Chapter Two: The Economizing Problem

I. The Foundation of Economics is made up of two fundamental facts: A. Societys economic wants are virtually unlimited and insatiable. 1. Economic wants: The desires of consumers to obtain and use various goods and services that provide pleasure or satisfaction. 2. Wants range from necessities to luxuries. Over time, wants often change andusuallymultiply as new products arise. Both products and services satisfy wants. 3. While a want for a particular good can be satised, the want for goods as a whole is insatiable. 4. The objective of all economic activity is to fulll wants. B. Economic resources are limited or scarce. 1. Economic resources: All natural, human, and manufactured resources that go into the production of goods and services. 2. These resources are categorized as either property or human resources. The four that follow are know as the factors of production. a. Land : All natural resources used in the production process. b. Capital : All manufactured aids used to produce goods and services. i. Also known as capital goods or investment goods, the process of producing such aids is known as investment. ii. Capital goods dier from consumer goods because capital goods indirectly satisfy consumer wants while consumer goods directly satisfy them. c. Labor : All physical and mental talents of individuals available and usable. d. An entrepreneur has several roles: i. Take initiative in combining the above three resources to produce a good or service. ii. Make the strategic business decisions to set the course of an enterprise. iii. Be the risk bearer, as there is no guarantee of prot. 3. Resource Payments a. Rental income: Income received from supplying raw materials. b. Interest income: Income received from supplying capital equipment. c. Wages: Income accruing to those who supply labor. d. Prots: Entrepreneurial income. 4. Relative Scarcity a. The inputs for production are connected by the fact that they are all scarce or limited in supply. Such scarcity limits productive activity and output.

II. Economics is concerned with doing the best with what we have and examining eciency to create the best use of resources. A. To achieve this, society must achieve both full employment and production. 1. Full employment: The use of all available resources (land, capital, and labor). a. availability is determined by societal constraints as well as logistical ones. 2. Full production: All employed resources must be used to provide maximum satisfaction of wants. a. If full production is not realized, then resources are considered underemployed. b. Full production implies two kinds of eciency: productive and allocative. i. Productive eciency: Production of any particular mix of goods and services produced in the least costly way. ii. Allocative eciency: Least-cost production of that particular mix of goods and services most wanted by society. B. Production Possibilities Model 1. A full-employment, full-production economy cannot have unlimited output of goods and services. a. Assumptions are made in order to simplify a model of production possibilities. i. Full employment and productive eciency ii. Fixed resources: Available supplies are xed in quantity and quality. iii. Fixed technology: The state of technology does not change during analysis period. iv. Two goods: The economy is producing only two types of goods: consumer and capital. b. Society must choose among alternatives for the production of consumer and capital goods. i. At any point in time, an economy achieving full employment and productive eciency must sacrice some of one good to obtain more of another good. Scarce resources prohibit such an economy from having more of both goods. a. The amount of product forgone to obtain one unit of a specic good is called the opportunity cost of that good. b. The law of increasing opportunity costs states that the more of a product is produced, the greater is its opportunity cost in marginal terms. This is caused by a lack of interchangeability of resources. 2. In graphing the possible production numbers of an economy (consumer versus capital), it is possible to create a production curve. a. Each point on the curve represents some maximum output of the two products obtainable when the economy is at full employment and productive eciency.

b. This curve is a production frontier ; it shoes the limit of attainable outputs. i. Points inside the curve are attainable, but inecient and are therefore not as desirable. ii. Points outside the curve are unattainable with the given supplies of resources and technology. 3. Allocative eciency requires that the economy produce at the most valued point on the curve. a. Economic decisions center on comparisons of marginal benets (MB) and marginal costs (MC). i. The optimal amount of activity occurs where MB = MC. a. MB greater than MC indicates underallocation. b. MB less than MC indicates overallocation. 4. Using a less perfect model; considering unemployment, growth, and the future. a. Unemployment and productive ineciencies lead to less production. i. Represented by points inside the production possibilities curve. b. Economies are not perfectly stagnant, quantity and quality of products can change, thus shifting the maximum output and therefore the position of the production possibilities curve. i. Increases in resource supplies and the quality of labor renders a net result of an increase in production. a. To note: this increase is not guaranteed. c. Advances in technology brings new goods as well as improved production methods. d. Economic growth: The ability to produce a larger total output and can be caused by a, b, c, or some combination. e. While a static, no-growth economy must sacrice some of one product in order to get more of another, a dynamic, growing economy can have larger quantities of both products. f. An economys current choice of positions on its production possibilitys curve helps determine the future location of that curve. i. This projection is partially dependent upon the quantity of goods for the future in comparison to those goods which are for the present consumer. g. Another thing to take into consideration is that a countrys economy is not limited to only its own resources as there are international trade markets that are relatively easy to access. i. An economy can circumvent output limits imposed by its domestic production possibilities curve through international specialization and trade. a. International specialization: directing domestic resources to output that a nation is highly ecient at producing. b. International trade: the exchange of these goods for goods produced abroad. ii. Specialization and trade enable a nation to get more of a desired good at less sacrice.

III. Economic Systems are created by societies to respond to the economizing problem. A. These economic systems are characterized by a particular set of institutional arrangements and a coordinating mechanism. These systems dier as to who owns the factors of production, and how economic activity is coordinated and directed. B. The Market System (capitalism) i. Private ownership of resources and the use of markets and prices to coordinate and direct economic activity. Goods and services are produces and resources are supplied by whoever is willing and able to. ii. Economic decision making is widely dispersed due to competition amongst independently acting buyers and sellers. iii. Pure capitalism is laissez-faire, but most countries who have a capitalist system have government intervention in the economy. C. The Command System (socialism or communism) i. Government owns most property resources and economic decision making occurs through a central economic plan. A central planning board makes nearly all major decisions regarding apportionment. In essence, everything is centrally commanded. ii. A pure command economy would rely on a central plan to allocate government owned property resources. However, in reality (the Soviet Union), some private ownership existed and market systems are starting to leak in to what remains of command systems. IV. The Circular Flow Model A. There are two groups of decision makers in a market economy: households and business. B. There are two broad markets: the resource market and the product market. i. Resource market: The place where resources or services of resource suppliers are bought and sold. a. Households sell resources and businesses buy them. i. Households own resources either directly as workers or entrepreneurs or indirectly through their ownership of business corporations. ii. Product market: The place where goods and services produced by businesses are bought and sold. a. Businesses combine the resources they have obtained to produce and sells goods and services. i. Households use the income they have received from their sale of resources to buy goods and services. ii. This model suggests a complex interrelated web of decision making and economic activity involving businesses and households. a. The real ow of economic resources and nished goods and services and the money ow of income and consumption expenditures are simultaneous, repetitive, and in opposite directions.