Transcript Opportunity Cost - McGraw Hill Higher Education

Resource Utilization
Chapter 02
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives

After this chapter you should be able to:
1.
2.
3.
4.
5.
6.
7.
8.
9.
Define economics.
Identify the central fact of economics and explain how it
related to the economic problem.
Name the four economic resources and explain how they
are used by the entrepreneur.
Explain and apply the concept of opportunity cost.
Describe and distinguish among the concepts of full
employment, full production, and underemployment.
Describe the concept of the production possibilities curve
and how it is used.
Identify and explain the three concepts upon which the law
of increasing costs is based.
Define and explain productive efficiency.
Identify and explain the factors which enable an economy to
grow.
2-2
Economics Defined

Economics studies the efficient allocation of the
scarce means of production toward the satisfaction
of human wants.
•
•
•
Efficiency as a goal emphasizes the need to maximize our
material output, given the amount of resources.
Means of production includes our resources and our
technological ability to use them to produce output.
 Resources are the things used to produce goods and
services.
 These resources are scarce (limited).
Satisfaction of human wants is the purpose of an
economy.
 Economists assume people know their wants.
 Definition does not distinguish between wants and
needs.
 Goods and services fulfill our material wants.
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The Central Fact of Economics: SCARCITY

This definition assumes that scarcity is the
fundamental economic problem:
•

Why is there an economic problem?
•
•

There are never enough resources to produce all of the
goods and services that people want.
The means of production (resources) are limited.
Economists assume that human wants are unlimited.
An economy is a system for organizing the
allocation of resources to produce and distribute the
goods and services that satisfy human wants.
•
The more efficient the economy is, the more wants we can
satisfy.
2-4
Four Economic Resources

There 4 categories of economic resources:
1.
2.
3.
4.

Land: natural resources
Labor: work
Capital: produced goods used to produce other goods and
services
Entrepreneurial ability: effort to organize the production process
In a market economy, each of these resources is
exchanged in markets for a type of income.
•
We sell our resources to earn income to purchase goods and
services to satisfy our wants.
2-5
Land Earns “Rents.”

Land (a broader meaning than our normal
understanding of the word).
•

How is “land” used in an economy?
•
•

Labor includes natural resources: timber, oil, coal, iron ore,
soil, water, as well as the ground in which these resources
are found.
Extraction of minerals (mining) and farming (agriculture)
Provides the site for factories, office buildings, shopping
centers, homes, etc.
Owners of land receive “rent.”
•
•
Economic rents are money received from something that is
given by nature, rather than produced by human effort.
Rent is earned by establishing ownership over resources.
2-6
Labor Earns Wages.

Labor:
•
•

Labor is work and time for which one is paid
Labor involves human effort.
Income received for one’s labor is called wages.
and/or salaries
•
•
About two-thirds of the total resource cost is the cost of labor
Notes that unpaid labor (housework, volunteer work) can
also contribute to the satisfaction of human wants.
2-7
Capital Earns Interest.

Capital
•
•
•

Capital is “man-made” goods used to produce other goods
or services.
Examples include office buildings, stores, and factories
(physical plant), equipment, and software.
Note that this is a different use of the term “capital” than
when it means the funds a business uses to buy plant and
equipment.
The income owners of capital receive is called
“interest.”
•
The purchase of new capital equipment is often funded
through loans, so the lender earns interest from its
productivity.
2-8
Entrepreneur Ability Earns Profits.

The entrepreneur
•
•
•
•
Sets up a business.
Assembles the needed resources.
Risks his/her own (or borrowed) money.
Is central to the American economy.

An entrepreneur earns a profit (or a loss)
depending upon his or her ability to run a business.

There are over 30 million businesses in the U.S.;
most are owned by entrepreneurs.
•
The vast majority work for themselves or have 1 or 2
employees.
2-9
Questions for Thought and Discussion

Why are the means of production scarce?

The text has a quote by F.V. Meyer that says
“Economics is the science of greed.” What does he
mean? Do you agree or disagree with the quote?

Which is the only category of resources that cannot
be increased over time?

What is the difference between an entrepreneur and
an inventor?
2-10
Our Economic Problem Revisited

Our economic problem is that we have limited
resources available to satisfy relatively unlimited
wants.

There are NOT enough resources to produce
everything that everyone wants.

Therefore, CHOICES must be made!
•
•
The wood used to build a table cannot be used to make
paper.
The time a nurse spends filling out forms cannot be used in
patient care.
2-11
Opportunity Cost: A Fundamental Concept
in Economics

Opportunity cost is the foregone value of the next
best alternative.
•

People weigh the costs and benefits of various
options, including opportunity costs.
•

The value of thing we give up (our second-best choice.
Economists assume that we choose the option we find more
valuable.
In the economic world, “both” is not an admissible
answer to a choice of “which one.”
2-12
Example: Choosing the Highest Valued
Alternative

Time is one of your resources. Options:
•
•
•
•
•

Spend time on social networking site.
Play video games.
Go to movies with friends.
Clean your room.
Study economics.
Whichever option is chosen, you will miss the value of the
other options.



If you go to the movie with friends, the direct cost is the
movie ticket and any transportation costs.
The opportunity cost is the value of the alternatives use
of your time (for example, the benefit of the improvement in
your grade from studying).
Opportunity cost may or may not have a dollar value. But
you implicitly place a value when you make a decision.
2-13
Inherit $40,000.
Two choices: Buy your dream car or go
to college

Suppose you bought
the car (paid $40,000)

What was the value of the
foregone option?
College graduate (lifetime earnings)
$1,300,000
High School graduate (lifetime earnings)
$800,000
Opportunity Cost
$500,000
2-14
Businesses and Government Face
Opportunity Costs Too.




A large corporation has to choose between using profits
to pay shareholder dividends (boosting stock value) or to
purchase additional capital equipment (which might
increase profits at a later date).
A small store has to choose which items get more shelf
space and which get less shelf space.
Governments have to choose how much to spend on
education, military, food inspections, environmental
protection, medical research, etc.
Some local governments are unpaving local roads so
they do not have to raise taxes on residents.
2-15
Questions for Thought and Discussion

Do Bill Gates and other wealthy persons face
scarcity? Do they have to weigh opportunity costs?

The direct costs of the wars in Iraq and Afghanistan
have been approximately $150 per year. What are
some of the opportunity cost of the wars in Iraq and
Afghanistan?

What are the opportunity costs of raising taxes to
fund government programs? What are the
opportunity costs of lowering taxes?
2-16
Full Employment and Full Production

Full employment is when a society’s human
resources are being used with maximum efficiency.
•
•

Generally, a 4 – 6% unemployment rate is considered full
employment.
There will always be a small percentage of the labor force
who are between jobs.
Full Production is when a society’s resources are
being allocated in the most efficient manner possible.
•
•
Full production can include physical resources (land and
capital) and human resources (labor and entrepreneurial
ability).
Generally, a 85–90% capacity utilization rate is
considered full production of a nation’s capital.
2-17
Underemployment of Resources

Underemployment of resources lowers the
productive output of the nation as a whole.
•
•
•
•

It is an economic problem, not just a personal problem.
Unemployment and low capacity utilization mean that
society is not allocating its resources efficiently in order to
maximize output.
An unemployment rate greater than 5% is considered
underemployment of our labor resources.
A capacity utilization rate less than 85% is considered
underemployment of our capital resources.
Underemployment of resources occurs during
recessions.
2-18
Employment Discrimination Causes
Underemployment of Society’s Resources

Employment discrimination excludes members of
particular groups from particular jobs.
•
•

Society loses out when people are kept from being fully
productive.
Discrimination has diminished but has not been eliminated
entirely.
Example: African Americans were kept out of major
league baseball until 1947.
•
•
Great baseball players like Satchel Paige played in the separate
Negro Leagues.
Society lost generations of contributions to baseball records.
2-19
The Production Possibilities Curve

The Production Possibilities Curve represents our
economy at
•
•

Full employment.
Full production.
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.
Guns versus Butter example focuses on government’s
choice between military spending or spending on social
programs.
• Remember: businesses and consumers face trade-offs
too!
2-20
The Production Possibilities Curve

Points S, A, B, C, D, and F are
efficient with full employment
and full production.

Points X. Y, and Z are points
where economy is producing
below efficiency since either
capital is being under utilized or
the workforce is underemployed.
You can produce more guns
without sacrificing butter, or vice
versa.

Any point above the production
possibility curve, such as W, is
not achievable.
2-21
Production Possibilities Curve
Hypothetical Production
Schedule
Units of
Butter
Point
Units of
Guns
A
15
0
B
14
1
C
12
2
D
9
3
E
5
4
F
0
5
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
2-22
Production Possibilities Curve
(Continued)
Hypothetical Production
Schedule
Point
A
Units of
Butter
15
Units of
Guns
0
B
14
1
C
12
2
D
9
3
E
5
4
F
0
5
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.
The opportunity cost of
gaining 1 unit of guns was 1
unit of butter
2-23
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.
 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. From
A to B you give up 1 unit of butter
to get 1 unit of guns.
 You give up more units of butter
to get 1 unit of guns at the
bottom. From E to F you have to
give up 5 units of butter.
2-24
Questions for Thought and Discussion

Explain how unemployment and discrimination are
problems for society as a whole, not just those individuals
who experience it. Give an example that was not
mentioned in your text.

Explain how the concept of opportunity costs is illustrated
on the Production Possibilities Curve.

In the Law of Increasing Costs, are we talking about
direct costs or opportunity costs increasing as we
produce more of one good or service?
2-25
Economic Growth


Economic growth enables a society to produce more
guns AND more butter – or whatever goods and
services are allocated resources.
What causes economic growth? More resources or
better technology (ways of using resources)
•
•
•

More or better trained labor
More or improved plant and equipment (capital)
Technological change (new fertilizer, shift from typewriter to
computer)
Economic growth can be illustrated by a new
Production Possibilities Curve.
•
The curve moves to up and to the right.
2-26
Economic Growth Illustrated
PPC in Year 1
PPC after economic
growth
PPC after more growth
2-27
Investing in Future Growth
Note that the axes
have new labels!
Note that investment in capital equipment today can lead to
economic growth in the future.
Choosing Point B in Year 1 gives us greater production
possibilities in the future than choosing Point A.
2-28
Questions for Thought and Discussion

Given limited resources, is growth always good?
•
Why do most mainstream economists embrace growth?

Is our economy in a period of full employment and
full production? What are the implications for you
when you look for a job after college?

Choose a trade-off between any two goods or
services and illustrate it on a Production Possibilities
Curve. Try to explain how the Law of Increasing
Costs would operate as you move along the curve.

Does the PPC move out in a recession year?
2-29