Chapter 2

Resource Utilization

2-1Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Objectives• The definition of economics

• The central fact of economics

• The four economic resources

• The concepts of opportunity cost, full employment, full production, and productive efficiency

• What enables the economy to grow

• The law of increasing cost

2-2Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

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

2-3Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

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 such as 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.

– Produces “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

2-7Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Capital• Capital

– Man-made goods used to produce other goods or services is what economists call “capital”

• Examples are office buildings, stores, and factories

– 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– 23 million businesses are virtually all

entrepreneurs• The vast majority work for themselves or have one or two

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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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)

Choice made

Highest valued alternative

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Inherit $40,000

• 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

Two choices – buy a car or go to college

Opportunity Cost $ 500,000

2-13Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

California1967-1997

• Prisons– Added 21

additional prisons

• Colleges– Added 1

additional college

The Opportunity Cost of building more prisons is building fewer colleges

2-14Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

California1990 - 1997

• Prison guards– + 10,000

• College employees– - 10,000

Obviously, the opportunity cost of one additional prison guard is one college employee

2-15Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Full Employment

•Five percent unemployment rate1

From 1971 – 1996 the unemployment rate was above 5%. In recent years, this has hovered above 4 %. If it stays this low, the next edition of the textbook may adjust this to 4 %

1

2-16Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Full Production•Eighty five to ninety percent utilization rate

2-17Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

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 percent

below what it could be• If there was truly an efficient allocation of

resources

2-18Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

The Production Possibilities Curve

• Represents our economy at–Full employment –Full production

2-19Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

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

2-20

Units of guns

16

14

12

10

8

6

4

2

AB

C

D

E

F

10

2 3 4 5 6

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

Hypothetical Production Schedule

Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Production Possibilities Curve

2-21

Units of guns

16

14

12

10

8

6

4

2

AB

C

D

E

F

10

2 3 4 5 6

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

Hypothetical Production Schedule

Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Production Possibilities Curve

To gain 1 unit of Guns

Had to give up 1 unit of butter

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 one unit of guns was one unit of butter

2-22

Units of guns

16

14

12

10

8

6

4

2

AB

C

D

E

F

10

2 3 4 5 6

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

Hypothetical Production Schedule

Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Production Possibilities Curve

To gain 1 unit of Guns

Had to give up 2 units of butter

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 one unit of guns was two units of butter

2-23

Units of guns

16

14

12

10

8

6

4

2

AB

C

D

E

F

10

2 3 4 5 6

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

Hypothetical Production Schedule

Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Production Possibilities Curve

To gain 1 unit of Guns

Had to give up 3 units of butter

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 one unit of guns was three units of butter

2-24

Units of guns

16

14

12

10

8

6

4

2

AB

C

D

E

F

10

2 3 4 5 6

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

Hypothetical Production Schedule

Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Production Possibilities Curve

To gain 1 unit of Guns

Had to give up 4 units of butter

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 one unit of guns was four units of butter

2-25

Units of guns

16

14

12

10

8

6

4

2

AB

C

D

E

F

10

2 3 4 5 6

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

Hypothetical Production Schedule

Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Production Possibilities Curve

To gain 1 unit of Guns

Had to give up 5 units of butter

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 one unit of guns was five units of butter

2-26

Units of guns

16

14

12

10

8

6

4

2

AB

C

D

E

F

10

2 3 4 5 6

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

Hypothetical Production Schedule

Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Production Possibilities Curve

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.

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

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

When you are at a point that is inside the line (PPF) it is possible to get more of both

If you were at point G, it would be possible to move to point D or any other point on the line (PPF) and get more butter and more guns

2-27Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Units of guns

16

14

12

10

8

6

4

2

AB

C

D

E

F

10

2 3 4 5 6

G

Points Inside and Outside the Production Possibilities Curve Frontier

Every point on the curve represents output at Full Employment and Full Production

Every point inside the curve represents output at less than Full employment and less than Full Production

2-28

Units of guns

16

14

12

10

8

6

4

2

AB

C

D

E

F

W

X

Y

1 2 3 4 5 60

Z

Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Where we usually are

A Recession

A Depression

Point W represents output at more than full employment and full production and is currently unattainable

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

2-29Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Economic Growth• Best available technology• Expansion of labor

–More or better trained labor

• Expansion of capital–More or improved plant and

equipment

2-30Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Production Possibilities Curves

A move from PPC to PPC to PPC represents economic growth1 32

2-31

Units of guns

15

10

5

0

PPC 1

PPC 2

PPC 3

5 10 15

Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Production Possibilities Curves Over Time Country A Country B

Country A represents slower economic growth than Country B

Country A capital goods is 3.8 units

Country B represents much faster economic growth than Country A

Country B capital goods is 7.0 units

2-32

Units of consumer goods

25

20

15

10

5

0

PPC 2001

PPC 1991

A.

Units of consumer goods

25

20

15

10

5

0

PPC 2001

PPC 1991

B

B.

5 10 15 5 10 15

A

Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

The Production Possibilities Frontier during World War II

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