Econ -Unit 1- Chap 2 Notes

Chapter 2: The Economizing Problem

The Foundation of Economics

• Economizing problem: Society's economic wants are virtually unlimited and insatiable; economic resources are limited or scarce.
  

  
  

  Unlimited Wants
  

• Economic Wants: the desires of consumers to obtain and use various goods and services that provide pleasure, satisfaction, or "utility"
  
• Necessities: food, shelter, clothing
  
• Over time, wants change and tend to multiply, fueled by new products
  
• The satisfaction of certain wants tends to trigger others
  
• Services, as well as products, satisfy our wants (ex: automobiles and washing machines are bought for the services they render)
  
• Businesses and unites of government also strive to satisfy economic goals
  
• The objective of all economic activity is to fulfill wants
  

  
  

  Scarce Resources
  

• Economic resources: all natural, human, and manufactured resources that go into the production of goods and services
  
• Property resources: land, raw materials, capital
  
• Human resources: labor and entrepreneurial ability
  

  
  

  Resource Categories
  

• Land: includes all natural resources
  
• Capital: includes all manufactured aids used in producing consumer goods and services (ex: tools, machinery, factory, transportation, equipment, etc…)
  

  ~Investment: the process of producing and purchasing capital goods
  

  ~Capital goods satisfy wants directly
  

  ~Consumer goods do so indirectly by aiding the production of consumer goods
  

• Labor: the physical and mental talents available and usable in producing goods and services
  
• Entrepreneurial Ability:
  

  ~Entrepreneur: takes the initiative in combining the resources of land, capital, and labor to produce a good or service
  

  -Makes the strategic business decisions
  

  -Commercializes new products, new production techniques, etc…
  

  -Has no guaranteed profit
  

• Factors of Production: land, labor, capital, and entrepreneurial ability
  

  
  

  Resource Payments
  

• The income received from supplying raw materials and capital equipment is called rental income and interest income
  
• Wages: the income accruing to those who supply labor
  
• Profits: the entrepreneurial income
  

  
  

  Relative Scarcity
  

• The four factors of production have one thing in common: they are limited in supply
  

  ~Their scarcity constrains productive activity and output
  

  Economics: Employment and Efficiency
  

• Economics is the social science that examines efficiency-- the best use of scarce resources
  

  
  

  Full Employment: Using Available Resources
  

• To realize the best use of scarce resources a society must achieve both full employment and full production
  
• Full Employment: the use of all available resources
  

  
  

  Full Production: Using Resources Efficiently
  

• Full Production: All employed resources must be used so that they provide the maximum possible satisfaction of our economic wants, if we fail to realize full production, economists say our resources are underemployed
  
• Productive efficiency: the production of any particular mix of goods and services in the least costly way
  
• Allocative efficiency: the least-cost production of that particular mix of goods and services most wanted by society
  

  ~This means apportioning limited resources among firms and industries in such a way that society obtains the combination of goods and services it wants the most
  

  
  

  Production Possibilities Table
  

• People must choose which goods and services to produce and which to forgo; the necessity and consequences of those choices can best be understood through a production possibilities model
  

  
  

  Assumptions
  

• Full employment and productive efficiency: the economy is employing all its available resources and is producing goods and services at the least cost
  
• Fixed resources: available supplies of the factors of production are fixed in both quantity and quality
  
• Fixed technology: The state of technology-- the methods used to produce output-- does not changed during our analysis
  
• Two goods: The economy is producing only two goods: pizzas and industrial robots
  

  ~Pizzas: symbolize consumer goods
  

  ~Industrial robots: symbolize capital goods
  

  
  

  The Need for Choice
  

• Fixed resources mean limited outputs of consumer goods and capital goods
  

  ~To increase the production of capital goods we must shift resources away from the production of consumer goods and vice versa
  

• Production Possibilities Table: lists the different combination of two products that can be produced with a specific set of resources (and with full employment and productive efficiency)
  

  ~A shift of resources to consumer goods catches up with society over time as the stock of capital goods dwindles, with the result that some potential for greater future production is lost
  

  ~A shift of resources to capital goods forgoes current consumption, thereby freeing up resources that can be used to increase the production of capital goods
  

  
  

  Production Possibilities Curve
  

• The data presented in a production possibilities table can also be shown graphically
  
• Each point on the production possibilities curve represents some maximum output of the two products
  

  ~The curve is a production frontier because it shows the limit of attainable outputs
  

  ~To obtain the various combinations that fall on the production possibilities curve, society must achieve both full employment and productive efficiency
  

  ~Points lying inside the curve are also attainable, but they reflect inefficiency
  

  ~Point lying outside are unattainable with the current supplies of resources and technology
  

  
  

  Law of Increasing Opportunity Cost
  

• Opportunity cost: the amount of other products that must be forgone or sacrificed to obtain 1 unit of a specific good
  
• Law of Increasing Opportunity Costs: The more of a product that is produced, the greater is its opportunity cost
  

  
  

  Shape of the Curve
  

• The law of increasing opportunity costs is reflected in the shape of the production possibilities curve
  

  
  

  Economic Rationale
  

• Economic resources are not completely adaptable to alternative uses
  
• Resources are better at producing one good than at producing others
  
• To get more consumer goods, resources whose productivity of capital goods is great in relation to their productivity of consumer goods will be needed
  

  ~It will take more and more of such resources and greater sacrifices of capital goods to achieve each increase of 1 unit in the production of consumer goods
  

  ~This lack of perfect flexibility, or interchangeability, on the part of resources is the cause of increasing opportunity costs
  

  
  

  Allocative Efficiency Revisited
  

• Allocative efficiency: requires that the economy produce at the most valued, or optimal, point on the production possibilities curve
  
• Economic decisions center on comparisons of marginal benefits and marginal costs
  
• Any economic activity-- whether production/consumption-- should be expanded as long as marginal benefit exceeds marginal costs and reduced if marginal cost exceeds marginal benefit
  
• The optimal amount of the activity occurs where MB (marginal benefit) = MC (marginal cost)
  
• The second unit of a particular product yields less additional utility or benefit to a person than the first, and a third provides even less marginal benefit than the second.
  

  ~Although total benefits rise when society consumes more consumer goods, marginal benefits decline
  

  
  

  Unemployment and Productive Inefficiency
  

• Graphically, we represent situations of unemployment or productive inefficiency by points inside the original production possibilities curve
  

  
  

  A Growing Economy
  

• When we drop the assumption that the quantity and quality of resources and technology are fixed, the production possibilities curve shifts positions-- the potential max output of the economy changes
  

  
  

  Increases in Resource Supplies
  

• Although resources supplies are fixed at any specific moment, they can and do change over time
  

  ~Ex: a growing population will increase the supplies of labor and entrepreneurial ability
  

  ~Labor quality usually improves over time
  

  ~The development of irrigation programs, for example, adds to the supply of arable land
  

• The net result of these increased supplies of the factors of production is the ability to produce more of both consumer goods and capital goods
  

  ~The greater abundance of resources will result in a greater potential output of one or both products at each alternative
  

  ~Society will have achieved economic growth in the form of expanded potential output
  

• But such a favorable change in the production possibilities data does not guarantee that the economy will actually operate at a point on its new production possibilities curve
  

  
  

  Advances in Technology
  

• Second Assumption: we have constant, unchanging technology
  
• Technological advances make possible the production of more consumer and capital goods
  
• When either supplies of resources increase or an improvement in technology occurs, the production possibilities curve outward and to the right
  
• Economic Growth: the ability to produce a larger total output
  

  The growth is a result of:
  

  ~Increases in supplies of resources
  

  ~Improvements in resource quality
  

  ~Technological advances
  

• Economic growth does not mean proportionate increases in a nation's capacity to produce all its products
  

  
  

  Present Choices and Future Possibilities
  

• An economy's current choice of positions on its production possibilities curve helps determine the future location of that curve
  
• By choosing an output more favorable to technological advances and to increases in the quantity and quality of resources, the economy will achieve greater economic growth
  

  
  

  A Qualification: International Trade
  

• Production possibilities analysis implies that an individual nation is limited to the combinations of output indicated by its production possibilities curve-- but we must modify this principle when international specialization and trade exist
  
• An economy can circumvent through international specialization and trade, the output limits imposed by its domestic production possibilities curve
  
• International Specialization: directing domestic resources to output that a nation is highly efficient at producing
  
• International Trade: involves the exchange of these goods for goods produced abroad
  
• Specialization and trade enable a nation to get more of a desired good at less sacrifice of some other good
  

  
  

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