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 Factors of Production Characteristics Compensation 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 Schedule Number of Houses Number of Automobiles 1 8, 000, 000 2 100, 000 7, 000, 000 3 200, 000 6, 000, 000 4 300, 000 5, 000, 000 5 400, 000 4, 000, 000 6 500, 000 3, 000, 000 7 600, 000 2, 000, 000 8 700, 000 1, 000, 000 9 800, 000

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 products 2. resources and technology are fixed 3. 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 a 1000 b unattainable f 900 Hamburgers 600 c 1000 0 a 900 1 b 600 2 c 0 3 d e inefficient d 0 1 2 3 Computers .

The Law of Increasing Costs Production Possibilities Curve Production Possibilities Schedule Hamburgers Opportunity Computers point Cost of on graph Computers a As the quantity of computers rises, so does their opportunity cost. 1000 b 900 1000 0 a Hamburgers 600 c 100 900 1 b 300 600 2 c 600 0 3 d d 0 1 2 3 Computers

Shifts in Production Possibilities Production Possibilities Curve With more computers, the curve shifts out in the next period. 1000 Hamburgers 0 3 Computers .

The Basic Economic Questions There are three basic questions any society must answer: 1. what to produce 2. how to produce 3. 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: Crown Land Universal Health Care Employment Insurance Social Security for seniors Welfare Media and Arts (CBC) Education There are also “negative” aspects of more government: High Taxes Underground Economy 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