Chapter 3:The Economic Problem – The Problem of Scarcity

Limited resources < Unlimited Wants

The Resources of the Economy Resources or Factors of Production are

the various things that can be used to produce goods and services

Land – resources given to us by nature eg. Minerals, fish, oxygen, rivers, lakes, sunlight

Labour – physical and mental efforts that people contribute to production

Capital – any manufactured good that is used for the production of other goods and services

Entrepreneurship – includes managerial and decision making skills; the bringing together of the factors of production to organize them into production

RESOURCES

Factorsof

ProductionCharacteris

ticsCompensati

on

Land All natural resources

Rent

Labour Human Resources

Wages and salaries

Capital Manufactured Resources

Interest and dividends

Entrepreneurship

Organization and Decision Making skills

Profits

SCARCITY, CHOICE and OPPORTUNITY COST

•  Scarcity of resources requires a choice between wants

Opportunity cost refers to the alternative that is sacrificed when a choice is made

Example: If a city decides to build a school instead of adding a wing to a hospital, then the opportunity cost of the school is the additional hospital facilities that the city would have had instead

PRODUCTION POSSIBILITIES

the PPC (production possibilities curve) is an economic model that illustrates the economic problem of scarcity

Assume that an economy devotes all of its resources to the production of only two goods, houses and automobiles

Several possible combinations of houses and automobiles is possible, as illustrated in the production possibilities schedule

Production Possibilities SchedulePossibilities Number of

Houses Number of Automobiles

1 0 8, 000, 0002 100, 000 7, 000, 0003 200, 000 6, 000, 0004 300, 000 5, 000, 0005 400, 000 4, 000, 0006 500, 000 3, 000, 0007 600, 000 2, 000, 0008 700, 000 1, 000, 0009 800, 000 0

If the economy uses all of its resources to produce automobiles, it can produce a maximum of 8, 000, 000 automobiles and no houses (possibility 1)

If it uses all of its resources to produce houses, then it can produce a maximum of 8, 000, 000 houses and no automobiles (possibility 9)

Between these two extreme cases are many possibilities

Note that for every 100, 000 houses produced, the economy sacrifices/does not produce 1 000, 000 automobiles.

Thus the opportunity cost of 100, 000 houses is 1, 000, 000 automobiles

That is, in order to produce one house the economy must sacrifice 10 automobiles

In this example the opportunity cost remains constant throughout

Houses

(00, 000)

Automobiles

(000, 000)

The Production Possibilities Model

The production possibilities model is based on three assumptions:1. an economy makes only two

products2. resources and technology are fixed3. all resources are employed to their

fullest capacity

The Production Possibilities Curve

• The production possibilities curve shows a range of possible output combinations for an economy.–It highlights the scarcity of resources.–It has a concave shape, which reflects

the law of increasing opportunity costs.

The Production Possibilities Curve

.

Production Possibilities Schedule

Hamburgers Computers point on graph

Production Possibilities Curve

0 1 2 3

1000

600

b

c

1000 0 a

900 1 b

600 2 c

0 3 d

ComputersH

amb

urge

rs

e

f

inefficient

unattainable

d

900

a

The Law of Increasing Costs

Production Possibilities Schedule

Hamburgers Opportunity Computers point Cost of on graph Computers

Production Possibilities Curve

0 1 2 3

1000

6001000 0 a

100

900 1 b 300

600 2 c

600

0 3 d Computers

Ham

bur

gers

As the quantityof computers

rises, so does theiropportunity cost.

a

b900

c

d

Shifts in Production Possibilities

Production Possibilities Curve

0 3

1000

Computers

Ham

bur

gers

With morecomputers, the curve shifts out

in the nextperiod.

.

The Basic Economic Questions

There are three basic questions any society must answer:1. what to produce2. how to produce3. for whom to produce

.

What to Produce?

What goods/services should our society produce & how much?

What is worth producing and what is not? What must we give up to produce the

chosen goods/services?

How to Produce?

Who will produce, with what resources and method?

How can we be most efficient? Technology vs. Manual labour?

 For Whom to Produce?

How will output be shared among the members of our society?

Who will get what? How will we decide on the “Division of the

Economic Pie” ?

• How a society answers the above questions will dictate the type of Economic System that will operate.

•  An economic system is a set of laws, institutions and common practices that help a nation define how to use its scarce resources to satisfy as many of its people’s needs and wants as possible.

The Traditional Economy

The practices of the past determine the answers to the three economic questions.

All goods/services produced today are the same as was produced in the past.

They are produced in the same manner and skills, etc. are passed on through family for generations.

This type of economic system is typical for less advanced societies where just meeting the basic needs of survival is the most important task of the day.

Currencies are rarely used here and barter is common.

·      Ex include:  Bedouin/Bushmen/Mongols/Lapps/Masai/Waura/Mbuti/Senoi  

The Command Economy (North Korea )

All production decisions are made by a small group of political leaders who in effect control the country in question. i.e. Central Planning

These leaders are usually high ranking members of the military. 

The central planning group answers all economic questions based on what is in the “best interest” of the state.

  All productive resources are owned by the state and “efficiently” allocated by the central planners.  The only obligation an individual has in this type of society is to serve and be loyal to the state.  In return, central planners take care of individual needs like food, shelter, medicine, education, etc.  More loyalty to the state is rewarded and lack of loyalty is punished.  Central planners determine who will work where, what equipment will be used, and how much each

worker will be paid.  Workers only really need to buy food, clothing and shelter as everything else is provided free of charge

by the state.  This means there is more emphasis on producing capital goods rather than consumer goods. 

The Market Economy

Economic questions are decided upon based on the interaction between buyers and sellers in free markets where resources are privately owned. i.e. free or private enterprise

•   What will be produced is determined by demand for the particular product or service in

question.•   Businesses will only produce what is in demand, otherwise they will be forced to close.•   How goods are produced is dictated by the producers quest for profits.•   Producers will try to be as efficient as possible to cut costs. This will, in turn, increase profits.•   A benefit of this action is the competition that will result in lower prices for the consumer.•   For whom to produce depends solely on consumer incomes. People with higher incomes will

be able to afford the most and those with low incomes the least.•   The basic elements of a market economy are private property, freedom of enterprise, profit

maximization and competition.•   The government’s only involvement with the economy is to provide law and order and to assist

with economic development.

The Mixed Market Economy (Canada, Sweden, UK)

Since very few pure economic systems exist today, the rest combine some aspects from each of the pure systems.

  The economy will have both private enterprise and state-run enterprise.  Basically a mixed system allows for more government involvement in the economy, usually to

provide some form of social welfare for its citizens.  Some of the more positive government run and/or controlled items are:

o Crown Lando Universal Health Careo Employment Insuranceo Social Security for seniorso Welfareo Media and Arts (CBC)o Education

  There are also “negative” aspects of more government:

•  o High Taxeso Underground Economyo Abuse of the System

Understanding Political Economies

• A democracy is a political system whereby a freely elected government represents (for a set term) the majority of citizens. There are usually many parties with a variety of political views.

 • A dictatorship is a political system whereby

a single person or party has absolute control over an entire nation (usually via the military). There are no free elections allowed.

Communism (China, Cuba, North Korea, Vietnam)

A political model based on the theories of Karl Marx, Friedrich Engels, and Vladimir Lenin

• The government owns all means of production and wealth.

There is no private property or free enterprise. Individuals produce according to their ability and

consume according to their needs. Central government planning is used. The theory was that everyone would share and the

society would prosper with no class system emerging. The reality was a corrupt centrally controlled economy

where the military ruled and communist party members were treated favourably.

 

Socialism (Norway, Denmark, Sweden, Finland)

Based on public ownership/control of the factors of production.

Democratic and peaceful methods are used to accomplish this.

Try to promote a fair and equal distribution of available goods/services via democratic decision-making process.

Co-operation and worker solidarity are encouraged.

Capitalism (Hong Kong, USA, Singapore)

Based on the theories of Adam Smith (1723-1790) Requires a democratically elected government to

maintain order and free/fair competition. Private ownership is encouraged. Producers are motivated to maximize profit

(minimize loss) by becoming more effective and efficient than the competition.

Most modern industrial countries use elements of this system mixed with elements of socialism to produce “welfare capitalism”

Fascism (Nazi Germany)

  Occupies the far right of the political spectrum. Usually combines a free-market economy with a

strict form of government. Force is used as a means of political/economic

control. Citizens are free to own property and make profits

as long as they do not oppose the party in power.

Economic Systems• There are three systems to choose from:

– Traditional economies focus on non-economic concerns and have tight social constraints.

– Market economies are consumer-centered and innovative but create inequality and instability.

– Command economies equalize incomes but often have a lack of freedom.

The Range of Economic Systems

• Most countries have mixed economies.– Modern mixed economies include both private

and public sectors.– Traditional mixed economies combine traditional

sectors with private and/or public sectors.

The Range of Economic Systems (b)

Economic Goals• There are seven major economic goals:

– economic efficiency– income equity– price stability– full employment– viable balance of payments– economic growth– environmental sustainability

Complementary and Conflicting Economic Goals

• Economic goals may be complementary.– An example is the relationship between full employment and

economic growth.• Economic goals may be conflicting.

– An example is the relationship between price stability and full employment.

The Founder of Modern Economics

Adam Smith:– explained how the division of labour increases production– argued that self interest is transformed by the invisible hand

of competition so that it creates significant economic benefits

– stressed the principle of laissez faire, which means that governments should not intervene in economic activity