Microeconomies

Learning objectives Lecture 2 The Economising Problem
Discuss the two fundamental facts that form the bases of the economising problem Define the economising problem and expand on the definition of economics introduced earlier Discuss the meaning of economic efficiency and examine the importance of specialisation to its achievement
Copyright 2007 McGraw-Hill Australia Pty Ltd Copyright 2007 McGraw-Hill Australia Pty Ltd, PPTs t/a Microeconomics 8e, by Jackson & Mclver. PPTs t/a Microeconomics 8e, By Muni Perumal, Australia by Jackson & McIver By Muni Perumal, University of Canberra, Australia
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Learning objectives (cont.)

Illustrate, extend and modify our definition of economics through the use of production possibilities tables and curves Introduce the concept of opportunity cost, the law of increasing opportunity costs, and the law of comparative advantage Restate and discuss the economising problem in terms of five fundamental questions
Learning objectives (cont.)

Survey briefly the different ways in which institutionally and ideologically diverse economies respond to the economising problem Use the production possibilities curve model to examine the trade-off between current and future consumption
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The foundation of economics

The economising problem is underpinned by two fundamental facts: Unlimited or insatiable wants of society for goods and services that give utility
Utility is the economists term for pleasure or satisfaction
Economic resources
Two broad categories of resources: Property resources
Land Raw materials Capital
Human resources
Labour Entrepreneurial ability
Economic resources are limited or scarce

Economic resources refer to all natural, human and manufactured resources that go into the production of goods and services
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Land
Broader than commonly understood An economic resource which includes all the natural resources that go into the production of goods and services Income received by land is rent
Capital
All the manufactured aids to production used to produce goods and services and distribute them to the final consumer without directly satisfying human wants Capital as used in economics does not refer to money. Money as such produces nothing, and is not considered an economic resource The process of producing and accumulating these capital goods is known as investment Payment for capital is interest
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Labour
Broader than commonly used All human physical and mental talents (excluding entrepreneurial talent) that can be used in producing goods and services Income accruing to labour is wage
Entrepreneurial ability
A specialised form of human resource Involves the combining of the other resources to produce a product, make non-routine decisions, innovate, and bear risk Profit is the reward for entrepreneurship
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Economics and efficiency

Efficiency is the use or administering of scarce resources to produce the maximum amount of the desired goods and services, thereby achieving the greatest possible fulfilment of societys wants
Economics and efficiency (cont.)

To achieve efficiency, there must be full employment and full production Full employment:
All available resources are employed
Full production:
The maximum amount of goods and services are
produced from the employed resources of an economy
Full employment implies two kinds of efficiency

Allocative efficiency Productive efficiency
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Allocative efficiency
Occurs when all available resources are devoted to the combination of goods most wanted by society

Specialisation and efficiency
Specialisation enhances efficiency
Two types of specialisation

Division of labour Geographic specialisation
Productive efficiency
Occurs when goods or services are produced using the lowest cost production methods
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The economising problem illustrated

The production possibilities curve (PPC) can be used to illustrate the concept of choice and opportunity cost Demonstrates that society must make choices about which goods and services to produce and which to go without
Production possibilities curve

Assumptions Efficiency: the economy is operating at full employment and achieving productive efficiency Fixed resources Fixed technology Two products only: capital good and consumer good
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Production possibilities curve (cont.)

Points on the PPC represent a maximum output of the two products Points inside the PPC are attainable, but are inefficient and undesirable Points outside the curve are superior but unobtainable given the assumptions of fixed technology and resources
Production possibilities of chocolate and tractors with full employment

___________________________________________________ Type of product Production alternatives A B C D E Chocolates (00000) 0 1 2 3 4 Tractors (000) 10 9 7 4 0 ___________________________________________________
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Q
Tractors (thousands)
10 9 8 7 6 5 4 3 2 Attainable but inefficient 1 0 1 2 3 4
A B C U D Unattainable

Opportunity cost
The amount of other products that must be sacrificed to obtain an additional unit of a good
W Attainable and efficient
The PPC is concave to the origin because of the law of increasing opportunity costs
More and more of a good must be given up to obtain additional units of the other good
E
5 6 7 8
Chocolate bars (hundred thousands)

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Law of increasing opportunity costs

Based on the fact that economic resources are not completely adaptable to alternative uses; they are imperfect substitutes Resources lack perfect flexibility or interchangeability
Allocative efficiency
Resources are efficiently allocated to any product when the output is such that its marginal benefit equals its marginal cost (MB = MC)
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Points inside the production possibility curve illustrate unemployment or productive inefficiency A movement towards full employment and productive efficiency from a point such as U will entail a greater output of at least one, if not both products
Unemployment and underemployment

Q
10 9 8 7 6 5 4 3 2 1 0 1 2 3 4
A B C A greater output of at least one if not both
D U
E
5 6 7 8
Chocolate bars (hundred thousands)
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Economic growth and PPC

Economic growth can be represented as an outward shift (to the right) of the PPC Economic growth results from:
Expanding resource supplies Technological advances
Economic growth and PPC (cont.)

Q 14
13 12 11 10 9 8 7 6 5 4 3 1 1 2 3 4 5 6 7 Chocolate bars (hundred thousands) 8 A B
Q
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Five fundamental questions

How much total output is to be produced? What combination of outputs is to be produced? How are these outputs to be produced? Who is to receive/consume these outputs? How can change be accommodated?
Alternative economic systems

How the fundamental questions are answered depends on the type of economic system Economies differ on two grounds: Ownership of the means of production How economic activity is co-ordinated
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Alternative economic systems (cont.)

Pure capitalism (or laissez-faire):
Private ownership of property and resources Freedom of enterprise and choice A system of markets and prices
Alternative economic systems (cont.)

Mixed systems
A mixture of pure capitalism and command economy Authoritarian capitalism refers to a regime with a high degree of government control, with privately owned property Market socialism is characterised by public ownership of property, with markets playing a significant role
The command economy:

Characterised by public ownership of resources and property Centralised economic planning
The traditional economy

In the traditional or customary economies found in many less developed countries, production methods, exchange and the distribution of income are all sanctioned by custom
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Present choice and future possibilities

The PPC can be used to: Illustrate the importance of societys choice between current and future consumption Demonstrate the economic basis for trade between nations
Economic growth in two countries

Alphania Goods for the future Goods for the future 2023 curve Betania 2023 curve
2003 curve Goods for the present
2003 curve Goods for the present

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Economic growth in two countries (cont.)

A current choice favouring present goods as made by Alphania will cause a modest rightward shift of the curve. A current choice favouring future goods as made by Betania will result in a greater rightward shift of the curve.
Next chapter: Demand and Supply
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Microeconomies

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Learning objectives Lecture 2 The Economising Problem

Learning objectives (cont.)

Learning objectives (cont.)

The foundation of economics

Economic resources are limited or scarce

Economics and efficiency

Economics and efficiency (cont.)

produced from the employed resources of an economy

Full employment implies two kinds of efficiency

Economics and efficiency (cont.)

Economics and efficiency (cont.)

Two types of specialisation

The economising problem illustrated

Production possibilities curve

Production possibilities curve (cont.)

Production possibilities of chocolate and tractors with full employment

Production possibilities curve (cont.)

Production possibilities curve (cont.)

W Attainable and efficient

Chocolate bars (hundred thousands)

Law of increasing opportunity costs

Production possibilities curve (cont.)

Unemployment and underemployment

A B C A greater output of at least one if not both

Chocolate bars (hundred thousands)

Economic growth and PPC

Economic growth and PPC (cont.)

Five fundamental questions

Alternative economic systems

Alternative economic systems (cont.)

Alternative economic systems (cont.)

The command economy:

The traditional economy

Present choice and future possibilities

Economic growth in two countries

2003 curve Goods for the present

2003 curve Goods for the present

Economic growth in two countries (cont.)

Next chapter: Demand and Supply

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