Chapter 2

Resource Utilization

(Limits, Alternatives, and Choices)

2-2

The Central Fact of Economics: SCARCITY

• This definition assumes that scarcity is the fundamental economic problem: o There are never enough resources to produce all of the

goods and services that people want.• Why is there an economic problem?

o The means of production (resources) are limited.o Economists assume that human wants are unlimited.

• An economy is a system for organizing the allocation of resources to produce and distribute the goods and services that satisfy human wants. o The more efficient the economy is, the more wants we

can satisfy.

2-3

Opportunity Cost: A Fundamental Concept in Economics

• Opportunity cost is the foregone value of the next best alternative.o The value of things we give up (our second-best

choice).

• People weigh the costs and benefits of various options, including opportunity costs. o Economists assume that we choose the option we

find more valuable.

• In the economic world, “both” is not an admissible answer to a choice of “which one.”

2-4

Choosing the Highest Valued Alternative

• Because time is linear, we must make choices. Here are your options:o spend time on social networking site.o play video games.o go to movies with friends. o study economics.

• Whichever option is chosen, you will miss the value of the other options. o If you go to the movie with friends, the direct cost is the movie ticket

and any transportation costs. o The opportunity cost is the value of the alternatives use of your time

(for example, the benefit of the improvement in your grade from studying).

o Opportunity cost may or may not have a dollar value. But you implicitly place a value when you make a decision.

2-5

Inherit $40,000Two choices: Buy a car or go to college

Bought the car (paid $40,000)

Can’t go to college

College graduate (lifetime earnings) College graduate (lifetime earnings) $1,300,000$1,300,000

High School graduate (lifetime earnings) High School graduate (lifetime earnings) $800,000$800,000Opportunity Cost $500,000$500,000

2-6

California 1967–1997

Prisons Added 21 additional

prisons

Colleges Added 1 additional college

The Opportunity Cost of building more prisons is building fewer colleges

1-7

The Consumer’s Budget Line12

10

8

6

4

2

0 2 4 6 8 10 12 14

Income = $120Pdvd = $20

= 6

Income = $120Pb = $10

= 12

Attainable

Unattainable

LO4

The Budget Line: Combinations of DVDs and Books Attainable with $120

Units of DVDs

(Price = $20)

Units of Books

(Price=$10)Total

Expenditure

6 0 $120

5 2 $1204 4 $1203 6 $1202 8 $1201 10 $1200 12 $120

2-8

Four Economic Resources

• There are four categories of economic resources: o Land - natural resources o Labor - work o Capital - produced goods used to produce other goods

and services o Entrepreneurial ability - effort to organize the

production process

• In a market economy, each of these resources is exchanged in markets for a type of income. o We sell our resources to earn income to purchase goods

and services to satisfy our wants.

2-9

Land Earns Rents

• Land (a broader meaning than our normal understanding of the word).o Land includes natural resources like timber, oil, coal,

iron ore, soil, water, as well as the ground in which these resources are found.

• How is land used in an economy? o Extraction of minerals (mining) and farming (agriculture)o It provides the site for factories, office buildings,

shopping centers, homes, etc. • Owners of land receive rent.

o Economic rent is money received from something that is given by nature, rather than produced by human effort.

o Rent is earned by establishing ownership over resources.

2-10

Labor Earns Wages.

• Labor: o is work and time for which one is paid. o involves human effort.

• Income received for one’s labor is called wages and/or salarieso About two-thirds of the total resource cost is the

cost of labor.o Unpaid labor (housework, volunteer work) can also

contribute to the satisfaction of human wants.

2-11

Capital Earns Interest.

• Capital:o “human-made” goods used to produce other goods or

services.o includes office buildings, stores, and factories (physical

plant), equipment, and software.o This is a different use of the term capital than when it means

the money a business uses to buy plant and equipment.

• The income owners of capital receive what is called interest. o The purchase of new capital equipment is often funded

through loans, so the lender earns interest from its productivity.

2-12

Entrepreneur Ability Earns Profits.

• The entrepreneur:o sets up a business.o assembles the needed resources.o risks his/her own (or borrowed) money.o is central to the American economy.

• An entrepreneur earns a profit (or a loss) depending upon his or her ability to run a business.

• There are over 30 million businesses in the U.S., most are owned by entrepreneurs.o The vast majority work for themselves or have one or two

employees.

2-13

Productive Efficiency

Is attained when the maximum possible output of one good is produced, given the output of other goods. Productive efficiency occurs only when we are

operating on the production possibilities curve. Productivity efficiency means that the output of

one good cannot be attained with out reducing the output of some other good.

2-14

Full Employment and Full Production

Full employment = 5% unemployment rate

From 1971–1996 the unemployment rate was above 5% (in recent years, this has lingered below 5%).

Full production— 85–90% plant utilization rate.

2-15

Underemployment of Resources

An unemployment rate greater than 5%

A capacity utilization rate less than 85%

Discrimination A phenomenon that has diminished but has not

been eliminated entirely. Probably keeps our output 10–15% below what

it could be. If there were truly an efficient allocation of

resources.

2-16

The Production Possibilities Curve• Points A, B, C, D, E, and F are

efficient with full employment and full production.

• Points X, Y, and Z are points where economy is producing below efficiency since either capital is being under utilized or the workforce is underemployed. You can produce more guns without sacrificing butter, or vice versa.

• Any point above the production possibility curve, such as W, is not achievable.

Production Possibilities CurveHypothetical Production

SchedulePoint Units of

ButterUnits of Guns

A 15 0

B 14 1

C 12 2

D 9 3

E 5 4

F 0 5

This Production Possibilities Curve shows the range of possible combinations of guns and butter extending from 15 units of butter and no guns at point A to 5 units of guns and no butter at point F

2-17

Production Possibilities CurveHypothetical Production

Schedule

Point Units of Butter

Units of Guns

A 15 0

B 14 1

C 12 2

D 9 3

E 5 4

F 0 5

• When you are on the curve, to get more of one thing you have to give up some of the other thing.

• The opportunity cost of gaining 1 unit of guns was 1 unit of butter

To gain 1 unit of Guns

Had to give up 1 unit of butter

2-18

2-19

Production Possibility Graph Different combinations of two

products that an economy can produce

Fixed resources Fixed technology Law of increasing costs: As

the output of one good expands, the opportunity cost of producing additional units of this good increases. Resource factor suitability Law of Diminishing

Returns Diseconomies of Scale

1-20

Production Possibilities Schedule

Type of Product

Pizzas (in hundred thousands)

Industrial Robots (in thousands)

Production Alternatives

A B C D E

10 9 7 4 0

0 1 2 3 4

Plot the points to create the graph…

LO6

1-21

Production Possibilities Graph

0 1 2 3 4 5 6 7 8 9

Unattainable

1413121110 9 8 7 6 5 4 3 2 1

A

B

C

D

EAttainable

W

Q

Q

LO6 Pizzas

Indu

stria

l rob

ots

2-22

Economic Growth

Improved technology

Expansion of labor More or better trained labor

Expansion of capital More or improved plant and equipment

1-23

Unemployment, Growth, & the Future

• Economic growth

Pizzas

Indu

stria

l rob

ots

Attainable

0 1 2 3 4 5 6 7 8 9

1413121110 9 8 7 6 5 4 3 2 1

UnattainableAB

C

D

E

Now attainable

A’

B’

C’

D’

E’

LO7

2-24

Investment, Consumption, and the Production Possibilities Curve

We can choose between consumption and investment.

Investment increases future production possibilities.

Greater investment means greater future production possibilities.

Point B gives us greater production possibilities than Point A.

Investmentgoods

Consumptiongoods

IA

CA

A

PPC 2015 with BPPC 2015 with BPPC 2015 with B

PPC 2005PPC 2005PPC 2005PPC 2015 with APPC 2015 with APPC 2015 with A

BBIB

CB