CHAPTER 2 Economic Systems and Decision · and includes food, clothing, and shelter. A want is a way of expressing a need. Food, for example, is a basic need related to survival

2 UNIT 1 FUNDAMENTAL ECONOMIC CONCEPTS

As you read this unit, learn how the study ofeconomics helps answer the following questions:

How do you make the decisionbetween buying gas for your car or taking your friend out for pizza?

Why is your friend from Russiastunned by all the shoes available at your local shoe store?

Why is an item at a departmentstore less expensive than that sameitem at a specialty shop?

CHAPTER 1

What Is Economics?CHAPTER 2

Economic Systems and DecisionMakingCHAPTER 3

Business Organizations

The factors of production—land,labor, capital, and entrepreneur-ship—make production possible.

The factors of production—land,labor, capital, and entrepreneur-ship—make production possible.

To learn more about basic economic conceptsthrough information, activities, and links to othersites, visit the Economics: Principles and PracticesWeb site at epp.glencoe.com

http://epp.glencoe.com

The study of economics

will help you become a

better decision maker—it helps

you develop a way of thinking

about how to make the best

choices for you. To learn more

about the scope of economics,

view the Chapter 2 video lesson:

What Is Economics?

Chapter Overview Visit the Economics: Principlesand Practices Web site at epp.glencoe.com andclick on Chapter 1—Chapter Overviews to previewchapter information.

Consumers must make choicesfrom many alternatives.


Cover Story

Harris Poll Shows High Interest

in EconomicsAmerican adults

have an exceptionally

keen interest in eco-

nomics. More than

seven in ten say they

share the same high

level of interest in

economics as they do

politics, business and

finance. A full 96%

believe basic econom-

ics should be taught in

high school. Yet, half

of these same adults and two out of three high school

students flunked an elementary quiz on basic economic

concepts. Clearly the time has come [to] place eco-

nomic literacy higher on the national education agenda.

—April 27, 1999 press release, The National Council

on Economic Education

The focus on economics educa-

tion is growing.

Main IdeaScarcity forces us to make choices. We can’t haveeverything we want, so we are forced to choosewhat we want most.

Reading StrategyGraphic Organizer As you read the section, com-plete a graphic organizer like the one below by list-ing and describing the three economic choices everysociety must make.

Scarcity and the Scienceof Economics

Key Termsscarcity, economics, need, want, factors of production,land, capital, financial capital, labor, entrepreneur,production, Gross Domestic Product (GDP)

ObjectivesAfter studying this section, you will be able to:1. Explain the fundamental economic problem.2. Examine the three basic economic questions every

society must decide.

Applying Economic ConceptsScarcity Read to find out why scarcity is the basic economic problem that faces everyone.

Economic choices

D o you think the study of economics is worthyour time and effort? According to the Harrispoll in the cover story, a huge percentage of

Americans think it is. They must know what econo-mists know—that a basic understanding of economicscan help make sense of the world around us.

The Fundamental Economic ProblemHave you ever noticed that very few peopleare satisfied with the things they have?

Someone without a home may want a small one;someone else with a small home may want a largerone; someone with a large home may want a man-sion. Others want things like expensive sports cars,lavish jewelry, and exotic trips. Whether they are richor poor, most people seem to want more than theyalready have. In fact, if each of us were to make a listof all the things we want, it would include morethings than we could ever hope to obtain.

The fundamental economic problem facing allsocieties is that of scarcity. Scarcity is the conditionthat results from society not having enough resourcesto produce all the things people would like to have.

CHAPTER 1: WHAT IS ECONOMICS? 5

As shown in Figure 1.1, scarcity affects almostevery decision we make. This is where the study ofeconomics comes in. Economics is the study ofhow people try to satisfy what appears to be seem-ingly unlimited and competing wants through thecareful use of relatively scarce resources.

Needs and WantsEconomists often talk about people’s needs and

wants. A need is a basic requirement for survivaland includes food, clothing, and shelter. A want isa way of expressing a need. Food, for example, is abasic need related to survival. To satisfy the needfor food, a person may “want” a pizza or otherfavorite meal. Because any number of foods willsatisfy the need for nourishment, the range ofthings represented by the term want is muchbroader than that represented by the term need.

“There Is No Such Thing as a Free Lunch”Because resources are limited, virtually every-

thing we do has a cost—even when it seems as if weare getting something “for free.”

For example, you may think you are getting afree lunch when you use a “buy one, get one free”coupon. However, while you may not pay for theextra lunch then and there, someone had to pay thefarmer for raising the food, the truck driver fordelivering the food, the chef for preparing thefood, and the server for serving the food.

How does business recover these costs? Chancesare that the price of the giveaway is usually hiddensomewhere in the prices the firm charges for itsproducts. As a result, the more a business givesaway “free,” the more it has to raise the prices forthe items it sells. In the end, someone always paysfor the supposedly “free” lunch—and that someonemay be you!

Unfortunately, most things in life are not freebecause someone has to pay for the production inthe first place. Economic educators use the termTINSTAAFL to describe this concept. In short,this term means that There Is No Such Thing As AFree Lunch.

Three Basic QuestionsBecause we live in a world of relatively scarceresources, we have to make wise economic

choices. Figure 1.1 presents three of the basic ques-tions we have to answer. In so doing, we make deci-sions about the ways our limited resources will beused.

WHAT to ProduceThe first question is that of WHAT to produce.

Should a society direct most of its resources to theproduction of military equipment or to otheritems such as food, clothing, or housing? Supposethe decision is to produce housing. Should its lim-ited resources be used for low-income, middle-income, or upper-income housing? How many ofeach will be needed? A society cannot have every-thing its people want, so it must decide WHAT toproduce.

E C O N O M I C SA T A G L A N C EE C O N O M I C SA T A G L A N C E Figure 1.1Figure 1.1

Scarcity

Using ChartsUsing Charts Scarcity is the fundamental economic problem that forces consumers and producers to use resources wisely. Why is scarcity a universal problem?

UnlimitedWants

LimitedResources

Choices

Scarcity

Whatto Produce

Howto Produce

For Whomto Produce


HOW to ProduceA second question is that of HOW to produce.

Should factory owners use mass production meth-ods that require a lot of equipment and few work-ers, or should they use less equipment and moreworkers? If an area has many unemployed people,the second method might be better. On the otherhand, mass production methods in countries wheremachinery and equipment are widely available canoften lower production costs. Lower costs makemanufactured items less expensive and, therefore,available to more people.

FOR WHOM to ProduceThe third question deals with FOR WHOM to

produce. After a society decides WHAT and HOWto produce, the things produced must be allocatedto someone. If the society decides to produce hous-ing, should it be distributed to workers, profes-sional people, or government employees? If thereare not enough houses for everyone, a choice mustbe made as to who will receive the existing supply.

These questions concerningWHAT, HOW, and FOR WHOMto produce are not easy for any soci-ety to answer. Nevertheless, theymust be answered as long as thereare not enough resources to satisfypeople’s seemingly unlimited wants.

The Factors of ProductionThe reason people cannot sat-isfy all their wants and needs is

the scarcity of productive resources.The factors of production, orresources required to produce thethings we would like to have, areland, capital, labor, and entrepre-neurs. As shown in Figure 1.2, allfour are required if goods and serv-ices are to be produced.

LandIn economics, land refers to the

“gifts of nature,” or natural resources

not created by humans. “Land” includes deserts,fertile fields, forests, mineral deposits, livestock,sunshine, and the climate necessary to grow crops.Because only so many natural resources are avail-able at any given time, economists tend to think ofland as being fixed, or in limited supply.

For example, there is not enough good farm-land to adequately feed all of the earth’s popula-tion, nor enough sandy beaches for everyone toenjoy, nor enough oil and minerals to meet ourexpanding energy needs indefinitely. Because thesupply of a productive factor like land is relativelyfixed, the problem of scarcity is likely to becomeworse as population grows in the future.

CapitalAnother factor of production is capital—the

tools, equipment, machinery, and factories used inthe production of goods and services. Such itemsare also called capital goods to distinguish themfrom financial capital, the money used to buy thetools and equipment used in production.

Economic Choices

Making Decisions If we cannot have everything we want,then we have to choose what we want the most. Why must asociety face the choices about what, how, and for whom toproduce?


Capital is unique in that it is the result of pro-duction. A bulldozer, for example, is a capitalgood used in construction. It also was built in afactory, which makes it the result of earlier produc-tion. Like the bulldozer, the cash register in aneighborhood store is a capital good, as are thecomputers in your school that are used to producethe service of education.

LaborA third factor of production is labor—people

with all their efforts, abilities, and skills. This cat-egory includes all people except for a uniquegroup of individuals called entrepreneurs, whichwe single out because of their special role in theeconomy.

Unlike land, labor is a resource that may varyin size over time. Historically, factors such as pop-ulation growth, immigration, famine, war, anddisease have had a dramatic impact on both thequantity and quality of labor.

EntrepreneursSome people are special because they are the inno-

vators responsible for much of the change in oureconomy. Such an individual is an entrepreneur, arisk-taker in search of profits who does somethingnew with existing resources. Entrepreneurs often arethought of as being the driving force in an economybecause they exhibit the ability to start new busi-nesses or bring new products to market. They pro-vide the initiative that combines the resources ofland, labor, and capital into new products.

ProductionWhen all factors of production—land, capital,

labor, and entrepreneurs—are present, production, orthe process of creating goods and services, can takeplace. In fact, everything we produce requires thesefactors. For example, the chalkboards, desks, andaudiovisual equipment used in schools are capitalgoods. The labor is in the form of services supplied


The Factors of Production

Synthesizing Information Synthesizing Information The four factors of production are necessary for production to take place. What four factors of production are necessary to bring jewelry to consumers?

Land includes the “gifts of nature,” or natural resources not created by human effort.

Capital includes the tools, equipment, and factories used in production.

Labor includes people with all their efforts and abilities.

Entrepreneurs are individuals who start a new business or bring a product to market.

Land Capital Labor Entrepreneurs


by teachers, administrators, and other employees.Land, such as the iron ore, granite, and timber usedto make the building and desks, as well as the landwhere the school is located, is also needed. Finally,entrepreneurs are needed to organize the other threefactors and make sure that everything gets done.

The Scope of EconomicsEconomics is the study of human efforts tosatisfy what appear to be unlimited and

competing wants through the careful use of rela-tively scarce resources. As such, it is a social sciencebecause it deals with the behavior of people asthey deal with this basic issue. There are four keyelements to this study: description, analysis, expla-nation, and prediction.

DescriptionEconomics deals with the description of eco-

nomic activity. For example, you will often hearabout the Gross Domestic Product (GDP)—the

dollar value of all final goods and services, andstructures produced within a country’s borders in a12-month period. GDP is the most comprehensivemeasure of a country’s total output and is a keymeasure of the nation’s economic health.Economics is also concerned with what is pro-duced and who gets how much, as well as with top-ics such as unemployment, inflation, internationaltrade, the interaction of business and labor, and theeffects of government spending and taxes.

Description is important because we need toknow what the world around us looks like.However, description is only part of the picturebecause it leaves many important “why” and “how”questions unanswered.

AnalysisIn order to answer such questions, economics

must focus on the analysis of economic activity aswell. Why, for example, are prices of some itemshigh while others are low? Why do some peopleearn higher incomes than others? How do taxesaffect people’s desire to work and save?

UNITED STATES LEADSIN ENTREPRENEURSA vast majority of the owners of the nearly 20million businesses in the United States are entre-preneurs. Most either work for themselves orhave a few employees.

A 10-nation study found that the United Statesleads when it comes to entrepreneurs. According tothe survey, nearly 1 in 12 Americans is trying to starta new business. In second place is Canada. The studyalso shows a strong link between business start-uprates and overall economic growth. The graphshows the percentage of the adult population start-ing new businesses.

6.8%8.5%

1.4%1.8%2.0%2.2%

3.3%3.4%Italy

BritainGermanyDenmarkFranceFinlandU.S.Canada

Source: 1999 Global Entrepreneurship Monitor

1. Analyzing Information In which nation isentrepreneurial activity strongest? Weakest?

2. Making Comparisons How does the levelof North America’s entrepreneurial activitycompare with Europe’s?

3. Drawing Conclusions Do you think there isa link between business start-up rates andoverall economic growth? Why or why not?

Critical Thinking


The importance of analysis is that it helps us todiscover why things work and how things happen.This, in turn, will help us deal with problems thatwe would like to solve.

ExplanationEconomics is also concerned with the explana-

tion of economic activity. After economists under-stand why and how things work, it is useful andeven necessary to communicate this knowledge toothers. If we all have a common understanding ofthe way our economy works, some economic prob-lems will be much easier to address or even fix in

the future. When it comes to the GDP, you willsoon discover that economists spend much of theirtime explaining why the measure is, or is not, per-forming in the manner expected.

PredictionFinally, economics is concerned with prediction.

For example, we may want to know if people’sincomes are going to rise or fall in the future,affecting their spending habits in the marketplace.Or, perhaps a community trying to choose betweenhigher taxes on homeowners or higher taxes onbusinesses needs to know the consequences of eachalternative before it makes its choice.

The study of economics can help to make thebest decision in both situations. Because econom-ics deals with the study of what is, or what tends tobe, it can help predict what may happen in thefuture, as well as the likely consequences of differ-ent courses of action.

Finally, it is also important to realize that theactual decisions about the economic choices to bemade are the responsibility of all citizens in a freeand democratic society. Therefore, the study ofeconomics helps all of us to become moreinformed citizens and better decision makers.

Checking for Understanding1. Main Idea Using your notes from the graphic

organizer activity on page 5, explain why asociety must face the choices about WHAT,HOW, and FOR WHOM to produce.

2. Key Terms Define scarcity, economics, need,want, factors of production, land, capital,financial capital, labor, entrepreneur, produc-tion, Gross Domestic Product (GDP).

3. Describe the fundamental economic problem.

4. List the three basic economic questions everysociety must answer.

5. Describe the factors of production.

6. List the four key elements of economics.

Applying Economic Concepts7. Scarcity How does scarcity affect your life?

Provide several examples of items you had todo without because of limited resources.Explain how you adjusted to this situation.For example, were you able to substituteother items for those you could not have?

8. Synthesizing Information Give an exampleof a supposedly “free” item that you seeevery day. Explain why the item is not reallyfree by stating who or what actually paysfor it.

Practice and assess key social studies skills withthe Glencoe Skillbuilder Interactive Workbook,Level 2.

Capital“Capital” comprises the tools, equipment, andfactories used to produce goods and services.As the economy changes, some economists areadjusting the definition to include “tools” suchas knowledge and intellectual property. Anexample of such knowledge and intellectualproperty are databases and software.


Alexis de Tocqueville, a French traveler,wrote about his travels in the UnitedStates during the 1830s. His book,Democracy in America, a two-volumestudy of the American people and theirinstitutions, is still relevant today.

The Role of theEntrepreneur

What astonishes me in the United States isnot so much the marvelous grandeur of suchundertakings as the innumerable multitudeof small ones.

—Alexis de Tocqueville, 1835

What [de Tocqueville noticed nearly 160years ago]—before the advent of AppleComputer, Genentech, Microsoft, or Nucor—isjust as true today. The only difference is that thespirit of enterprise is more than ever a globalphenomenon with few bounds.

From the row of kiosks selling goods on nearlyevery block in Moscow to the cramped factories inTaiwan, Russian biznez-men and Chinese chang-shang are reshaping their nations’ economies inmuch the same way asthose ingenious oldYankees created the basisfor America’s business cul-tures just after independ-ence was won.

Any [de Tocqueville ofmodern times] wouldnotice something elseabout this global shift:

Changes in the rules of thebusiness game are puttinga premium on theentrepreneurial quali-ties of [the smaller]companies. Today’ssuccessful enterprisesare nimble, innova-tive, close to the cus-tomer, and quick to themarket. They’re notbureaucratic, centrally con-trolled institutions that are slowto change. It adds us to a new manage-ment catechism with many of the hallmarks ofsmall business. . . .

Sure, some industries, such as auto making andpetrochemicals, still require size and scale. But theswift pace of technological change and the frag-mentation of markets are eroding the traditionaleconomies of scale. Indeed, some managementthinkers now speak of the “diseconomies ofscale,” the unresponsiveness, sluggishness, andhigh costs that come with bureaucracy. While thebehemoths try to adjust to new competitive reali-ties, younger and smaller companies haveemerged as the agents of change in economiesaround the world. . . .

—Reprinted from Small Business Trends and Entrepreneurship, by the editors of Business Week, copyright © 1995 by The McGraw-Hill Companies, Inc.

Examining the Newsclip1. Summarizing Information What are the

entrepreneurial qualities of small companies?

2. Finding the Main Idea What does the writermean by “diseconomies of scale”?

N e w s c l i p

11

12

Basic Economic Concepts

Main IdeaAn economic product is a good or service that is use-ful, relatively scarce, and exchangeable.

Reading StrategyGraphic Organizer As you read the section, describethree different transactions that could take place inthe factor market. Use a web like the one below tohelp you organize your answer.

Effect

EffectFactor market

Effect

Key Termseconomic product, good, consumer good, capitalgood, service, value, paradox of value, utility, wealth,market, factor market, product market, economicgrowth, productivity, division of labor, specialization,human capital, economic interdependence

ObjectivesAfter studying this section, you will be able to:1. Explain the relationship among scarcity, value,

utility, and wealth.2. Understand the circular flow of economic activity.

Applying Economic ConceptsSpecialization Read to discover how specializationincreases production.

Cover Story

On SpecializationTo take an example, . . . One man draws out the

wire, another straightens it, a third cuts it, a fourth

points it, a fifth grinds it at

the top for receiving the

head; to make the head

requires two or three

distinct operations;

to put it on, is a

peculiar business, to

whiten the pins is

another; it is even a

trade by itself to put

them into the paper;

and [the making of] a

pin is, in this manner,

divided into about eight-

een distinct operations.

—Adam Smith, The Wealth of

Nations, 1776

E conomics, like any other social science, hasits own vocabulary. To understand econom-ics, a review of some key terms is necessary.

Fortunately, most economic terms are widely used,and many will already be familiar to you.

Goods, Services, and ConsumersEconomics is concerned with economicproducts—goods and services that are useful,

relatively scarce, and transferable to others.Economic products are scarce in an economicsense. That is, one cannot get enough to satisfyindividual wants and needs. Because of these char-acteristics, economic products command a price.

GoodsThe first type of economic product is a good—

an item that is economically useful or satisfiesan economic want, such as a book, car, or com-pact disc player. A consumer good is intendedfor final use by individuals. When manufacturedgoods are used to produce other goods and serv-ices, they are called capital goods. An example

Adam Smith

12

of a capital good would be a robot welder in a fac-tory, an oven in a bakery, or a computer in a highschool.

Any good that lasts three years or more whenused on a regular basis is called a durable good.Durable goods include both capital goods, such asrobot welders, and consumer goods such as auto-mobiles. A nondurable good is an item that lastsfor less than three years when used on a regularbasis. Examples of nondurable goods include food,writing paper, and most clothing items.

ServicesThe other type of economic product is a service,

or work that is performed for someone. Servicesinclude haircuts, home repairs, and forms of enter-tainment such as concerts. They also include thework that doctors, lawyers, and teachers perform.The difference between a good and a service is thata service is intangible, or something that cannot betouched.

ConsumersThe consumer is a person who uses goods and

services to satisfy wants and needs. As consumers,people indulge in consumption, the process ofusing up goods and services in order to satisfywants and needs.

Value, Utility, and WealthIn economics, value refers to a worth thatcan be expressed in dollars and cents. Why,

however, does something have value, and why aresome things worth more than others? To answerthese questions, it helps to review an early problemfaced by economists.

Paradox of ValueAt first, early economists were puzzled by a con-

tradiction between necessities and value called theparadox of value. The paradox of value is the situa-tion where some necessities, such as water, have littlemonetary value, whereas some non-necessities, suchas diamonds, have a much higher value.

Economists knew that scarcity is required forvalue. For example, water was so plentiful in manyareas that it had little or no value. On the otherhand, diamonds were so scarce that they had greatvalue. The problem was that scarcity by itself is notenough to create value.

UtilityIt turned out that for something to have value, it

must also have utility, or the capacity to be usefuland provide satisfaction. Utility is not somethingthat is fixed or measurable, like weight or height.Instead, the utility of a good or service may varyfrom one person to the next. One person may geta great deal of satisfaction from a home computer;another may get very little. One person may enjoya rock concert; another may not. A good or servicedoes not have to have utility for everyone, onlyutility for some.

For something to have value, economistsdecided, it must be scarce and have utility. This isthe solution to the paradox of value. Diamonds arescarce and have utility—and therefore they possessa value that can be stated in monetary terms. Waterhas utility, but is not scarce enough in most placesto give it much value. Therefore, water is lessexpensive, or has less value, than diamonds.

INFOBYTEINFOBYTE

Durable Goods Orders The Department of Com-merce’s report on durable goods orders highlightsthe number of new orders placed with domesticmanufacturers for goods intended to last overthree years. The report is divided into broad cate-gories; these include defense, nondefense, andcapital and noncapital goods. Noncapital goodsare generally of the consumer spending varietyand include automobiles and large appliances.Capital goods tend to be of the investment spend-ing nature, while defense goods indicate govern-ment spending.


WealthAnother concept is wealth. Wealth, in an eco-

nomic sense, is the accumulation of those productsthat are tangible, scarce, useful, and transferable fromone person to another. Consequently, a nation’swealth is comprised of all items, including naturalresources, factories, stores, houses, motels, theaters,furniture, clothing, books, highways, video games,and even footballs.

While goods are counted as wealth, services arenot because they are intangible. However, this doesnot mean that services are not useful. Indeed, whenAdam Smith wrote The Wealth of Nations in 1776, hewas referring specifically to the ability and skills ofa nation’s people as the source of its wealth. Toillustrate, if a country’s material possessions weretaken away, its people, through their skilled efforts,could restore these possessions. On the other hand,if a country’s people were taken away, its wealthwould deteriorate.

The Circular Flow of EconomicActivity

The wealth that an economy generates ismade possible by the circular flow of eco-

nomic activity. The key feature of this circular flowis the market, a location or other mechanism thatallows buyers and sellers to exchange a certain eco-nomic product. Markets may be local, regional,national, or global. More recently, markets haveevolved in cyberspace, with buyers and sellers inter-acting through computer networks without leavingthe comfort of their homes.

Factor MarketsHow does this circular flow operate? As shown

in Figure 1.3, individuals earn their incomes infactor markets, the markets where productiveresources are bought and sold. This is where entre-preneurs hire labor for wages and salaries, acquireland in return for rent, and borrow money forinterest. The concept of a factor market is a sim-plified version of the real world, of course, but itis nevertheless realistic. To illustrate, you partici-pate in the factor market whenever you go to workand sell your labor to an employer.

Product MarketsAfter individuals receive their income from the

resources they sell, they spend it in product markets,markets where producers sell their goods and serv-ices to consumers. Thus, the money that individu-als receive from businesses in the factor marketsreturns to businesses in the product markets.Businesses then use this money to produce moregoods and services—and the cycle, through eco-nomic activity, repeats itself.

As you can see from Figure 1.3, markets serve asthe main links between individuals and businesses.Note that money circulates on the outside, illus-trating payments for goods, services, and the fac-tors of production. The actual factors ofproduction, and the products made with these pro-ductive inputs, flow in the opposite direction onthe inside.

Wealth

Natural Resources Fertile land is a naturalresource and an item of wealth. Why are natu-ral resources considered part of the nation’swealth?



Productivity and Economic GrowthEconomic growth occurs when a nation’stotal output of goods and services increases

over time. This means that the circular flow inFigure 1.3 becomes larger, with more factors of pro-duction, goods, and services flowing in one direc-tion, and more payments flowing in the oppositedirection. A number of factors are responsible foreconomic growth, but productivity is the mostimportant.

ProductivityEveryone benefits when scarce resources are

used efficiently. This is described by the term productivity, which is a measure of the amount ofoutput produced by a given amount of inputs in aspecific period of time. Productivity goes up when-ever more output can be produced with the sameamount of inputs in the same amount of time. Forexample, if a company produced 500 units of aproduct in one period, and if it produced 510 in


The Circular Flow of Economic Activity

BusinessIncome

ConsumerSpending

Payments forResources

Income fromResources

GoodsServices

GoodsServices

BuyProductiveResources

LandCapitalLabor

Entrepreneurs

ProductMarkets

FactorMarkets

Individuals

$$$$

$$$$

Businesses

Using Charts The circular flow diagram shows the high degree of economic interdependencein our economy. In the diagram, the factors of production and the products made from them flow inone direction. The payments for the factors, which consumers spend on goods and services, flowin the opposite direction. As a consumer, what role do you play in the circular flow of economic activity?

Using Charts The circular flow diagram shows the high degree of economic interdependencein our economy. In the diagram, the factors of production and the products made from them flow inone direction. The payments for the factors, which consumers spend on goods and services, flowin the opposite direction. As a consumer, what role do you play in the circular flow of economic activity?


the next period with the same number of inputs,then productivity went up.

Productivity is often discussed in terms of labor,but it applies to all factors of production. For thisreason, business owners try to buy the most effi-cient capital goods, and farmers try to use the mostfertile land for their crops.

Division of Labor and SpecializationDivision of labor and specialization can improve

productivity. Division of labor takes place whenwork is arranged so that individual workers do fewertasks than before. In most cases, a worker who per-forms a few tasks many times every day is likely tobecome more proficient than a worker who performshundreds of different tasks in the same period.

Specialization takes place when factors of pro-duction perform tasks that they can do relativelymore efficiently than others. Note that specializa-tion is not limited to a single factor of productionsuch as labor. For example, complex industrialrobots are often built to perform just one or twosimple assembly line tasks. In regional specializa-tion, different regions of the country often special-ize in the things they can produce best—as whenIdaho specializes in potatoes, Iowa in corn, andTexas in oil, cotton, and cattle.

One of the best examples of the advantagesoffered by the division of labor and specialization isHenry Ford’s introduction of the assembly line intoautomobile manufacturing. This process cut the timenecessary to assemble a car from a day and a half tojust over 90 minutes. It also cut the price of a new car

by more than 50 percent. The resultwas an improvement in productivity.

Another example of the changesthat can result from specialized toolscan be seen in American agriculture.In 1910 it took more than 13 millionfarmers to feed the U.S. population,at that time about 90 million. Today,2 million farmers can feed a popula-tion that is more than three times aslarge as it was in 1910.

Investing in Human CapitalOne of the main contributions to

productivity comes from investmentsin human capital, the sum of theskills, abilities, health, and motivationof people. Government can invest inhuman capital by helping to provideeducation and health care. Businessescan invest in training and other pro-grams that improve the skill andmotivation of its workers. Individualscan invest in their own education bycompleting high school, going totechnical school, or going to college.

Figure 1.4 shows that investmentsin education can have substantialpayoffs. According to the data in thetable, high school graduates havesubstantially higher incomes than


Effect of Education on Income

Education

Source: U.S. Department of Commerce, Bureau of the Census, 2003

FemalesAverage Income For

Males

Less Than 9th Grade

9th to 12th Grade (no diploma)

High School Graduate & Equivalency

Some College, no degree

Associate Degree

Bachelor’s Degree

Master’s Degree

Professional Degree

Doctorate Degree

$25,112

$30,656

$39,017

$46,696

$48,153

$71,361

$87,099

$130,764

$104,237

$18,227

$23,625

$27,525

$33,002

$34,560

$45,778

$57,874

$72,689

$70,302

Using Tables Education is one way to invest in human capital. How does this type of invest-ment pay off for both employers and employees?

Using Tables Education is one way to invest in human capital. How does this type of investment pay off for both employers and their employees?

Visit epp.glencoe.com and click onTextbook Updates—Chapter 1 foran update of the data.


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CHAPTER 2 Economic Systems and Decision · and includes food, clothing, and shelter. A want is a way of expressing a need. Food, for example, is a basic need related to survival