copyright © 2001 by the mcgraw-hill companies, inc. all rights reserved. mcgraw-hill/irwin the...

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

The Economic The Economic Organization Of Organization Of

SocietySociety

Chapter 2Chapter 2


2 - 2

Laugher CurveLaugher Curve

Q. How many Marxists does it take to screw in a light bulb?

A. None.

The bulb contains within itself the seeds of its own revolution.


2 - 3

IntroductionIntroduction

An economic system must coordinate individuals' wants and desires.


2 - 4


An economic system has to solve three coordination problems: What, and how much, to produce. How to produce it. For whom to produce it.


2 - 5


Every economy faces the problem of how to make individuals do what society wants them to do.


2 - 6


Sometimes the goals of society and individuals conflict. An example is the NIMBY (Not In My Back Yard)

phenomenon. NIMBY was a 1990s mindset in which individuals approve

of a project so long as it is placed somewhere else.


2 - 7


One problem every economy faces is what to do with individuals who want to do what "society" does not want them to do.


2 - 8


An economic system must give the incentive to do those things that alleviate scarcity—produce more and consume less.


2 - 9


The coordination problems faced by society are immense.


2 - 10


The two main economic systems of the past 50 years, capitalism and socialism, answer these coordination problems differently.


2 - 11

CapitalismCapitalism

Capitalism is an economic system based upon private property and the market in which, in principle, individuals decide how, what, and for whom to produce.


2 - 12

Under Capitalism:Under Capitalism:

Individuals are encouraged to follow their own self-interest, while market forces of supply and demand are relied upon to coordinate those individual pursuits.


2 - 13


Distribution of goods is to each according to his or her ability, effort, or inherited property.


2 - 14


Government must allocate and defend private property rights. Private property rights – the

control a private individual or firm has over and asset or a right.


2 - 15

Reliance on the MarketReliance on the Market

Markets work through a system of rewards and payments.

Individuals are free to do whatever they want as long as it is legal.


2 - 16

Reliance on the MarketReliance on the Market

Prices coordinate individuals' wants. If there is not enough of something,

its price goes up. If there is too much, price goes down.


2 - 17

What’s Good About the What’s Good About the Market?Market? Most economists believe the market is a

good way to coordinate individuals' needs.


2 - 18

What’s Good About the What’s Good About the Market?Market? The primary debate among economists

is about how markets should be structured, and whether they should be modified and adjusted by government regulation.


2 - 19

SocialismSocialism

Socialism is, in theory, an economic system based on individuals’ good will toward others, not on their own self-interest.

In principle, society decides what, how, and for whom to produce.


2 - 20

Socialism in TheorySocialism in Theory

Socialism is an economic system that tries to organize society in the same way as families are organized.

Everyone contributes what they can and get what they need.


2 - 21

Socialism in TheorySocialism in Theory

If individuals' inherent goodness will not make them consider the general good, government will force them.


2 - 22

Socialism in PracticeSocialism in Practice

Economic systems based on upon people's goodwill have tended to break down.


2 - 23

Socialism in PracticeSocialism in Practice

Socialism in practice is often called Soviet-style socialism. Soviet-style socialism is an economic

system that uses administrative control or central planning to solve the coordination problems what, how, and for whom.


2 - 24

Types of Economic Types of Economic Systems of the PastSystems of the Past Feudalism dominated the Western world

from about the 8th to the 15th century.

Feudalism is an economic system in which traditions rule.


2 - 25

Evolving Economic Evolving Economic SystemsSystems Feudalism gave way to mechantilism.

Mechantilism is an economic system in which government determines the what, how, and for whom decisions by doling out the rights to undertake certain economic decisions.


2 - 26

Evolving Economic Evolving Economic SystemsSystems Mercantilism gave way to the Industrial

Revolution. Industrial revolution – a time when technology and

machines rapidly modernized industrial production and mass produced goods replaced handmade goods.


2 - 27

Evolving Economic Evolving Economic SystemsSystems Capitalism evolved from the Industrial

Revolution.


2 - 28

Evolving Economic Evolving Economic SystemsSystems Some economists prefer to call the

system that evolved from mercantilism the market economic system—an economic system that relies on markets to coordinate economic activities.


2 - 29

The Need for The Need for Coordination in an Coordination in an Economic SystemEconomic System Every economic needs coordination –

even capitalism.


2 - 30

The Need for The Need for Coordination in an Coordination in an Economic SystemEconomic System In his 1776 classic, Wealth of Nations,

Adam Smith explained how markets could coordinate the economy without the active involvement of government.


2 - 31

The Need for The Need for Coordination in an Coordination in an Economic SystemEconomic System Markets coordinate economic activity by

using the price mechanism to direct individuals' self-interest into society's interest.


2 - 32

Evolutionary Changes Evolutionary Changes Within SystemsWithin Systems Both capitalism and socialism are

constantly evolving with changes in social customs, political forces, and the strength of markets.


2 - 33

Evolutionary Changes Evolutionary Changes Within SystemsWithin Systems A purer form of capitalism evolved into

welfare capitalism—an economic system in which the market operates but government regulates markets significantly.


2 - 34

Evolutionary Changes Evolutionary Changes Within SystemsWithin Systems The opposite took place in socialist

nations—socialism integrated capitalist institutions into its existing institutions.


2 - 35

A Blurring of the A Blurring of the Distinction Between Distinction Between Capitalism and Capitalism and SocialismSocialism Recent events point to a blending of

capitalism and socialism.


2 - 36

A Blurring of the A Blurring of the Distinction Between Distinction Between Capitalism and Capitalism and SocialismSocialism If this trend continues, the 21st century

will see the emergence of a single general type of economic system, a blended capitalist-socialist system.


2 - 37

The choices made by society are often presented in terms of a production possibility curve.

The Production The Production Possibilities Curve and Possibilities Curve and Economic ReasoningEconomic Reasoning


2 - 38

The production possibilities curve shows the trade-offs among choices we make.

The Production The Production Possibilities Curve and Possibilities Curve and Economic ReasoningEconomic Reasoning


2 - 39

The Production The Production Possibility TablePossibility Table A production possibility table lists a

choice's opportunity costs by summarizing what alternative outputs you can achieve with your inputs.


2 - 40

The Production The Production Possibility TablePossibility Table Three things to know to understand a

production possibility table: Opportunity cost – every decision has a cost

in forgone opportunities. Output – an output is simply a result of an

activity. Input – an input is what you what you put into

a production process to achieve an output.


2 - 41

The Production The Production Possibility CurvePossibility Curve A production possibility curve

measures the maximum combination of outputs that can be achieved from a given number of inputs.

It slopes downward from left to right.


2 - 42

The Production The Production Possibility CurvePossibility Curve The production possibility curve not only

represents the opportunity cost concept, it also measures the opportunity cost.


2 - 43

The Production The Production Possibility CurvePossibility Curve The production possibility curve

demonstrates that: There is a limit to what you can achieve, given the

existing institutions, resources, and technology. Every choice made has an opportunity cost—you can get

more of something only by giving up something else.


2 - 44

Eco

nom

ics

grad

e

100

88

70

4640

58 66 78 94 98History grade

20 hours of history

0 hours of economics

ED

C

B

20 hours of economics 0 hours of historyA

Hours of study in history

Grade inhistory

Hours of study in economics

Grade ineconomics

20 19 18 17 16 15 14 13 12 11 10

9 8 7 6 5 4 3 2 1 0

98 96 94 92 90 88 86 84 82 80 78 76 74 72 70 68 66 64 62 60 58

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97

100

The Production The Production Possibility CurvePossibility Curve


2 - 45

Increasing Marginal Increasing Marginal Opportunity CostOpportunity Cost The production possibility curve is

generally bowed outward since some resources are better suited for the production of some goods.


2 - 46

Increasing Marginal Increasing Marginal Opportunity CostOpportunity Cost The concept of comparative advantage

explains why opportunity costs increase as the consumption of a good increases.

Some resources are better suited for the production of some goods than to the production of other goods.


2 - 47

Increasing Marginal Increasing Marginal Opportunity CostOpportunity Cost

Y

1098

6543210

.2Y

1X

A

X1 2 3 4 5 6 7 8 9

If the slope of the production curve is -2 at A, the

opportunity cost of 1X is 2Y.

7


2 - 48

Increasing Marginal Increasing Marginal Opportunity CostOpportunity Cost The principle of increasing opportunity

cost states that opportunity costs increase the more you concentrate on an activity.

In order to get more of something, one must give up ever-increasing quantities of something else.


2 - 49


% of resources devoted toproduction of guns

Number of guns

% of resources devoted toproduction of butter

Pounds of butter Row

0 20 40 60 80

100

0 4 7 9 11 12

100 80 60 40 20 0

15 14 12 9 5 0

A B C D E F


2 - 50

1211


AB

utte

r

Guns4 7 90

1 gun

5 pounds of butter

5

9

15

3 guns

2 pounds of butter

B

C

D

E

F

14

12

4 guns

1 pound of butter


2 - 51


But

ter

Slope is flat at A. Low opportunity

cost of guns.

Slope is steep at B. High opportunity cost of guns.

Guns

B

A


2 - 52

EfficiencyEfficiency

In our production, we would like to have productive efficiency—achieving as much output as possible from a given amount of inputs or resources.


2 - 53


Efficiency involves achieving a goal as cheaply as possible.

Efficiency has meaning only in relation to a specified goal.


2 - 54


Any point within the production possibility curve represents inefficiency—getting less output from inputs which, if devoted to some other activity, would produce more output.


2 - 55


Any point outside the production possibility curve represents something unattainable, given present resources and technology.


2 - 56

Efficiency and InefficiencyEfficiency and InefficiencyG

uns

10

8

6

4

2

0 2 4 6 8 10

Butter

C D

A

B

Efficientpoints

Inefficientpoint

Unattainable point, given available technology, resources and labor force


2 - 57

Shifts in the Production Shifts in the Production Possibility CurvePossibility Curve Society can produce more output if:

Technology is improved. More resources are discovered. Economic institutions get better at

fulfilling our wants.


2 - 58

Shifts in the Production Shifts in the Production Possibility CurvePossibility Curve More output is represented by an

outward shift in the production possibility curve.


2 - 59

Neutral Technological Change

Butter

A

B Guns0

Shifts in the Production Shifts in the Production Possibility CurvePossibility Curve

C

D


2 - 60

Biased Technological Change

Shifts in the Production Shifts in the Production Possibility CurvePossibility Curve

0

B

A

Butter

Guns

C


2 - 61

Distribution and Distribution and Production EfficiencyProduction Efficiency The production possibilities curve

focuses on productive efficiency and ignores distribution.

An increase in output that goes to one person and not to anyone else would not necessarily be efficient in some societies.


2 - 62

Distribution and Distribution and Production EfficiencyProduction Efficiency U.S.economists often talk about

efficiency as if it means productive efficiency and achieving society's goals.

In our society, more is generally preferred to less and many policies have relatively small distributional effects.


2 - 63

Examples of Shifts in Examples of Shifts in the Production the Production Possibility CurvePossibility Curve If more inputs are available for the

production of X and Y equally, the PPC shifts out along both X and Y axes.

If fewer inputs are available for the production of X and Y equally, the PPC shifts in along both X and Y axes.


2 - 64

Examples of Shifts in Examples of Shifts in the Production the Production Possibility CurvePossibility Curve If more inputs are available for good X

only, the PPC shifts out on the X axis only.

If more inputs are available for good Y only, the PPC shifts out on the Y axis only.


2 - 65

(a) (c) (d)(b)

Examples of Shifts in Examples of Shifts in the Production the Production Possibility CurvePossibility Curve


2 - 66

The Production The Production Possibility Curve and Possibility Curve and Economic SystemsEconomic Systems The production possibility curve

presents choices in a timeless fashion but most choices are dependent on previous choices made sequentially with a time dimension.


2 - 67

The Production The Production Possibility Curve and Possibility Curve and Economic SystemsEconomic Systems Sequential decisions can best be seen

within a framework of a decision tree—a visual description of sequential choices.


2 - 68

The Production The Production Possibility Curve and Possibility Curve and Economic SystemsEconomic Systems Low-level choices are choices that

involves general acceptance of the path one has taken.

Institutional choices are choices that make major institutional changes.


2 - 69

The Production The Production Possibility Curve and Possibility Curve and Economic SystemsEconomic Systems Systemic choices are fundamental

choices that determine the set of institutional and low-level choices available.


2 - 70

The Production The Production Possibility Curve and Possibility Curve and Economic SystemsEconomic Systems All decisions are made in context – what

makes sense in one context may not make sense in another.


2 - 71

The Production The Production Possibility Curve and Possibility Curve and Economic SystemsEconomic Systems Decisions are contextual.

What the production possibility curve for a particular decision looks like depends on existing institutions

The analysis can be applied only in the institutional and historical context.


2 - 72

A Decision TreeA Decision Tree

Low-leveldecisions

Institutionaldecisions

Systemicdecisions

B A


2 - 73

The Production The Production Possibility Curve and Possibility Curve and Tough ChoicesTough Choices The production possibility curve

represents tough choices.


2 - 74

The Production The Production Possibility Curve and Possibility Curve and Tough ChoicesTough Choices Politicians make promises as though

the production possibility curve did not exist or that the economy can operate outside the economy's production possibility curve.


2 - 75

The Production The Production Possibility Curve and Possibility Curve and Tough ChoicesTough Choices Economists continually point out that

seemingly free lunches often involve significant costs thus earning for themselves the nickname, the dismal science.


2 - 76Comparative Comparative Advantage, Advantage, Specialization, and Specialization, and TradeTrade The production possibility curve

becomes bowed out when individuals specialize in the production of goods for which they have a comparative advantage and trade with others.


2 - 77Comparative Comparative Advantage, Advantage, Specialization, and Specialization, and TradeTrade The comparative advantage argument

used to explain the bowed-out shape of the production possibilities curve can be used to show how trade makes society better off.


2 - 78Comparative Comparative Advantage, Advantage, Specialization, and Specialization, and TradeTrade Collaboration and specialization can

make society better off. Total production can rise.


2 - 79Comparative Comparative Advantage, Advantage, Specialization, and Specialization, and TradeTrade The outward bow graphically represents

the potential gains from trade.


2 - 80

The Gains From TradeThe Gains From Trade

Sunder can either write one economics paper or four creative writing papers in a day.

Ti can either write one creative writing paper or four economics papers in a day.


2 - 81


Sunder has a comparative advantage in creating writing and Ti has a comparative advantage in economics.


2 - 82


The following table and production possibility curves demonstrate how output increases when two individuals collaborate and specialize in the activity for which each has a comparative advantage.


2 - 83



2 - 84



2 - 85


Each individual's PPC is drawn by connecting the number of papers each can write in a day on a graph.


2 - 86

The Gains From TradeThe Gains From TradeE

cono

mic

s

1 2 3 4 5

4

3

2

1

5

(b) Sunder

(a) Ti

Creative writing


2 - 87


The combined PPC curve is drawn by finding three points and connecting them.


2 - 88

The Gains From TradeThe Gains From TradeE

cono

mic

s

1 2 3 4 5

(c) Combined with trade

4

3

2

1

5

(b) Sunder

(a) Ti

B

C

A

Creative writing


2 - 89


Point A: This is the combined number of economics papers they both can write in a day.

If economics papers are on the Y axis, it is point 0,5.


2 - 90


Point B: This is the combined number of creative papers they both can write in a day.

If economics papers are on the Y axis, it is point 5,0.


2 - 91


Point C: This is where each is focusing on that activity for which he or she has a comparative advantage.

Sunder writes four creative papers and Ti writes four economics papers.

This is the coordinates 4,4.


2 - 92


The combined PPC is bowed out because of Point C – comparative advantage and specialization.


2 - 93

The Division of LaborThe Division of Labor

Markets allow specialization and the division of labor.

They allow individuals to develop their comparative advantages, thereby increasing the production possibilities of society.


2 - 94

Markets, Markets, Specialization, and Specialization, and GrowthGrowth Markets and specialization have led to

growth.


2 - 95

Markets, Markets, Specialization, and Specialization, and GrowthGrowth The growth in per capita income

(constant 1990 dollars) in the past 2 millennia has been astonishing.

This owes largely to the introduction of markets and democracy.


2 - 96

Markets, Markets, Specialization, and Specialization, and GrowthGrowth As people are allowed to compete and

specialize, they get better at what they do, develop new technologies and the market grows ever larger.


2 - 97

Growth in the Past Two Growth in the Past Two MillenniaMillennia

$6,000

$5,000

$4,000

$3,000

$2,000

$1,000

2000150010005000

Pe

r ca

pit

a in

co

me

(in

19

90 in

tern

ati

on

al d

olla

rs)


The Economic The Economic Organization Of Organization Of

SocietySociety

End of Chapter 2End of Chapter 2

copyright © 2001 by the mcgraw-hill companies, inc. all rights reserved. mcgraw-hill/irwin the...

Documents

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introduction u

u individuals

capitalism u capitalism

u government

u distribution of goods

individuals conflict

goals of society