The Economic Problem:The Economic Problem:Scarcity and ChoiceScarcity and Choice

What is Production?What is Production?

• ProductionProduction is the process by which resources is the process by which resources are transformed into useful forms.are transformed into useful forms.

• ResourcesResources, or , or inputsinputs, refer to anything , refer to anything provided by nature or previous generations provided by nature or previous generations that can be used directly or indirectly to satisfy that can be used directly or indirectly to satisfy human wants.human wants.

• Capital resourcesCapital resources• Human resourcesHuman resources• Natural resourcesNatural resources

Three Basic QuestionsThree Basic Questions

• The mechanics of decision making in a larger economy The mechanics of decision making in a larger economy are more complex, but the type of decisions that must are more complex, but the type of decisions that must be made are nearly identical.be made are nearly identical.

• All societies must decide:All societies must decide:

• WhatWhat will be produced? will be produced?

• HowHow will it be produced? will it be produced?

• WhoWho will get what is produced? will get what is produced?

Three Basic QuestionsThree Basic Questions

Capital Goods and Consumer GoodsCapital Goods and Consumer Goods

• Consumer goodsConsumer goods are goods are goods produced for present produced for present consumption.consumption.

• Capital goodsCapital goods are goods used are goods used to produce other goods or to produce other goods or services over time.services over time.

The Economic ProblemThe Economic Problem

• The economic problem:The economic problem: Given scarce resources, Given scarce resources, how, exactly, do large, complex societies go about how, exactly, do large, complex societies go about answering the three basic economic questions?answering the three basic economic questions?

• Economic systemsEconomic systems are the basic arrangements are the basic arrangements made by societies to solve the economic problem. made by societies to solve the economic problem. They include:They include:

• Command economiesCommand economies

• Laissez-faire economiesLaissez-faire economies

• Mixed systemsMixed systems

The Economic ProblemThe Economic Problem

• In a In a command economycommand economy, a central government either , a central government either directly or indirectly sets output targets, incomes, and directly or indirectly sets output targets, incomes, and prices.prices.

• In a In a laissez-faire economylaissez-faire economy,, literally from the French: literally from the French: “allow (them) to do,” individual people and firms “allow (them) to do,” individual people and firms pursue their own self-interests without any central pursue their own self-interests without any central direction or regulation. The central institution of a direction or regulation. The central institution of a laissez-faire economy is the laissez-faire economy is the free-market systemfree-market system..

• A A marketmarket is the institution through which buyers and is the institution through which buyers and sellers interact and engage in exchange.sellers interact and engage in exchange.

Laissez-Faire Economies:Laissez-Faire Economies:The Free MarketThe Free Market

• Consumer sovereignty Consumer sovereignty is the idea that is the idea that consumers ultimately dictate what will be consumers ultimately dictate what will be produced (or not produced) by choosing what produced (or not produced) by choosing what to purchase (and what not to purchase).to purchase (and what not to purchase).

• Free enterprise:Free enterprise: under a free market system, under a free market system, individual producers must figure out how to individual producers must figure out how to plan, organize, and coordinate the production plan, organize, and coordinate the production of products and services.of products and services.

Laissez-Faire Economies:Laissez-Faire Economies:The Free MarketThe Free Market

• The The distribution of outputdistribution of output is also determined is also determined in a decentralized way. The amount that any in a decentralized way. The amount that any one household gets depends on its income one household gets depends on its income and wealth.and wealth.

• The basic coordinating mechanism in a free The basic coordinating mechanism in a free market system is price. market system is price. PricePrice is the amount is the amount that a product sells for per unit. It reflects what that a product sells for per unit. It reflects what society is willing to pay.society is willing to pay.

Mixed Systems, Markets, and Mixed Systems, Markets, and GovernmentsGovernments

Markets are not perfect, and governments play a Markets are not perfect, and governments play a major role in all economic systems in order to:major role in all economic systems in order to:

• Minimize market inefficienciesMinimize market inefficiencies

• Provide public goodsProvide public goods

• Redistribute incomeRedistribute income

• Stabilize the macroeconomyStabilize the macroeconomy

• Promote low levels of unemploymentPromote low levels of unemployment

• Promote low levels of inflationPromote low levels of inflation