 | Economics is the study
of choice. Specifically, economics is the study of how individuals
and society choose to use limited resources in an effort to satisfy people's
unlimited wants.
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| Scarcity
is a basic fact of economic life. Factors of production (land, labor,
capital, entrepreneurship) are scarce in relation to our desires for goods
and services.
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| Whenever you have scarcity you
have to make a choice. For example, in your personal life you must decide
which choice will give you the greatest satisfaction. Whichever choice you
make, there will be a cost involved which economists call opportunity
cost. When you choose between two options, the option that you give up
is the opportunity cost of your decision. For example, if you choose to take
the vacation trip instead of buying a new television set, the opportunity
cost of the vacation trip is the new TV set you could have had.
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| Opportunity cost refers to the
next best alternative that is given up when a decision is made to use
a resource in a particular way.
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| All economic activity entails
opportunity costs. On a national level factors of production (resources)
used to produce one output cannot simultaneously be used to produce
something else. When we choose to produce one thing, we forsake the
opportunity to produce some other good or service. For
example, total production is often divided into two categories--military
production and domestic production. When the economy is operating at
full capacity (all resources are being used), the only way we can have more
military production is to produce fewer domestic goods and services.
Likewise, the only way we can have more domestic production is to reduce
military production.
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| A production possibilities
curve illustrates the limits to production and the opportunity costs
associated with different output combinations. It shows the alternative
combinations of final goods and services that could be produced in a given
period if all available resources and technology were used efficiently.
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| The bent shape of the
production possibilities curve reflects the law of increasing opportunity
costs. This law states that increasing quantities of any good can be
obtained only by sacrificing ever-increasing quantities of other goods.
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| Inefficient or incomplete use
of resources will fail to attain production possibilities. Additional
resources or better technologies will expand them. This is the essence of
economic growth.
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| Every country must decide WHAT
to produce, HOW to produce, and FOR WHOM to produce with its limited
resources. These are the three basic economic questions that
every nation of the world must consider when making these choices: (1) What
goods and services shall be produced? (2) How shall they be produced? and
(3) For whom shall they be produced?
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| How the choices of WHAT, HOW,
and FOR WHOM are made reflects the economic system of a country. There
are basically three kinds of economic systems in the world. They are:
(1) traditional , (2) command, and (3) market economies.
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| Traditional economies
are found primarily in the rural, non-industrial areas of the world. In
these economies, which are often referred to as subsistence economies, there
is no national economy. Instead, there are many small, segmented, economies,
each centered around a family or tribal unit. In these economies, the family
or tribal unit produces most of its own goods, and consumes what it
produces. Thus, the basic questions of "what," "how,"
and "for whom," are answered directly by the people involved, with
the answers usually based on tradition.
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| Before the downfall of their
communist governments, the former Soviet Union, and the communist countries
of Eastern Europe were command economies. Today, China is the best
remaining example of a command economy. In command economies, the basic
economic questions are usually answered by government officials. Command
economies are often referred to as planned economies because the government
engages in elaborate, detailed planning in an effort to produce and
distribute goods and services according to the wishes of government leaders.
Also, the government usually owns the means of production in command
economies.
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| The United States, Canada,
Japan, and Western Europe are market economies. A market economy is
just the opposite of a command economy. In command economies, the basic
economic questions are answered by the government. In market economies,
individual households and businesses answer the basic economic questions
through a system of freely operating markets. Furthermore, in market
economies the means of production are usually privately owned. When we
examine the American economy in the following chapter, we will take a
detailed look at how a market economy operates.
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| In actual practice, there are
no economies where the basic economic questions are answered totally either
by government or by a system of freely operating markets. All major
economies are mixed economies in the sense that both markets and
government decisions play a role in answering the basic economic questions.
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| In mixed economies, a
distinction is usually made between the private sector and the public
sector. There are enormous differences in the public-private sector mix
of the major economies of the world. For example, in China most of the
economic activity is in the public sector but, in the United States, most of
the economic activity is in the private sector. Therefore, it is accurate to
label China as a predominantly command economy, and the United States as a
predominantly market economy.
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| Economic systems fail
when a country doesn’t achieve it’s production possibilities curve, or
move the curve to the right. Market failure exists when market signals
generate sub-optimal outcomes. Government failure occurs when government
intervention worsens economic outcomes. The challenge for economic theory
and policy is to find the mix of market signals and government directives
that best fulfills our social and economic goals.
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| The study of economics focuses
on the broad question of resource allocation. Macroeconomics is concerned
with allocating the resources of an entire economy to achieve aggregate
economic goals (e.g., full employment). Microeconomics focuses on the
behavior and goals of individual market participants. |
