Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-1 Chapter 2 The economising

Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal

2-1

Chapter 2

The economisingproblem


2-2

Learning objectives• 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 in Chapter 1

• Discuss the meaning of ‘economic efficiency’ and examine the importance of specialisation to its achievement


2-3

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


2-4

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, and the importance of comparative advantage as a basis for trade between nations

• Review the volume and pattern of Australia’s trade


2-5

The foundation of economicsThe economising problem is underpinned by two

fundamental facts:• Unlimited or insatiable wants of society for goods

and services that give utility– ‘Utility’ is the economist’s term for pleasure or

satisfaction

• Economic resources are limited or scarce– ‘Economic resources’ refers to all natural, human

and manufactured resources that go into the production of goods and services


2-6

Economic resourcesTwo broad categories of resources:• Property resources

– Land

– Raw materials

– Capital

• Human resources– Labour

– Entrepreneurial ability


2-7

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


2-8

Capital• All the manufactured aids to production used

to produce goods and services and to 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


2-9

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


2-10

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


2-11

Relative intensity of resource use in production

• Land-intensive commodity is a commodity in which the production process uses a relatively large amount of land

• Labour-intensive product uses relatively large amounts of labour

• Capital-intensive product uses relatively larger amounts of capital


2-12

Economics and efficiency

• Efficiency is the use or administering of scarce resources to produce the maximum amount of desired goods and services, thereby achieving the greatest possible fulfilment of society’s wants


2-13

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


2-14


• Allocative efficiency– Occurs when all available resources are devoted

to the combination of goods most wanted by society

• Productive efficiency– Occurs when goods or services are produced

using the lowest cost production methods


2-15


• Specialisation and efficiency– Specialisation enhances efficiency

• Two types of specialisation– Division of labour

– Geographic specialisation


2-16

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


2-17

Production possibilities curveAssumptions• Efficiency: The economy is operating at full

employment and achieving productive efficiency• Fixed resources• Fixed technology• Two products only: capital good and consumer

good


2-18

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


2-19

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

___________________________________________________


2-20

1 2 3 4 5 6 7 80

1

2

3

4

5

6

7

8

9

10

The production possibilities curveQ

Q

A

B

C

D

E

Chocolate bars (hundred thousands)

Tra

cto

rs (

thou

san

ds)

Attainable andefficient

W

Unattainable

Attainablebut inefficient

U


2-21

The production possibilities curve (cont.)• Opportunity cost

– The amount of other products that must be sacrificed to obtain an additional unit of a good

• 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


2-22

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


2-23

Allocative efficiency• Resources are efficiently allocated to any product

when the output is such that its marginal benefit equals its marginal cost (MB = MC)


2-24

The production possibility curve• 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, ifnot both, products


2-25


Tra

cto

rs (

thou

san

ds)

1 2 3 4 5 6 7 80

1

2

3

4

5

6

7

8

9

10

Unemployment and underemploymentQ

Q

A

B

C

D

E

U

A greater output of at least one if

not both


2-26

Economic growth and the 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


2-27

Q

Q

Tra

cto

rs (

thou

san

ds)


1413121110 9 8 7 6 5 4 3 1

1 2 3 4 5 6 7 8

AA′′

BB′′

CC′′

DD′′

EE′′

Economic growth and PPC


2-28

Five fundamental questions

1. How much total output is to be produced?

2. What combination of outputs is to be produced?

3. How are these outputs to be produced?

4. Who is to receive/consume these outputs?

5. How can change be accommodated?


2-29

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


2-30

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

• The command economy– Characterised by public ownership of resources

and property

– Centralised economic planning


2-31

Alternative economic systems• 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 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


2-32

Present choice and future possibilitiesThe PPC can be used to:• Illustrate the importance of society’s choice

between current and future consumption• Demonstrate the economic basis for trade

between nations


2-33

Goods for the present Goods for the present

Goo

ds f

or t

he f

utur

e

Goo

ds f

or t

he f

utur

e

Economic growth in two countries

2003 Curve

2023 curve2023 curve

2003 Curve

Alphania Betania


2-34

Economic basis for tradeWhy do nations trade? What is the basis of trade

between nations?• Distribution of economic resources differs

between nations• Different technologies and/or resources are

required for production:– Labour-intensive commodities

– Land-intensive commodities

– Capital-intensive commodities


2-35

Specialisation and comparative advantageTwo isolated nations• Constant costs

– Straight-line production possibilities curve

• Different opportunity costs– Different resource mix and different levels of

technology

• Self-sufficiency


2-36

Production possibilities

Clo

thin

g (K

)

Clo

thin

g (K

)Cereals (C) Cereals (C)

30

25

20

151210 0

30

25

20

15 10 0

5 10 15 18 20 30 5 8 10 15 20

A

B

Australia Taiwan


2-37

Principles of comparative advantage• Total output will be greatest when each good

is produced by that nation which has the lower domestic opportunity cost

• Australia has a comparative advantage in cereal

The terms of trade• Commodity terms of trade is the rate at which

one commodity can be exchanged for another, expressed in physical units of each commodity


2-38

Clo

thin

g (K

)

Clo

thin

g (K

)

4540

35

302520

151210 5

0

30

25

20

1510 5

05 10 15 18 20 25 30 5 8 10 15 20

A

B

Tradingpossibilities line

Tradingpossibilities line

Cereal (C) Cereal (C)

A′′

B′′

Australia Taiwan

Gains from trade and trading possibilities

S S’


2-39

Gains from trade under increasing cost• Increasing costs impose limits upon the gains

from specialisation and trade• The primary effect of increasing costs is to

make specialisation less than complete


2-40

The gains from trade

Cereals (C)

Clo

thin

g (K

)

0

Australia

S

A

E

C

Trade line

S’

A’


2-41

S

D

B

d

The gains from trade (cont.)

Cereals (C)

Clo

thin

g (K

)

0

Taiwand’

B’

Trade line

S’

Documents

Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 2-1 Chapter 2 The economising