The Economizing Problem

The Foundation of Economics

The economizing problem:

  • Society’s economic wants: that is, the economic wants of its citizens and institutions - are virtually unlimited and insatiable[1]
    • By economic wants we refer to the desires of consumers to have and use goods and services that provide statisfaction, or utility.
    • These wants extend over a wide range of products: from necessities such as food, shelter, or clothing to luxuries such as prefumes, race cars, designer shoes etc.
    • As time passes consumer wants multiply and change.
    • For example, we now want goods such as DVD players, and digital cameras that did not exist before.
    • Services such as car repair work, are also considered economic wants.
  • Scarcity of available resources: resources are limited and therefore these wants cannot all be satisfied.
    • There is only so much lumber or raw metal to be had in the world, and there is only so much time in any given day

We solve the fundamental problem of economics, in part, by achieving efficiency. There are two types of efficiency:
  • productive efficiency: when all resources are used to their utmost efficiency. There is no greater output that can be a result of the resources than the output at its maximum productive efficiency.
  • allocative efficiency: when all resources are distributed to consumers. That is, no goods which people do not want are produced. The allocation of these resources that satisfies the most number of wants in the economy has reached maximum allocative efficiency.
    • Allocative efficiency occurs at the point that the marginal benefit is equal to the marginal cost.
  • The process of producing and purchasing capital goods is known as investment. (McConnel and Brue)

Unlimited Wants

  • Economic wants are classified[2]as “desires of consumers to obtain and use various goods and services that provide pleasure or satisfaction, [called utility]”
    • These wants include necessities (food, shelter, and clothing) to luxuries (sports bcars, jewelry, and cologne).
  • Time changes and adds to our wants, bringing new services and products into the market for consumers to purchase. For example a few years ago we didn't want 3D TV's because they didn't exist. The more products that come out the more our wants widen towards the unlimited.
  • Businesses and government seek satisfaction of their wants too: businesses want more capital and newer technology for better production, and the government reflects its citizens’ wants through highways, new programs, and military protection[3]
  • Economists assume that humans are rational and therefore make decisions based on "rational self interest."
  • According to Wilson, the objective of all economic activity is to fulfill those wants.
  • Example: Food, clothes cars, gas.
  • Individuals can only be satisfied of wants only for a limited time period.

Other Things Equal Assumption

  • Other Things Equal Assumption (or ceteris paribus) is to assume that all other variables, except those under immediate consideration, are held constant for a particular analysis[4]
  • Very important when attempting to predict

Types of Resources:

  • Types of resources are also called factors of production: these factors of production consist of any resources needed to produce goods and services (factors of production account for input while finished good account for output).
  • Property resources include land, raw materials, and capital; human resources include labor and entrepreneurial ability.
  • Land: This includes using all natural resources, not only physical."
  • "Gift of Nature"(McConnel and Brue).
    • Example: Forests, Rivers, lakes.
  • Labor: This includes the talents and abilities of people that are used as resources
    • Example: Teacher
  • Capital: Any resource that is manufactured and is used in producing other consumer goods
    • Example: Computers
    • Capital goods and consumer goods differ from each other in that only consumer goods satisfy ‘wants’ directly. Capital goods solely aid the production of consumer goods (McConnell and Brue, 23).
    • Financial capital- Money used as a means of obtaining real capital such as tools or machinery (McConnell and Brue, 23).
    • capital investment is the strategic producing and purchasing of capital goods[5]
    • capital goods do not directly satisfy consumer wants, but rather goes into the process of producing goods that do
  • Entrepreneurial Ability: a resource apart from labor that includes the ability of one to take the initiative, make decisions, innovate, and bear risk[6]
  • The entrepreneur makes the strategic business decisions that set the course of an enterprise. (McConnel and Brue)
  • The entrepreneur is a innovator (McConnel and Brue)
    • Example: Founders of firms
    • in taking the initiative: they put together different resources to produce a good or service.
    • in being an innovator: they make new new products, and new ways to produce these goods or services that are either more efficient or improve the product.
  • These four resources, factors of productions, are combined to produce goods and services.
  • They are scarce in supply

Resource Payments:

  • Rental Income: income received from supplying raw materials
  • Interest Income: income received from capital investment
  • Wages: income for those who supply labor
  • Profit: Entrepreneurial income (may be negative-loss)

Relative Scarcity:

  • All types of economic resources have one thing in common: they are all scarce or limited in supply[7]
  • Most resources used by humans are scarce on our planet, such as arable land, minerals, and fossil fuels. Other scarce resources may consist of capital goods, and labor.
  • Because of our unlimited wants, scarcity is inevitable. There is always one type of resource or material good that is wanted, thus making its supply relatively scarce.
    • if an area wants farm land then they sacrifice the ability to use the farm land for other purposes.
  • The scarcity of resources constraints productivity activity and output.
  • For example in 2002 output per person was limited to $36, 000 in the Unites States.

Economics: Employment and Efficiency

  • Economics is the social science concerned with the problem of using scarce resources to attain the maximum fulfillment of society's unlimited wants.
    • Society wants to use its limited resources efficiently, producing as many goods and services as possible in order to maximize satisfaction.

Full employment: Using Available Resources

  • Full employment: The use of all available resources to produce want-satisfying goods and services[8]
  • All available resources must be used. This takes into account the exceptions that each society decides on such as what age must an individual be to be employed, how long and how many periods must land stay dormant to gain nutrients, and reduce the use of certain resources.
  • No worker should be out of work if they are willing and able to work.
  • Capital equipment and arable land should not sit idle.
  • To best use scarce resources a society must achieve both full employment and full production.

Full Production: Using Resources Efficiently

  • Full employment is not enough to achieve efficiency, so society must realize full production as well.
  • Full production: Employment of available resources so that the maximum amount of (or total value of ) goods and services is produced[9]
  • obtains the most desired combination of goods and services by efficiently distributing limited resources among industries and firms[10]
  • Full production has two kinds of efficiency: productive efficiency and allocative efficiency
    • Failing to reach full production implies that one’s economic resources are ‘underemployed’ (24).
    • Productive efficiency: Making a type of good or service in the cheapest way possible.
      • Example: Society has $1000 of resources available. Society wants to produce TVs and can make them for $50. By doing this $950 will go to other things. This is preferred over the option of making TVs for $100 and $900 going to other things.
    • Allocative efficiency:The cheapest way possible of making a good or service most wanted by society.
      • Example: Society wants video games and not books, so society will allocate its resources to video games and not to the books. Society will use its limited resources to get what it wants most and the rest to other goods.

Production Possibilities Table

  • The necessity and consequences of people having to choose which goods and services to produce and which to not can be seen through a production possibilities table, followed by a production possibilities curve.
  • Production Possibilities Table: table that lists the different combinations of two products that can be produced with a specific set of resources(McConnell and Brue).
  • Assumptions:
    • Full employment and productive efficiency - the economy is basically using all of its resources and producing goods and services at the lowest possible cost.
    • Fixed resources - the supplies that are available stay the same in both quantity and quality.
    • Fixed technology - the different ways and methods used to produce a good or service does not change.
    • Two goods - the economy is only producing two goods: consumer goods, products that directly satisfy our wants, and capital goods, products that indirectly satisfy our wants by more efficiently producing consumer goods.
  • There is a need to choose what products we want under the assumption of fixed resources and we can choose in either two ways
    • We can choose to produce products that directly satisfy our wants and shift resources directly to consumer goods leaving less resources towards capital goods
    • We can choose to reduce current consumption of resources toward consumer goods as to leave more for capital goods that will increase production in the future

Production Possibilities Curve:

  • Society cannot get everything it wants since there are limited resources and cannot have unlimited output. So society must make sacrifices and choose which good or service they want to produce over what they can give up.
  • A production possibilities curve is a graph that shows the possible productions of two goods/services that use the same fixed levels of the factors of production.
  • Used to represent several economic concepts such as productive efficiency, opportunity cost and scarcity of resources.
  • Production possibilities curves portrays productive efficiency in that the level of production of one good is maximized based off of the production level of another good.

Law of Increasing Opportunity Cost

  • Opportunity cost is whatever must be given up to obtain another good or service. (Opportunity cost is opportunity lost).
  • For example, if Joe has $1 and he spends that dollar on a candy bar, his opportunity cost is not the dollar itself, but anything else he could have used that dollar to purchase.
  • Law of Increasing Opportunity Cost states that the more one product is produced the greater the opportunity cost of another good or service.[11]
    • This is to say that other alternatives must be sacrificed (perhaps more productively efficient and necessary alternatives) in order for production of the same product to occur.

Shaping of the Curve

  • The production possibilities curve is meant to relfect the law of increasing opportunity cost.
  • The curve of it is bowed out from the origin of the graph.
    • A production possibilities curve assuming constant costs (and thus no increasing opportunity costs) assumes a linear form.
external image ppp-incr.gif

  • Points on the curve are attainable and efficient.
  • Points inside of the curve are attainable but inefficient.
  • Points outside of the curve are unattainable with current technology and resources.

Economic Rationale (for the Law of Increasing Opportunity Costs)

  • Economic resources are not completely adaptable to alternative uses, so many resources are better at producing one good than at producing another. As production of one good is increased, resources that are less and less adaptable to the production of that good must be used. Those resources then cannot be used to produce the goods which they are ideally suited to produce. Thus, as production of a certain good increases, so does opportunity cost.

Allocative Efficiency Revisted

  • Allocative efficiency requires that the economy produce at the optimal point of the production possibilities curve-- that is, the point at which consumers demands for each product is met but not exceeded, and maximum profit is made.
  • The Marginal benefit should always exceed that marginal cost in expanding, taking into consideration the economic perspective where MB=MC, because this is where the optimal amout of activity happens(McConnell and Brue)

==Types of Economies [12]
  • Market system: The interactions between the consumers and suppliers determine the equilibrium price and quantity of each good or service. Theoretically, the privately owned resources are allocated according to where marginal benefit equals marginal cost. This may also be referred to as capitalism.
    • There are not pure "market economies" in the world, just mixed-market economies because all economies have some sort of regulation
    • Based off of the concept of supply and demand
    • Laissez-faire- A view of capitalism that emphasizes minimal government in the market system. Monetarists—part of a modern sub-group under classical economics—are also opposed to discretionary fiscal policy, but support the monitory rule.
    • Many countries that are considered capitalist do not practice laissez-faire economics. Discretionary fiscal and monetary policy may often be used to try and prevent recessions or inflation.
  • Command System (communism or socialism): The government owns nearly all of the economic resources and determines how to allocate these resources in order produce a specified set of goods and services.
    • A pure command system, one in the economy depends solely on a central plan to allocate all government-owned property, is impossible in practice. Even the Soviet Union, the primary example of a command system before it disintegrated in 1992, allowed some private ownership and markets.

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