Core Issues in Economics
Factors of Production:
  • Factors of Production 
    • resource inputs used to produce goods and  services  (e.g., land, labor, capital, entrepreneurship)
  • There are four basic factors of production.
    1. Land
      • refers not just to the ground but to all natural resources such as crude oil, water, air and minerals.
    2. Labor 
      • refers to the skills and abilities to produce goods and services.  Hence, both the quantity and the quality of human resources are included in the “labor” factor.
    3. Capital 
      • final goods produced for use in the production of other goods  (e.g., equipment,         structures)
    4. Entrepreneurship 
      • the assembling of resources to produce new or improved products and technologies.
Limits to Output:
  • No matter how an economy is organized there is a limit to how fast it can grow.
  • The most evident limit is the amount of resources available for producing goods and services.
Guns versus Butter:
  • One of the persistent choices about resource use entails defense spending.
  • The U.S. government spends more than $250 billion a year on national defense.
  • From an economic view, those defense expenditures also represent an enormous claim on scarce resources.
  • The 1.5 million men and women serving in the armed forces aren’t available to build schools, design clothes, or teach economics.
  • The land, labor, capital, and entrepreneurship devoted to producing military hardware are not available for producing civilian goods, thus the “guns vs. butter” dilemma.
  • Since the end of the Cold War, the United States has chosen to produce more “Butter” (Civilian goods) and fewer “guns” resulting in defense spending declining from a high of 6.4 percent of total output in 1986 to only 3.3 percent in 1999.
  • This freeing up of resources from the military sector is referred to as the “peace dividend”.
Opportunity Costs:
  • The most desired goods or services that are forgone in order to obtain something else.
  • Everything we do involves an opportunity cost.
Production Possibilities:
  • The Production Possibilities Curve
    • the alternative combinations of final goods and services that could be produced in a given time        period with all available resources and technology.
    • each point on the production possibilities curve depicts an alternative mix of output.
    • the production possibilities curve illustrates two essential principles:
      • Scarce resources – there is a limit to the amount we can produce in a given time period with available resources and technology.
      • Opportunity costs – We can obtain additional quantities of any desired good only by reducing the potential production of another good.
  • Increasing Opportunity Costs 
    • the shape of the production possibilities curve reflects another limitation on our choices.
    • why do opportunity costs increase?  because it is difficult to move resources from one industry to another.
    • the “law” of increasing opportunity cost says that we must give up ever-increasing quantities of other goods and services in order to get more of a particular good.
  • Efficiency 
    • increasing opportunity costs aren’t a sign of inefficiency.
    • efficiency means “getting the most from what you’ve got” – that is, using factors of production in the most productive way.
    • maximum output of a good from the resources used in production.
    • there’s no guarantee, of course, that we’ll always use resources efficiently.
    • a production possibilities curve shows potential output, not necessarily actual output.
    • if we are inefficient, actual output will be less than the potential output
  • Economic Growth
    • an increase in output (real GDP); an expansion of production possibilities.
    • all output combinations that lie outside the production possibilities curve are unattainable with available resources and technology.
    • over time, population increases and we get more labor.  Also, if we continue building factories and machinery, the stock of available capital will also increase.
    • the quality of labor and capital can also increase if we train workers and pursue new technologies.
    • all of these changes will increase potential output and will shift the production possibilities curve outward.
    • with more resources or better technology, our production possibilities increase
The Market Mechanism:
  • The use of market prices and sales to signal desired outputs (or resource allocations).
    • The essential feature of the market mechanism is the price signal.
    • The market mechanism can also answer the HOW and FOR WHOM questions.
      • To maximize their profits, producers will seek to use the lowest-cost method of producing a good.
      • A market distributes goods to the highest bidder.  Individuals who are willing and able to pay the most for a good tend to get it in a pure market economy.
  • Adam Smith said the “invisible hand” determines what gets produce, how, and for whom.
Government Intervention:
  1. The laissez-faire (doctrine of “leave it alone”) policy Adam Smith favored has always had its share of critics.
  2. Karl Marx emphasized how free markets tend to concentrate wealth and power in the hands of the few, at the expense of the many.
    • As Marx saw it, unfettered markets permit the capitalists (those who own the machinery and factories) to enrich themselves while the proletariat (the workers) toil long hours for subsistence wages.
    • Marx argued that the government not only had to intervene but had to own all the means of production.
  3. John Maynard Keynes seemed to offer a less drastic solution.
    • The market, he conceded, was pretty efficient in organizing production and building better mousetraps.
    • However, individual producers and workers had no control over the broader economy.  He believed the cumulative actions of so many economic agents could easily tip the economy in the wrong direction.
    • In Keynes’ view, government should play an active but no all-inclusive role in managing the economy

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this page is maintained by Reed Fisher
last updated August 25, 2008