The foundation of economics
The most fundamental economic problem is that of scarcity. That is, society's desire for goods and services is unlimited while the resources it has to produce those goods and services are limited. Therefore, society must choose among alternative production possibilities. The decision to produce a particular good or service necessarily involves sacrificing some alternative good that could have been produced with the same resources.
Productive resources are referred to as factors of production. They are sparated into four categories:
- Land - includes all natural resources,
- Capital - tools, equipment, factories, technology, etc.,
- Labor - includes all human activity
- Entrepreneurial ability - is a unique type of labor. Entrepreneurs are individuals who risks their own money to start a new business. They are innovators of new products, production techniques, and forms of organization.
The payments to resource owners include rent and interest received by suppliers of property resources, wages and salaries received by labor and profit received by entrepreneurs.
Economic efficiency implies full employment of available resources and
full production. Full employment means all available resources should
be employed. Full production means that employed resources are providing
maximum satisfaction of our material wants.
Definitions:
- Opportunity cost - the value of the next best alternative which must be sacrificed
- Allocative efficiency - resources are being used to produce the combination of goods and services most wanted by society.
- Productive efficiency - goods and services are being produced with least costly production techniques
- Full production - the economy is producing the goods that consumers
want (allocative efficiency) in the most efficient way possible (productive
efficiency).
Production Possibilities Model
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The production possibilities model is a device used to illustrate the economic problem of scarcity.
Assumptions of the model
- The economy is operating efficiently (full employment and full production).
- There is a fixed amount of resources
- There is a constant level of technology
- There are only two goods: consumer goods and capital goods
- Given the following data:
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