McGraw-Hill/Irwin ©2009 The McGraw-Hill Companies, All Rights Reserved

Chapter 2

Resource Utilization

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Learning Objectives

In this chapter you’ll learn:1. The definition of economics.2. The central fact of economics.3. The four economic resources.4. The concepts of full employment, full production, and

underemployment.5. The concept of the production possibilities curve.6. Productive efficiency.7. What enables an economy to grow.8. The law of increasing costs.9. The concept of opportunity cost.

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Economics Defined

Economics is the efficient allocation of the scarce means of production toward the satisfaction of human wants.• The means of production are limited.• Human wants are unlimited.

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The Central Fact of Economics: SCARCITY

Scarcity• Resources are the things society uses to produce goods

and services.• These resources are scarce (limited).

The economic problem• There are never enough resources to produce all of the

goods and services that people want.

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Four Economic Resources

Land

Labor

Capital

Entrepreneurial ability

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Land

Land (a broader meaning than our normal understanding of the word).• Includes natural resources: timber, oil, coal, iron ore, soil,

water, as well as the ground in which these resources are found.

• Is used for the extraction of minerals and farming.• Provides the site for factories, office buildings, shopping

centers, homes, etc. • Owners of land receive “rent.”

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Labor

Labor

• The work and time for which one is paid is what economists call “labor”

• Money received for one’s labor is called wages and/or salaries

• About two-thirds of the total resource cost is the cost of labor

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Capital

Capital• Man-made goods used to produce other goods or services

is what economists call “capital.”• Examples are office buildings, stores, and factories.• Consists of mainly plant and equipment.

• The money owners of “capital” receive is called “interest.”• Capital is the MOST important of the four economic

resources.

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Entrepreneurial Ability

The entrepreneur• Sets up a business.• Assembles the needed resources.• Risks his/her own (or borrowed) money.• Makes a “profit” or incurs a “loss.”• Is central to the American economy.

25 million businesses are virtually all entrepreneurs.• The vast majority work for themselves or have 1 or 2

employees.

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Our Economic Problem Revisited

Limited resources versus unlimited wants.

There are NOT enough resources to produce everything that everyone wants.

Therefore, CHOICES must BE MADE!

Every choice has an “opportunity cost” associated with it!

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Questions for Thought and Discussion

Why are the means of production scarce?

Why is capital the most important factor of production?

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Opportunity Cost: An Important Fundamental Concept in Economics

Because we cannot have everything we want, we must make choices.

The thing we give up (our second-best choice) is called the opportunity cost of our choice.• This is the foregone value of the next best alternative.

In the economic world, “both” is not an admissible answer to a choice of “which one.”

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Highest Valued Alternative

Options:• Watch TV.• Talk on the telephone.• Go on a date.• Study economics.

• Opportunity cost is the highest valued alternative that could have been chosen (i.e., study economics).

• Opportunity cost may or may not have a dollar value.

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Inherit $40,000Two choices: Buy a car or go to

college

Bought the car (paid $40,000)

Can’t go to college

College graduate (lifetime earnings) $1,300,000

High School graduate (lifetime earnings) $800,000

Opportunity Cost $500,000

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California 1967–1997

Prisons• Added 21 additional

prisons

Colleges• Added 1 additional college

The Opportunity Cost of building more prisons is building fewer colleges

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Questions for Thought and Discussion

Do Bill Gates or other wealthy persons face scarcity?

Why is capital such an important resource?

What is the opportunity cost of America’s involvement in Iraq?

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Productive Efficiency

Is attained when the maximum possible output of one good is produced, given the output of other goods.• Productive efficiency occurs only when we are operating on

the production possibilities curve.• Productivity efficiency means that the output of one good

cannot be attained with out reducing the output of some other good.

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Full Employment and Full Production

Full employment = 5% unemployment rate

From 1971–1996 the unemployment rate was above 5% (in recent years, this has lingered below 5%).

Full production— 85–90% plant utilization rate.

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Underemployment of Resources

An unemployment rate greater than 5%

A capacity utilization rate less than 85%

Discrimination• A phenomenon that has diminished but has not been

eliminated entirely.• Probably keeps our output 10–15% below what it could

be.• If there were truly an efficient allocation of resources.

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The Production Possibilities Curve

The Production Possibilities Curve represents our economy at

• Full employment.

• Full production.

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The Landscape of the Production Possibility Frontier

Points S, A, B, C, and T are efficient with full employment and full plant capacity.

Point D is producing at below efficiency since either plants are being under utilized or the workforce is underemployed.

Any point above the production possibility curve is not achievable.

- Inefficiency -- Inefficiency -

Output of Butter

Outputof Guns

AA

DDBB

CC

TT

SS

Production PossibilitiesCurve ( PPC )

Production PossibilitiesCurve ( PPC )

Production PossibilitiesCurve ( PPC )Only clothing

is producedOnly clothingis producedOnly clothingis produced

Only foodis producedOnly foodis producedOnly foodis produced

All output combinations on the frontier curve are efficient.

All output combinations on the frontier curve are efficient.

All output combinations on the frontier curve are efficient.

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Production Possibilities Curve

Hypothetical Production Schedule

Point Units of Butter

Units of Guns

A 15 0

B 14 1

C 12 2

D 9 3

E 5 4

F 0 5

Units of guns

16

14

12

10

8

6

4

2

AB

C

D

E

F

10

2 3 4 5 6

This Production Possibilities Curve shows the range of possible combinations of guns and butter extending from 15 units of butter and no guns at point A to 5 units of guns and no butter at point F

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Production Possibilities Curve (Continued)

Hypothetical Production Schedule

Point Units of Butter

Units of Guns

A 15 0

B 14 1

C 12 2

D 9 3

E 5 4

F 0 5

Units of guns

16

14

12

10

8

6

4

2

AB

C

D

E

F

10

2 3 4 5 6

• When you are on the curve, to get more of one thing you have to give up some of the other thing.

• The opportunity cost of gaining 1 unit of guns was 1 unit of butter

Had to give up 1 unit of butter

To gain 1 unit of Guns

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Production Possibilities Curve (Continued)

Hypothetical Production Schedule

Point Units of Butter

Units of Guns

A 15 0

B 14 1

C 12 2

D 9 3

E 5 4

F 0 5

Units of guns

16

14

12

10

8

6

4

2

AB

C

D

E

F

10

2 3 4 5 6

• When you are on the curve, to get more of one thing you have to give up some of the other thing.

• In this particular instance, the opportunity cost of gaining 1 unit of guns was 2 units of butter.

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Law of Increasing Costs

As we shift from butter to guns, we have to give up increasing units of butter for each additional unit of guns.

This is known as the “law of increasing cost.” As the output of one good expands, the opportunity cost of producing additional units of this good increases.

You give up fewer units of butter to get 1 unit of guns up top.

You give up more units of butter to get 1 unit of guns at the bottom

Units of guns

16

14

12

10

8

6

4

2

AB

C

D

E

F

10

2 3 4 5 6

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Economic Growth

Best available technology

Expansion of labor• More or better trained labor

Expansion of capital• More or improved plant and equipment

Investment means growth

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Investment, Consumption, and the Production Possibilities Curve

We can choose between consumption and investment.

Investment increases future production possibilities.

Greater investment means greater future production possibilities.

Point B gives us greater production possibilities than Point A.

Investmentgoods

Consumptiongoods

IA

CA

A

PPC 2015 with BPPC 2015 with BPPC 2015 with B

PPC 2005PPC 2005PPC 2005

PPC 2015 with APPC 2015 with APPC 2015 with A

BBIB

CB

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Questions for Thought and Discussion

Given limited resources, is growth always good? • Why do most mainstream economists embrace growth?

What is the relationship between investment, consumption, and growth? • Can you illustrate this by drawing a graph using production

possibility curves?