ECONOMICS : CHAPTER 2– ECONOMIC SYSTEMS AND TOOLS ECONOMICS: choices SCARCITY: meeting unlimited wants with limited resources. Economic System: The mechanisms used to answer the three economics questions

THREE ECONOMIC QUESTIONS What will be produced? How will it be produced? Who are we producing for? These questions are interdependent

PURE MARKET ECONOMY Private firms produce everything No government involvement Markets answer the What?How?Who questions

FEATURES OF MARKET ECONOMY All resources are privately owned Economic activity is based on the prices in the free competitive markets. Income goes back to the resource owners

Invisible Hand Adam Smith Market forces coordinate production as if by an “Invisible Hand” (pure market, mixed) The “invisible hand” promotes the general welfare Voluntary choices answer the economic questions.

PURE MARKET PROBLEMS Hard to enforce property rights Property rights: resource owners have the right to use the resources and can supply the highest bidders with those resources. No government: no authority to protect

PURE MARKET PROBLEMS cont. Resources aren’t equal No guarantee of income Property rights: resource owners can use their resources and supply those resources to the highest bidders as they wish.

PURE MARKET PROBLEMS cont. Monopolies No public goods: things that everyone uses but not charged for

PURE COMMAND ECONOMY Communism Everything is government owned. Limits amount of all goods available to consumers. Sometimes called: communism Central planners answer the economic questions INVISIBLE HAND: ADAM SMITH: In market competition Promotes the general welfare. Voluntary choices answer who? What? How?

Pure Command Economy Problems Consumers are low priority Freedom of choice: limited to none Can be inefficient Resources owned by central authority wasted Environmental damage

PURE ECONOMIES DON’T EXIST

MIXED ECONOMY The U. S. Also a market economy Government makes up about 1/3 of economic activity Private sector is regulated

TRANSITIONAL ECONOMY SHIFTING FROM ONE ECONOMY TO ANOTHER Privatization: Have to convert government owned into private.

TRADITIONAL ECONOMY Customs and/or religion answer the economic questions.

PRODUCTION POSSIBILITIES FRONTIER Chapter 2 Section 2 PRODUCTION POSSIBILITIES FRONTIER

Efficiency Producing the maximum possible with the fewest resources available.

Simplify the Assumption Output is limited to two products Ex. Consumer goods: pizza or haircuts Ex. Capital goods: pizza ovens hair clippers Focus on a specific period of production Available resources are fixed (quantity and quality) Technology does not change (workforce knowledge)

PPF Production Possibilities Frontier Shows the possible combination of the two good that could be made when the available resources are used efficiently P. 47 #7

PPF Model Points along the line show an economy’s resources are being used efficiently Points inside the show inefficiency Points outside are unattainable because the resources are not available.

Movement Along PPF To move along the PPF production of some of one good has to be given up to produce more of the other.

The resources in the economy are not all perfectly adaptable to the production of both types of goods The opportunity cost of capital goods increases as the economy produces more capital goods and fewer consumer goods

LAW OF INCREASING OPPORTUNITY Each additional increment of one good requires the economy to give up successively larger increments of the other good

Shifts in PPF Outward Shift = Economic Growth The ability to make stuff has grown Labor force increased Increase in availability of other resources

Decrease in available resources Decrease in quality of resources Inward Shift Decrease in available resources Decrease in quality of resources

Increase in Stock of Capital Goods The capital goods produced in one period means it can produce the next period. (OUTWARD SHIFT) Choosing between consumer goods and capital goods is really between present consumption and future production

WHY PPF MODEL Efficiency: shows efficient combination of outputs Scarcity: With limited stock of resources and technology an economy can only produce so much

WHY PPF MODEL Opportunity Cost: shown with the downward slope (producing more of one good means producing less of another) Law of Increasing Opportunity Cost: Outward bow: Not all resources are perfectly adaptable Shift outward: economic growth

CHOICE PPF Emphasizes need for choice Choice determines current consumption and capital stock for next period

COMPARATIVE ADVANTAGE Chapter 2 Sec. 3 COMPARATIVE ADVANTAGE

ABSOLUTE ADVANTAGE The ability to do something with fewer resources than other producers.

LAW OF COMPARATIVE ADVANTAGE Best guide for deciding who should do what

LAW OF COMPARATIVE ADVANTAGE The worker with the lowest opportunity cost of producing an output should specialize.

SPECIALIZATION INDIVIDUAL WORKERS FOCUS ON SINGLE TASKS THIS ALLOWS EACH ONE TO BE MORE EFFICIENT AND PRODUCTIVE WORKER: FIRM, REGION OR COUNTRY FOR LAW OF COMPARATIVE ADVANTAGE AND SPECIALIZATION

ABSOLUTE ADVANTAGE: FOCUS ON WHICH WORKER USES THE FEWEST RESOURCES COMPARATIVE ADVANTAGE: FOCUS ON WHAT ELSE THOSE RESOURCES COULD HAVE PRODUCED (OPPORTUNITY COST OF THOSE RESOURCES)

MEDIUM OF EXCHANGE THE ONE THING THAT EVERYONE IS WILLING TO ACCEPT IN EXCHANGE FOR ALL GOODS AND SERVICES

COMPARATIVE ADVANTAGE WHEN PRODUCTION AND TRADE CONFORM TO THE COMPARATIVE ADVANTAGE, RESOURCES ARE MOST EFFICIENTLY ACROSS THE COUNTRY AND AROUND THE WORLD

DIVISION OF LABOR SORTS THE PRODUCTION PROCESS INTO SEPARATE TASKS TO BE CARRIED OUT BY SEPARATE WORKERS.