the economizing problem economic systems lecture 3 & 4 dominika milczarek-andrzejewska
TRANSCRIPT
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The Economizing Problem
Economic Systems
Lecture 3 & 4Dominika Milczarek-
Andrzejewska
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Outline of Lecture 3 and 4
• Unlimited Wants• Scarce Resources• Resource Categories• Employment and Efficiency• Production Possibilities Curve• Economic Systems (Market and
Command System)• Circular Flow Model
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Economizing problem:
Society’s material wants are unlimited while resources are limited or scarce.
• Suppose you have $50 and are deciding how to spend it.
• Should you buy a new pair of jeans or three compact discs?
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Unlimited Wants (The First Fundamental Fact)
1. Economic wants - desires of people to use goods and services that provide utility
2. Luxuries or necessities– Food and race cars
3. Services satisfy wants as well as goods4. Businesses and governments also have
wants– Business – equipment; government - schools
5. Over time, wants change and multiply– DVD, digital cameras
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Scarce Resources (The Second Fundamental Fact)
• Economic resources - limited relative to wants
• Economic resources - sometimes called factors of production
• Four categories:– Land or natural resources,– Capital or investment goods (tools,
equipment, factories, etc.)– Labor or human resources– Entrepreneurial ability
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Entrepreneurial ability
1.Takes initiative - Combines resources needed for production
2. Makes strategic business decisions
3.Innovator for new products, production techniques, organizational forms
4.Bears the risk of time, effort, and funds
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Resource payments
Property resources:LAND
CAPITAL
Human resources:LABOR
ENTREPRENEUR
RENTAL INCOMEINTEREST INCOME
WAGES
PROFITS
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Employment and Efficiency
• Economics is a science of efficiency in the use of scarce resources.
• Efficiency requires:– full employment of available resources
and – full production
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Allocative and Productive Efficiency
Full production: employed resources are providing maximum satisfaction of our economic wants.
Full production implies two kinds of efficiency:1. Allocative efficiency - resources are used
for producing the combination of goods and services most wanted by society– for example, producing computers with word
processors rather than manual typewriters
2. Productive efficiency - least costly production techniques are used
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Allocative and Productive Efficiency
• Full production means producing the “right” goods (allocative efficiency) in the “right” way (productive efficiency)
• Allocative efficiency requires productive efficiency
• Productive efficiency can occur without allocative efficiency – Goods can be produced in the least costly
method without being the most wanted by society
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Production Possibilities
Assumptions:1. Economy is operating efficiently2. Available supply of resources is fixed in
quantity and quality at this point in time3. Technology is constant during analysis4. Economy produces only two types of
products
• Choices will be necessary because resources and technology are fixed
• A production possibilities curve is a graphical representation of choices
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Using all of our resources, to get some pizza, we must give
up some robots!
What if we could only produce ...
10,000 Robotsor
400,000 Pizzas
Production Possibilities
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PIZZA 0 1 2 34(in hundred thousands)ROBOTS 10 9 74 0(in thousands)
in table form
Production Possibilities
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PIZZA 0 1 2 34(in hundred thousands)ROBOTS 10 9 74 0(in thousands)graphical form
Rob
ots
(th
ou
san
ds)
Pizzas (hundred thousands)
Production Possibilities
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PIZZA 0 1 2 34(in hundred thousands)ROBOTS 10 9 74 0(in thousands)graphical form
Rob
ots
(th
ou
san
ds)
Pizzas (hundred thousands)
Production Possibilities
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PIZZA 0 1 2 34(in hundred thousands)ROBOTS 10 9 74 0(in thousands)graphical form
Rob
ots
(th
ou
san
ds)
Pizzas (hundred thousands)
Production Possibilities
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PIZZA 0 1 2 34(in hundred thousands)ROBOTS 10 9 74 0(in thousands)graphical form
Rob
ots
(th
ou
san
ds)
Pizzas (hundred thousands)
Production Possibilities
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PIZZA 0 1 2 34(in hundred thousands)ROBOTS 10 9 74 0(in thousands)graphical form
Rob
ots
(th
ou
san
ds)
Pizzas (hundred thousands)
Production Possibilities
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PIZZA 0 1 2 34(in hundred thousands)ROBOTS 10 9 74 0(in thousands)graphical form
Rob
ots
(th
ou
san
ds)
Pizzas (hundred thousands)
Production Possibilities
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Rob
ots
R
ob
ots
(th
ou
san
ds)
(th
ou
san
ds)
Pizzas Pizzas (hundred thousands)(hundred thousands)
1313121211111010 99 88 77 66 55 44 33 22 11
1 2 3 4 5 6 7 81 2 3 4 5 6 7 8
A B
C
D
E
W
Attainablebut
Inefficient
UnattainablUnattainablee
AttainableAttainable& Efficient& Efficient
Production Possibilities
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Production Possibilities • Points on the curve represent maximum
possible combinations of goods given resources and technology
• Points inside the curve represent underemployment or unemployment
• Points outside the curve are unattainable
• Optimal or best product-mix: – a point on the curve; – the exact point depends on society (a normative
decision)
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Law of Increasing Opportunity Costs
Opportunity cost - the amount of other products that must be foregone to obtain more of any given product
• The more of a product produced the greater is its opportunity cost
• The slope of the production possibilities curve becomes steeper, demonstrating increasing opportunity cost. – the curve is bowed out, – concave from the origin
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Law of Increasing Opportunity Costs
Economic Rationale:
• Economic resources are not completely adaptable to alternative uses
For example:
– To get increasing amounts of pizza, resources that are not particularly well suited for that purpose must be used
– Workers that are accustomed to producing robots on an assembly line may not do well as kitchen help
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Allocative Efficiency Revisited
How does society decide its optimal point on the production possibilities curve?
– It is advantageous to have the additional product if
MB > MC
– It is not “worth” it to society to produce the extra unit if
MB < MC
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P
Q
Marg
inal B
en
efi
t &
Cost
Quantity of Pizzas
$15
10
5
1 2 3
MC
MB
MB=MC
Allocative Efficiency: MB=MC
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Unemployment and Growth
• Unemployment and productive inefficiency– the economy is producing less than full
production or– inside the curve
• In a growing economy, the production possibilities curve shifts outward– when resource supplies expand in
quantity or quality– when technological advances are
occurring
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Q
Q
Rob
ots
(th
ou
san
ds)
Pizzas (hundred thousands)
13121110 9 8 7 6 5 4 3 2 1
1 2 3 4 5 6 7 8
U
Unemployment &Underemployment Shown by Point U
More of either orboth is possible
Production Possibilities
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Economic Growth
Q
Q
Rob
ots
(th
ou
san
ds)
Pizzas (hundred thousands)
1413121110 9 8 7 6 5 4 3 2 1
1 2 3 4 5 6 7 8
A’
B’
C’
D’
E’
Production Possibilities
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Production Possibilities
Shifts of production Possibilities Curve:• Increases in the quality and quantity
of female participation in the labor force
• Technological advances
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International Trade
• A nation can avoid the output limits of its domestic Production Possibilities through international specialization and trade
• Specialization and trade have the same effect as having more and better resources of improved technology
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Economic Systems
• Differences:
– Who owns the factors of production and
– The method used to coordinate economic activity
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Economic Systems• The market system:
– There is private ownership of resources;– Markets and prices coordinate and
direct economic activity;– Each participant acts in his or her own
self-interest;– In pure capitalism the government plays
a very limited role;– In the European version of capitalism,
the government plays a substantial role.
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Economic Systems• Command economy, socialism or
communism:– There is public (state) ownership of
resources.– Economic activity is coordinated by
central planning.
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The Circular Flow Model
• Two groups of decision makers in the private economy: households and businesses
• The market system coordinates these decisions.
• In the resource markets:– Households sell resources– Businesses buy resources in order to produce
goods and services
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The Circular Flow Model
• Interactions determine the price of each resource
• Flow of payments from businesses for the resources constitutes business costs and resource owners’ incomes.
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The Circular Flow Model
• In the product markets:– Households purchase goods and services– Businesses offer products for sale– Interactions determine the price of each product– Flow of consumer expenditures constitutes sales
receipts for businesses
Circular flow model illustrates this complex web of decision-making and economic activity that give rise to the real and money flows.
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BUSINESSES HOUSEHOLDS
RESOURCEMARKET
PRODUCTMARKET
The Circular Flow Model
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BUSINESSES HOUSEHOLDS
RESOURCEMARKET
RESOURCES INPUTS
PRODUCTMARKET
The Circular Flow Model
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BUSINESSES HOUSEHOLDS
RESOURCEMARKET
RESOURCES INPUTS
$ COSTS $ INCOMES
GOODS &GOODS &SERVICESSERVICES
GOODS &GOODS &SERVICESSERVICES
PRODUCTMARKET
The Circular Flow Model
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BUSINESSES HOUSEHOLDS
RESOURCEMARKET
RESOURCES INPUTS
$ COSTS $ INCOMES
PRODUCTMARKET
GOODS &SERVICES
GOODS &SERVICES
The Circular Flow Model
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BUSINESSES HOUSEHOLDS
RESOURCEMARKET
RESOURCES INPUTS
$ COSTS $ INCOMES
PRODUCTMARKET
GOODS &SERVICES
GOODS &SERVICES
$ CONSUMPTION$ REVENUE
The Circular Flow Model
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The Circular Flow Model
Limitations of the model:• No transactions between households
and businesses• Lack of government and the “rest of
the world”• Lack of explanation how prices of
products and resources are determined
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Key Terms
• ECONOMIC RESOURCES• FACTORS OF
PRODUCTION• FULL EMPLOYMENT • FULL PRODUCTION• PRODUCTIVE
EFFICIENCY• ALLOCATIVE
EFFICIENCY• PRODUCTION
POSSIBILITIES TABLE• PRODUCTION
POSSIBILITIES CURVE
• OPPORTUNITY COST• LAW OF INCREASING
OPPORTUNITY COST• ECONOMIC GROWTH• ECONOMIC SYSTEM• MARKET SYSTEM• CAPITALIZM • COMMAND SYSTEM• RESOURCE MARKET• PRODUCT MARKET• CIRCULAR FLOW
MODEL