Chapter 2
A CLOSER LOOK AT THE
ECONOMIC PROBLEM
Central Economic Questions
• 3 central economic questions
- Output Q: what & in what quantities?
- Input Q: How & how much of scarce resources?
- Distribution Q: For whom & where?
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2.1 What should be produced?
Economic goods
Consumer goods
Non-durable goods
Semi-durable goods
Durable goodsFinal goods & intermediate
goods
Private goods & public goods
Homogenous & heterogeneous
goods
Capital goods
Free goods
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Figure 2-1 The production possibilities curve once
again
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Figure 2-2 Improved technique for producing
capital goods
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Figure 2-3 Improved technique for producing
consumer goods
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Figure 2-4 Increase in the quantity or productivity
of the available resources
2.2 Factors of production
Primary factors of production
Natural resources
Labour
Secondary factors of
production
Capital
Entrepreneurship
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2.3 The Distribution issue
• This is a normative issue
• Who will receive What from the economy?
• Need income different from wealth
• Functional distribution of income:
– Rent, wages, interests & profits
• Personal distribution of income
• Sectoral distribution of income
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2.4 Economic Systems
• System: network of interlocked parts
forming an overall pattern
• Economic system: pattern of organisation
aimed at solving the 3 econ. Questions
• Criteria for classification: property rights
& coordinating mechanism
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Major differences between
economic systemsTraditional Command Market Mixed
What? custom Central
authority
Demand from
consumers &
profitability
Demand, profits
+ Gvt
intervention
How? custom Central
authority
Prices &
productivity of
factors
Prices,
productivity +
Gvt intervention
For Whom? custom Central
authority
Those who can
afford
Affordability +
Gvt intervention
Ownership of
factors of
production
Private &
Community
- State:
socialism
- Private:
Capitalism
Private & State
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2.5 Contributions to economic
scienceADAM SMITH (1723-1790)
• Market system: invisible hand
• The wealth of nations: division of labour, free trade and limited role for government
• Classical school
KARL MARX (1818-1883)
• Evolution of Institutions: Capitalism - Socialism - Capitalism
• Das Kapital: Capitalism is exploitative and self-destructive
• Predicted popular revolution but did not anticipate the capacity of capitalism to adapt.
JOHN MAYNARD KEYNES (1883-1946)
• Government intervention to support aggregate demand
• The general theory: foundation for modern macroeconomics
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