FAR EASTERN UNIVERSITY HIGH SCHOOL

Accountancy, Business and Management

Nicanor Reyes Street, Sampaloc, Manila

CHAPTER 2

Lesson 2: The Economizing Problem

Introduction:

This chapter examines the fundamentals of economics-scarcity, choices and cost. We first
introduce the economic goals and then examine the economizing problem, focusing closely on
wants and needs. Next, we develop the economic model of the Production Possibilities Frontier
that incorporates and illustrates several key ideas and then we will end the subject with the
Economics Systems

Objective:

1. To learn about the different resource categories;

2. To understand the eight economic goals and the United Nation’s Sustainable
Development Goals;
3. Properly distinguish between consumer goods and capital goods, labor-intensive
method of production, allocative efficiency and productive efficiency, a centrally
planned economy and a market economy with respect to the problems of production
and distribution of goods; and
4. Define and draw the production possibilities frontier and use it to analyze production
possibilities curve and use it to analyze production, resource allocation, and growth
of the economy overtime.

Economic Goals

If economic policies are designed to achieve certain economic goals, then we need to
recognize a number of goals that are widely accepted in many countries.

• Economic Growth

– Produce more and better goods and services, or, more simply, develop a higher
standard of living.

Lesson 2: The Economizing Problem

 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

• Full employment

– Provide suitable jobs for all citizens who are willing and able to work.

• Economic Efficiency

– Achieve the maximum fulfillment of wants using the available productive

resources.

• Price-level stability

– Avoid large upswings and downswings in the general price level; that is, avoid
inflation and deflation.

• Economic Freedom

– Guarantee that business, workers, and consumers have a high degree of

freedom in their economic activities.

• Equitable distribution of income

– Ensure that no group of citizens faces poverty while most other enjoy
abundance.

• Economic security

– Provide for those who are chronically ill, disabled, laid off, aged, or otherwise
unable to earn minimal levels of income.

• Balance of trade

– Seek a reasonable overall balance with the rest of the world in international
trade and financial transactions.

Some of these goals are complementary; when one is achieved, some other one will also
be realized. But other goals may conflict or even be mutually exclusive. They may entail trade-

Lesson 2: The Economizing Problem

 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

offs, meaning that to achieve one we must sacrifice another. When goals conflict, society must
establish ways to prioritize the objectives it seeks.

The Foundation of Economics

Two fundamental facts together constitute the economizing problem and provide a foundation
for economics:

1. Unlimited Wants
Society’s economic wants-that is, the economic wants of its citizens and
institutions-are virtually unlimited and insatiable.
2. Scarce Resources
Economic resources-the means of producing goods and services-are limited.

All that follows depends directly on these two facts.

Resource Categories

• Land

-this includes all natural resources−all “gifts of nature” −that are used in the production
process, such as arable land, forests, mineral and oil deposits, and water resources.

• Capital (capital goods or investment goods)

- includes all manufactured aids used in producing consumer goods and services. Included
are all tools, machinery, equipment, factory, storage, transportation, and distribution facilities.
The process of producing and purchasing capital goods is known as investment.

Capital goods differ from consumer goods because the latter satisfy wants directly, while
the former do so indirectly by aiding the production of consumer goods.

• Labor

- is a broad term for all the physical and mental talents of individuals available and usable
in producing goods and services. The service of a logger, retail clerk, machinist, teacher,

Lesson 2: The Economizing Problem

 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

professional football player, and nuclear physicist all fall under the general heading
”labor”.

• Entrepreneurial Ability

-the special human resource that is distinct from labor. The entrepreneur takes the
initiative in combining the resources of land, capital, and labor to produce a good or service. Both
a sparkplug and a catalyst, the entrepreneur is the driving force behind production and the agent
who combines the other resources in what is hoped will be a successful business venture.

Production Possibilities Model

As resources are scarce, a full-employment, full-production economy cannot have an

unlimited output of goods and services. Consequently, people must choose which goods and
services to produce and which to forgo. The necessity and consequences of those choices can
best be understood through a production possibilities model.

The discussion of the Production Possibilities Model will begin with simplifying
assumptions:

1. Full employment and productive efficiency

The economy is employing all its available resources (full employment) and is
producing goods and services at least cost (productive efficiency.)
2. Fixed resources
The available supplies of the factors of production are fixed in both quantity and
quality. Nevertheless, they can be reallocated, within limits, either for factory sites
or for food production.
3. Fixed technology
The state of technology-the methods used to produce output-does not change
during the analysis. This assumption and the previous one imply that we are
looking at an economy at a certain point in time or over a very short period of time

Lesson 2: The Economizing Problem

 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

4. Two goods
The economy is producing only two goods: wheat and tanks.

TAKE NOTE!

• Full Employment: Using Available Resources

- No workers should be out of work if they are willing and able to work. Nor should capital
equipment or arable land sit idle.

• Full Production

-All employed resources must be used so that they provide the maximum possible
satisfaction of our economic wants.

• Productive Efficiency

- is the production of any particular mix of goods and services in the least costly way.

• Allocative Efficiency

-is the least-cost production of the particular mix of goods and services most wanted by
society.

Table 2.1 Production Possibilities of Wheat and Tanks with Full Employment and Productive
Efficiency

Lesson 2: The Economizing Problem

 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

A production possibilities table lists the different combinations of two products that can
be produced with a specific set of resources (an with full employment and productive efficiency)

Figure 2.1 The Production Possibilities Curve

Each point on the production possibilities curve represents some maximum output of the
two products. The curve is a frontier because it shows the limit of attainable outputs. Points lying
inside (to the left of) the curve are also attainable, but they reflect inefficiency and therefore are
not as desirable as points on the curve. Points lying outside (to the right of) the production
possibilities curve would represent a greater output than the output at any point on the curve.
Such points, however, are unattainable with the current supplies of resources and technology.

Law of Increasing Opportunity Cost

As resources are scarce relative to the virtually unlimited wants they can be used to
satisfy, people must choose among alternatives. More tanks mean fewer wheat. The amount of
other products that must be forgone or sacrificed to obtain 1 unit of a specific good is called the
opportunity cost. In our case, the number of bushels of wheat that must be given up to get
another unit of tank is the opportunity cost, or simply the cost, of that unit of tank.

Lesson 2: The Economizing Problem

 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

In moving from choice A to choice B in Table 2.1, we find that the cost of additional 1000
units of tanks is 50000 bushels of wheat. But as we pursue the concept of cost through the
additional production possibilities−B to C, C to D, D to E, and E to F− an important economic
principle is revealed: The opportunity cost of each additional number of tanks is greater than the
opportunity cost of the preceding one. The example illustrates the Law of Increasing Opportunity
Costs; The more of a product that is produced, the greater is its opportunity cost (“marginal”
being implied.)

Note these points about these opportunity costs:

• Here opportunity costs are being measured in real terms, that is, in actual goods rather
than in money terms.
• We are discussing marginal (meaning “extra”) opportunity costs, rather than cumulative
or total opportunity costs. For example, the marginal opportunity of 1000 units of tanks
in Table 2.1 is 50000 bushels of wheat (=1,000,000 – 950,000). But the total opportunity
cost of 850,000 bushels of wheat is 2,000 tanks (=1000 units of tanks for choice B plus
1000 unit difference for choice B).

Figure 2.2 The Law of Increasing Opportunity Cost

Lesson 2: The Economizing Problem

 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

Shape of the Curve

The law of increasing opportunity cost is reflected in the shape of the production possibilities
curve: The curve is bowed out from the origin of the graph. Figure 2.1 shows that when the
economy moves from A to F, it must give up successively larger amounts of wheat (50,000,
100,000, 150,000, 300,000 and 400,000) to acquire equal increments of tanks (1,000
throughout). This is shown in the slope of the production possibilities curve which becomes
steeper as we move from A to F. A curve that gets steeper as we move down it is “concave to the
origin.”

The Production Possibilities Frontier can be used to illustrate seven (7) economic concepts:
1. Scarcity is illustrated in the frontier itself. Implicit in the concept of scarcity is the idea
that we can have something but not all things. The PPF separates and attainable region
from an unattainable region.

2. Choice is represented by our having to decide among the many attainable combinations
of the two goods. For example, will we choose the combination of goods represented by
point A or by point B?

3. Opportunity Cost is most easily seen as a movement from one point to another, such as
movement from point A to point B. More tanks are available at point B than at point A,
but fewer bushels of wheat are available. In short, the opportunity cost of more tanks is
fewer bushels of wheat.

4. Productive efficiency is represented by the points on the points (such as A-F), while
productive inefficiency is represented by any point inside the PPF.

5. Unemployment (in terms of resources being unemployed) exists at any productive-

inefficient point (any point below the PPF), whereas resources are fully employed at any
productive-efficient point (such as any point in the range A-F)

Lesson 2: The Economizing Problem

 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

6. Economic Growth refers to the increased productive capabilities of an economy.

Economic growth is illustrated by an outward shift in the PPF. Two major factors that
produce economic growth are (1) an increase in the quantity of resources and (2) an
advance in technology.
An increase in the quantity of resources (e.g, through a discovery of new resources)
makes a greater quantity of output possible. In Figure 2.3 (a), an increase in the quantity
of resources makes it possible to produce both more military goods and more civilian
goods. Thus, the PPF shifts outward from PPF1 to PPF2.

• Technology refers to the body of skills and knowledge involved in the use of
resources in production. An advance in technology commonly increases the
ability to produce more output with a fixed quantity of resource or the ability to
produce the same output with a smaller quantity of resources. For example,
suppose an advance in technology allows the production of more of both
military and civilian goods with the same quantity of resources. As a result, the
PPF in Figure 2.3 (a) shifts outward from PPF1 to PPF2. The outcome is the same
as when the quantity of resources is increased.
If the advance in technology allows only more of one good (instead of
both goods) to be produced with the same quantity of resources, then
the PPF shifts outward, but not in the same way as shown in Figure 2.3
(a). To illustrate, suppose an advance in technology allows only more
civilian goods to be produced but not more military goods. Therefore, the
maximum amount of military goods that can be produced does not
change, but the maximum amount of civilian goods rises. This situation
gives us the shift from PPF1 to PPF2 shown in Figure 2.3 (b).
Figure 2.3 (a) Economic Growth Within a PPF Framework

An increase in resources or an advance in

MILITARY GOODS

technology (that can lead to more of both goods

PPF2 being produced) can increase the production
capabilities of an economy, leading to economic
PPF1 growth and a shift outward in the PPF, as shown
in part (a).

0 CIVILIAN GOODS

Lesson 2: The Economizing Problem

 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

Figure 2.3 (b) Economic Growth Within a PPF Framework

If the advance in technology leads to the

greater production of only one goods (such as
civilian goods in this figure), then PPF shifts
MILITARY GOODS

outward, as shown in part (b).

PPF1 PPF2

0 CIVILIAN GOODS

Economic Systems

• Every society needs to develop an economic system−a particular set of institutional

arrangements and a coordinating mechanism−to respond to the economizing problem.

• Economic systems differ as to (1) who owns the factors of production and (2) the method
used to coordinate and direct economic activity.

1. Market System (Capitalism)

This system is characterized by private ownership of resources and the use of markets
and prices to coordinate and direct economic activity.

In pure capitalism−or laissez-faire capitalism−government’s role would be limited to

protecting private property and establishing an environment appropriate to the operation of the
market system.

The term laissez-faire means let it be, that is, keep the government from interfering with
the economy. The idea is that such interference will disturb the efficient working of the market
system.

Lesson 2: The Economizing Problem

 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

2. The Command System (Socialism)

In this system, government owns most property resources and economic decision making
occurs through a central economic plan.

A central planning board appointed by the government makes nearly all the decisions
concerning the use of resources, the composition and distribution of output, and the organization
of production.

A pure command economy would rely exclusively on a central plan to allocate the
government-owned property resource.

Lesson 2: The Economizing Problem