The Economizing Problem
CHAPTER TWO
The Economizing Problem
CHAPTER OVERVIEW
This crucial chapter introduces students to a number of important concepts. The first part of the chapter stresses the economizing problem, which results because we have unlimited wants but limited resources. A discussion of full employment and efficiency follows. Both productive and allocative efficiency are defined and emphasized as desirable goals. The production possibilities curve model is introduced to illustrate these important concepts. Using this model, the concepts of opportunity costs and increasing opportunity costs, unemployment, growth, and present versus future possibilities are all demonstrated. Additional emphasis is placed on allocative efficiency, which is a concept new to most students. Some real-world applications of the production possibilities idea are presented.
The chapter concludes by discussing how market and command economic systems differ, concentrating on who owns the factors of production and the method used to coordinate economic activity. The circular flow model is introduced to provide an overview of the way a market system operates.
WHAT’S NEW
The discussion of “utility” has been moved to chapter 1, along with accompanying Origin of the Idea web-button. This caused the remaining chapter web-buttons to be renumbered.
A “Consider This” box on the college attendance decision and opportunity cost has been added to the text. A “Concept Illustration” piece on opportunity cost has been added to the instructors’ manual. Both previously appeared on the web site.
The term “industrial robots” has been changed to “industrial machines” and “machines” to reduce student confusion. This change affects labels on some of the graphs and tables from the previous edition.
Global Perspective 2.1 and references to Yugoslavia’s production possibilities curve that appeared in the previous edition have been deleted.
The LAST WORD has been changed to a discussion of the terrorist attack on September 11, 2001, and the wars in Afghanistan and Iraq. Content from the previous edition’s LAST WORD on “Women and Expanded Production Possibilities” has been incorporated into the body of the chapter. A new LAST WORD question has been added.
The first five chapter questions have been revised, and the first WEB-BASED QUESTION has been updated to reflect changes in the BLS website.
INSTRUCTIONAL OBJECTIVES
After completing this chapter, students should be able to:
1. Define the economizing problem, incorporating the relationship between limited resources and unlimited wants.
2. Identify types of economic resources and types of income associated with various factors.
3. Differentiate between full employment and full production.
4. Explain the concepts of allocative and productive efficiency and how they differ.
5. Construct a production possibilities curve when given appropriate data.
6. Illustrate economic growth, unemployment and underemployment of resources, allocative and productive efficiency, and increasing costs using a production possibilities curve.
7. Give examples of underallocation and overallocation of resources.
8. Give some real-world applications of the production possibilities concept.
9. Summarize the general relationship between investment and economic growth.
10. Highlight the main features of a market economy and a command economy.
11. Identify the decision makers and the markets in a market system using the circular flow diagram.
12. Identify the two roles each that households and businesses play using the circular flow diagram.
13. Differentiate between product and resource markets.
14. Define and identify the terms and concepts listed at the end of the chapter.
COMMENTS AND TEACHING SUGGESTIONS
1. This chapter is an important introduction to economic reasoning and provides a foundation and framework for learning the principles of economics. Three topics that should be stressed include: (1) the problem of scarcity and the necessity of choice, (2) the production possibilities model, and (3) the circular flow model.
2. Most students are all too familiar with the problem of scarcity. Although income and time are not resources in the way in which we define resources in economics, these are what are most scarce to students. Explain how making a budget is dealing with the problem of their limited financial resources and their virtually unlimited wants. Other examples can be how businesses choose between two products when allocating their limited resources and how they choose between two resources when allocating their limited revenues. Further discussion can bring in examples of allocating federal and/or state tax revenues, especially when state revenues compete with funding the state university.
3. To personalize the problem of opportunity cost, ask what else they could be doing during a specific economics class; what are their foregone alternatives? Why might it be more expensive for older students to attend the class than younger ones? Encourage students to find examples of opportunity cost in newspaper articles and magazines. Choice is a necessary part of life; every action has its costs and benefits. Identifying and quantifying these tradeoffs is at the heart of economic analysis.
You may also want to use the following illustration to facilitate student understanding of opportunity cost.
Concept Illustration – Opportunity Cost
The concept of opportunity cost can be illustrated through the eyes of a small child. Suppose that a young girl named Amber receives a $30 gift certificate from her grandparents to be used at Toys4Me. The grandparents take the girl to the store, where she spots several toys she would like—all priced above $30. After gaining a sense of what is affordable, Amber narrows her focus to small stuffed animals ($10 each) and picture books ($5 each).
The grandparents tell Amber that she can buy three stuffed animals, six books, or some limited combinations of the two items. She initially settles on one stuffed animal at $10 and four picture books at $5 each. The grandparents assure her that this selection works; it will exactly use up the $30 certificate. Amber takes the goods to the checkout counter.
But while waiting to pay, she changes her mind. She decides she wants another stuffed animal because they are so cute. What should she do? The grandparents tell her to go pick out a second stuffed animal and then return two of her four books to the shelf. She makes the exchange, ending up with two stuffed animals at $10 each and two picture books at $5 each.
From an adult’s perspective, the second stuffed animal cost $10. But in the eyes of the child, it cost two picture books. To get the second stuffed animal, Amber had to give up two books. That sacrifice was the opportunity cost of her last-minute decision. Amber’s way of looking at cost is one of the fundamental ideas in economics.
4. Current news articles can serve many purposes in a principles class. Most instructors assign a high priority to helping students apply the general principles of economics to the specific problems and decisions they make. Short essays, oral reports, class discussion and longer-term projects are all examples of how current news could be incorporated into the course. A term project focused on current issues such as health care, welfare reform, environmental problems, defense spending, or education can help students develop an appreciation of the problem of scarcity and the tradeoffs that need to be considered when formulating public policy.
The problems of underdeveloped countries could also be used to illustrate the seriousness of choosing between capital goods and consumer goods. Focusing a project on the problems of a single developing country can be interesting. It would allow students to make many comparisons including the impact of differing economic systems, degree of government regulation, environmental quality standards, differences in resource availability, climate, educational levels, and of course the choice between consumer and capital goods.
5. Reference is made to the production possibilities curve in later chapters. It is essential that students become thoroughly familiar with its use, including the significance of its concave shape.
6. Some instructors may want to insert old Chapter 40 (now an Internet chapter found at www.mcconnell16.com) on the Russian transition to capitalism following Chapter 2. Students tend to be fascinated with the contrasts between the former Soviet and American systems; the contrasts seem to make students more aware of aspects of capitalism that may have been taken for granted. In any case the instructor may want to supplement the chapter by assigning students to find current news items on the economies of the transitional economic systems of the former Eastern bloc countries. This helps to point out that the economizing problem is common to all societies, not just to capitalist systems.
7. The circular flow diagram provides a very useful overview of the market system because it clarifies the interaction between product and resource markets. Follow each of the streams starting with the households, owners of the factors of production, providing the resource services to businesses. The role of business is to combine the inputs and to produce output that then moves through the product markets to the households. The student can then be asked: “Why do they work?” The answer is: to receive a portion of what they have helped to produce. The movement through the money stream starts with the households receiving money income that gives them the ability to purchase goods and services from the product markets. It can be shown that those same dollars are given different names as they move through the economy, i.e., money income becomes consumption expenditures and then business revenue followed by the costs of production, and finally money income again. Also, there can be a discussion about what happens in an economy if one part of the two streams does not function, such as in Russia. The circular flow diagram provides a visual perspective that helps many students.
STUDENT STUMBLING BLOCKS
1. Most students have difficulty with the concept of allocative efficiency as opposed to productive efficiency. Even after mastering the concept, they may downplay its significance until they are given examples of situations where allocative efficiency has not existed. A comparison between capitalist outcomes and those of a centrally planned economic system is helpful because students can relate to the idea that having planners decide for society what should or should not be produced may result in outcomes that the individual households do not like.
2. The concept of “full employment” is potentially problematic, particularly for those courses that will eventually cover macroeconomics. The use of the term in this chapter refers to the use of all available resources, human and non-human. In macroeconomics the concept is used to describe general conditions in labor markets and the economy as a whole, but is usually focused on the economy’s use of its human resources. Even then it is recognized that under conditions of full employment there is unemployed labor. There is also the potential for confusion as the concept applies to the land resource. Fully employed deposits of coal or petroleum do not imply exhaustion of those resources. It is more a question of whether there is an adequate amount of these non-human resources available to sustain full employment in labor markets. A full discussion of this is probably not appropriate with students at this point, but you may find it useful to emphasize here that the concept is most often applied to the human resources. Then, when the topic arises again in Chapter 8 (for those covering macroeconomics), students will be less likely to feel that you are changing definitions on them.
3. The production possibilities curve simplifies many concepts for students who don’t have “graph anxiety.” However, for those who are uncomfortable with graphs, this model may confuse rather than simplify. Computerized tutorials will be especially helpful for these students.
4. The new LAST WORD on the September 11, 2001, terrorist attacks and subsequent wars in Afghanistan and Iraq may elicit emotional and/or politically charged responses from students. While one must be sensitive, especially regarding those directly and negatively impacted by those events, it presents an opportunity to demonstrate how economists attempt to detach their emotional and political biases to achieve a more objective economic analysis. It is also an opportunity to point out that the usual role of the economist is to tell us what choices are available, not what choices should be made.
LECTURE NOTES
I. The foundation of economics is the economizing problem: society’s material wants are unlimited while resources are limited or scarce.
A. Unlimited wants (the first fundamental fact):
1. Economic wants are desires of people to use goods and services that provide utility, which, as introduced in chapter 1, means pleasure, happiness, or satisfaction.
2. Products are sometimes classified as luxuries or necessities, but the division is subjective.
3. Services satisfy wants as well as goods.
4. Businesses and governments also have wants.
5. Over time, wants change and multiply.
B. Scarce resources (the second fundamental fact):
1. Economic resources are limited relative to wants.
2. Economic resources are sometimes called factors of production and include four categories:
a. Land or natural resources,
b. Capital or investment goods which are all manufactured aids to production like tools, equipment, factories, transportation, etc.,
c. Labor or human resources, which include physical and mental abilities used in production,
d. Entrepreneurial ability, a special kind of human resource that provides four important functions:
i. Combines resources needed for production
ii. Makes basic business policy decisions
iii. Is an innovator for new products, production techniques, organizational forms
iv. Bears the risk of time, effort, and funds
3. Resource payments correspond to resource categories
a. Rent and interest to suppliers of property resources
b. Wages and salaries to labor resources
c. Profits to entrepreneurs
4. Quantities of resources are limited relative to the total amount of goods and services desired.
II. Economics: Employment and Efficiency
A. Basic definition: economics is the social science concerned with the problem of using scarce resources to attain the greatest fulfillment of society’s unlimited wants.
B. Economics is a science of efficiency in the use of scarce resources. Efficiency requires full employment of available resources and full production.