l0 IPART ONE

I Introduction to Economics and the Economy

Income Changes The location of the budset lineu:i.r yt! money income. An increase in moneylncomeshifts the b-udget line to -the right; a decrease in moneyincome shifts it to the left. To verifi, this, recalculate the.table in Figure 1.1, assuming the card value (income) is

Land Land means much more to the economist than itdoes to most people. To the economisr land includes allnarural resources ("gifi* of nature") used in the productionprocess, such as arable land, forests, mineral and oil de_posits, and water resources.

Labor _The resource labor consisrs of the physical and

mental talents of individuals used in producing goods andservices. The services of a logger, retail clerk, inachinist,t9_agher, professional football player, and nuclear physicisiall fall under the general heading ,,labor.,'

Capital For economists, capital (or capital goods) in-cludes all manufactured aids used in producing'Tnsumergoods and services. Included are all factory srorage, trans_portation, and distribution facilities, as well as iools andmachinery. Economists refer to the purchase of capitalgoods as investrnent.

Capital goods differ from consumer goods becauseconsumer goods satisfiz wants directly, wlereas capitalgoods do so indirectly by aiding the production of con-sumer goods. Note that the term ,,capital', as used byeconomists refers not to money but to tools, machineryand other productive equipment. Because money producesnothing, economists do not include it as an econtmic re_source. Money (or money capital or flnancial capital) issimply a means lbr purchasing capital goods.

Entrepreneurial Ability Finally, there is the spe-cial hurnan resource, distinct fiom labor, called entrepre_neurial ability. The entrepreneur performs .severalrunctlons:

. The entrepreneur takes the initiative in conrbininsthe resources of land, labor, and capital to producJ agood or a service. Both a sparkplug and a catalyst,the entrepreneur is the driving force behind pioduc_tion and the agent who combines the other ,.rorrr_ces in what is hoped will be a successful businessvenrure.

* The entrepreneur makes the strategic businessdecisions ttrat set the course of an e-nterprise.

" The entrepreneur is an innovator. He or she com_mercializes new products, new production techniques,or even new forms of business organization.

" The entrepreneur is a risk bearer. The entrepreneurhas no guarantee of profit. The reward for the entre_preneur's time, efforb, and abilities may be profits orlosses. The entrepreneur risks not only his o. h.,invested funds but those of associates and stockhold_ers as well.

\fllilBudget lines

(a) $Z+O and (b) $60, and plot the new bud-get lines in the graph. No wonder peoplelike to have more income: That shifts theirbudget lines ourward and enables them tobuy more goods and services. But evenwith more income, people will still facespending tradeoffs, choices, and opporru-nity costs. (Key Question 7)

Because wants exceed incomes, individuals face aneconomizing problem; tJrey must decide what ro buy andwhat to forgo.A budget line (budget constraint) shows the variouscombinations of two goods that a consumer can Durchasewith a specific money incorneStraighcline budget consrrainrs imply constant opporrunirycosts associated with obtaining more of either of ihe rwogoods.

Society's Economizing problemSociety must also make choices under conditions of scar_ciry. It, roo, faces an economizing problem. Should itdevote more of its limired r"ro,rr".Jto the criminal iusticesystem (police, courts, and prisons) or to education(teachers, bools, and schools)? If it decides ro devore moreresources to both, what other goods and services does itforgo? Health care? Energy development?

Scarce ResourcesSociety has limited or scarce economic resources, mean_ing all natural, human, and manufactured resources thatgo into the production of goods and services. This in_cludes the entire set of factory and farm buildings and allthe e_quipment, tools, and machinery used to"producemanufacrured goods and agricultural products; ,il trrrrr_portation and communication facilitiei; all rypes of labor;and land and mineral rcsources"

Resource CategoriesEconomists classi$r economic resources into four seneralcategories.

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Because land, labor, capital, and entrepreneurial abil-ity are combined to produce goods and services, they arecalled the factors of production' or simply "inputs."

Production Possibilities NlodelSociety uses its scarce resources to produce goods andservices. The alternatives and choices it faces can best beunderstood through a macroeconomic model of produc-

tion possibilities. To keep things simple, let's initiallyassume:

. Full ernploymenr The economy is employing all its

available resources.. Fixed resoarces The quantity and quality of the fac-

tors of production are fixed.. Fixed technolog The state of technology (the meth-

ods used to produce output) is constant.' Two goods The economy is producing only two

goodsr pizzas and industrial robots' Pizzas syrnbolizeconsumer goods, products that satis$t our wants di-rectly; industrial robots (for example, the kind usedto weld automobile frames) symbolize capital goods,products that satisfit our wants indirecdy by makingpossible more efficient production of consumergoods.

Production Possibilities ThbleA production possibilities table lists the different combi-nations of two products that can be produced with a spe-cific set of resources, assuming full employment. Table

1.1 presents a simple, hypothetical economythat is pro-

ducing pizzas and industrial robots; the data are, of

course, hypothetical. At alternative A, this economywould be devoting all its available resources to the pro-duction of industrial robots (capital goods); at alterna-tive \ all resources would go to pizza production(consurirer goods). Those alternatives are unrealistic ex-tremes; an economy rypically produces both capitalgoods and consumer goods, as in B, C, and D. As wemove from alternative A to E, we increase the produc-tion of pizzas at the expense of the production of indus-trial robots.

TABLE l. I Production Possibilities of Pizzas and IndustrialRobots

" ""'" l F-ir.iriillternatlvis -

.-

T y p e o f P r t d u c t " , , , , , , ; , , ; ' , ,

, t A l r , . . i r ' ; B ; 1 , ; , Q r , r b E

Pizzas (in hundred thousands) 0 | 2

Robots (in thousands) l0 9 7

4

0

34

cHArrER r I 1rLimits, Alternatives, and Choices I

Because consumer goods satisft our wants directlgany movement toward E looks tempting. In producingmore pizzas, society increases the current satisfaction ofits wants. But there is a cost: More pizzas means fewerindustrial robots. This shift of resources to consumergoods catches up with society over time because thestock of capital goods does not expand at the currentrate, with the result that some potential for greater fu-ture production is lost. By moving toward alternative E,society chooses "more now" at the expense of "muchmore later."

By moving toward A, society chooses to forgo currentconsumption, thereby freeing up resources that can beused to increase the production of capital goods. By build-ing up its stock of capital this way, society will have greaterfuture production and, therefore, greater future consump-tion. By moving toward A, society is choosing "more later"at the cost of ttless now.tt

Generalization: At any point in time, a fully employedeconomy must sacrifice some of one good to obtain moreof another good. Scarce resources prohibit such an econ-omy from having more of both goods. Society must chooseamong alternatives. There is no such thing as a free pizza,or a free industrial robot.

Production Possibilities CurveThe data presented in a production possibilities table areshown graphically as a production possibilities qrrve.

Such a curve displays the different combinations of goods

9 ! :1Production

possibilities curve

and services that society can produce ina fully employed economy, assuming afixed availability of supplies of resourcesand constant technology. We arbitrarilyrepresent the economy's output of capitalgoods (here, industrial robots) on thevertical axis and the output of consumergoods (rere, pizzas) on the horizontal axis,as shown in Figure 1.2 (Key Graph).

Each point on the production possibilities curve rep-resents some maximum ouput of the two products' Thecurve is a "constraint" because it shows the limit of at-tainable outputs. Points on the curve are attainable aslong as the economy uses all its available resources.Points lying inside the curve are also attainable, but theyreflect less total output and therefore are not as desirableas points on the curve. Points inside dre curve imply thatthe economy could have more of both industrial robotsandpizzas if it achieved full employment of its resources.Points lying beyond the production possibilities curve,like W, would represent a greater output than the output

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Fl GUfiE | .l The produstion poecibilifiicr curv6. Fach point on theproduction pocrhilhiss curvo raFossnts ssme madmrrm combination of gro produsts ttctcan be pnoducad if ruourtes arc fully employed.\Aften m eaonomy b opcrating on thecurve, thorc industrlrl robo* merns lers pizzas, rnd vice vcrea" Limhed rcsources ald a fixedt$hnotogy make any conrbinrdoo of industrial rpbots and phras lyiry ou$id. rha curs(such rs at W) unatoinable. fuints inside th€ curye arr atdlnabh,but they lndlcate d|at fultemployrnent is no! belng rtalized.

I , 4 5 6 7Pizzas (hunft ed thousands)

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