Chapter 2

A CLOSER LOOK AT THE

ECONOMIC PROBLEM

Central Economic Questions

• 3 central economic questions

- Output Q: what & in what quantities?

- Input Q: How & how much of scarce resources?

- Distribution Q: For whom & where?

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2.1 What should be produced?

Economic goods

Consumer goods

Non-durable goods

Semi-durable goods

Durable goodsFinal goods & intermediate

goods

Private goods & public goods

Homogenous & heterogeneous

goods

Capital goods

Free goods

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Figure 2-1 The production possibilities curve once

again

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Figure 2-2 Improved technique for producing

capital goods

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Figure 2-3 Improved technique for producing

consumer goods

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Figure 2-4 Increase in the quantity or productivity

of the available resources

2.2 Factors of production

Primary factors of production

Natural resources

Labour

Secondary factors of

production

Capital

Entrepreneurship

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2.3 The Distribution issue

• This is a normative issue

• Who will receive What from the economy?

• Need income different from wealth

• Functional distribution of income:

– Rent, wages, interests & profits

• Personal distribution of income

• Sectoral distribution of income

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2.4 Economic Systems

• System: network of interlocked parts

forming an overall pattern

• Economic system: pattern of organisation

aimed at solving the 3 econ. Questions

• Criteria for classification: property rights

& coordinating mechanism

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Major differences between

economic systemsTraditional Command Market Mixed

What? custom Central

authority

Demand from

consumers &

profitability

Demand, profits

+ Gvt

intervention

How? custom Central

authority

Prices &

productivity of

factors

Prices,

productivity +

Gvt intervention

For Whom? custom Central

authority

Those who can

afford

Affordability +

Gvt intervention

Ownership of

factors of

production

Private &

Community

- State:

socialism

- Private:

Capitalism

Private & State

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2.5 Contributions to economic

scienceADAM SMITH (1723-1790)

• Market system: invisible hand

• The wealth of nations: division of labour, free trade and limited role for government

• Classical school

KARL MARX (1818-1883)

• Evolution of Institutions: Capitalism - Socialism - Capitalism

• Das Kapital: Capitalism is exploitative and self-destructive

• Predicted popular revolution but did not anticipate the capacity of capitalism to adapt.

JOHN MAYNARD KEYNES (1883-1946)

• Government intervention to support aggregate demand

• The general theory: foundation for modern macroeconomics

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