Labour Entrepreneurship

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 2.3 The Distribution issue
• This is a normative issue
• Who will receive What from the economy?
• Need income different from wealth
• Functional distribution of income:
– Rent, wages, interests & profits
• Personal distribution of income
• Sectoral distribution of income
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 2.4 Economic Systems
• System: network of interlocked parts
forming an overall pattern
• Economic system: pattern of organisation
aimed at solving the 3 econ. Questions
• Criteria for classification: property rights
& coordinating mechanism

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 Major differences between
economic systems
Traditional Command Market Mixed
What? custom Central Demand from Demand, profits
authority consumers & + Gvt
profitability intervention
How? custom Central Prices & Prices,
authority productivity of productivity +
factors Gvt intervention
For Whom? custom Central Those who can Affordability +
authority afford Gvt intervention
Ownership of Private & - State: - Private: Private & State
factors of Community socialism Capitalism
production

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2.5 Contributions to economic
science
ADAM SMITH (1723-1790)
• Market system: invisible hand
• The wealth of nations: division of labour, free trade and limited role
for government
• Classical school

KARL MARX (1818-1883)

• Evolution of Institutions: Capitalism - Socialism - Capitalism
• Das Kapital: Capitalism is exploitative and self-destructive
• Predicted popular revolution but did not anticipate the capacity of
capitalism to adapt.

JOHN MAYNARD KEYNES (1883-1946)

• Government intervention to support aggregate demand
• The general theory: foundation for modern macroeconomics

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