Chapter 2

Resource Utilization

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

2-1

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

2-2

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

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

2-3

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

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

2-4

Four Economic
Resources
Land
Labor
Capital
Entrepreneurial ability
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

2-5

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

2-6

Labor
Labor
The work and time for which one is
paid is what economists call labor
Money received for ones labor is
called wages and/or salaries
About two-thirds of the total resource
cost is the cost of labor
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

2-7

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

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

2-8

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

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

2-9

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!

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

2-10

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

2-11

Highest Valued Alternative

Options

Watch TV
Talk on the telephone
Go on a date
Study economics

Choice made

Highest valued alternative

Opportunity cost is the highest valued

alternative that could have been chosen (i.e.,
study economics)

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

2-12

Inherit $40,000
Two choices buy a car or go to college

Bought the car

Cant go to college

(Paid $40,000)

College graduate (lifetime earnings)

High School graduate (lifetime earnings)
Opportunity Cost
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

$1,300,000
800,000
$ 500,000
2-13

California
1967-1997
Prisons
Added 21
additional prisons

Colleges
Added 1
additional college

The Opportunity Cost of building more

prisons is building fewer colleges

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

2-14

California
1990 - 1997
Prison guards
+ 10,000

College employees
- 10,000

Obviously, the opportunity cost of one

additional prison guard is one college
employee
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

2-15

Full Employment
Five percent
unemployment rate

1From 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 %

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

2-16

Full Production
Eighty five to ninety
percent utilization
rate
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

2-17

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

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

2-18

The Production Possibilities

Curve
Represents our economy at
Full employment
Full production

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

2-19

Production Possibilities Curve

16
14

Hypothetical Production Schedule

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

A
B
C

12
10

8
6

4
2
0

F
1

Units of guns

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

2-20

Had to give up 1 unit of butter

Production Possibilities Curve

16
14

Hypothetical Production Schedule

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
In this particular instance, the opportunity cost
of gaining one unit of guns was one unit of
butter

A
B
C

12
10

8
6

4
2
0

F
1

Units of guns

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

2-21

Had to give up 2 units of butter

Production Possibilities Curve

16
14

Hypothetical Production Schedule

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
In this particular instance, the opportunity cost
of gaining one unit of guns was two units of
butter

A
B
C

12
10

8
6

4
2
0

F
1

Units of guns

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

2-22

Had to give up 3 units of butter

Production Possibilities Curve

16
14

Hypothetical Production Schedule

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
In this particular instance, the opportunity cost
of gaining one unit of guns was three units of
butter

A
B
C

12
10

8
6

4
2
0

F
1

Units of guns

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

2-23

Had to give up 4 units of butter

Production Possibilities Curve

16
14

Hypothetical Production Schedule

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
In this particular instance, the opportunity cost
of gaining one unit of guns was four units of
butter

A
B
C

12
10

8
6

4
2
0

F
1

Units of guns

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

2-24

Had to give up 5 units of butter

Production Possibilities Curve

16
14

Hypothetical Production Schedule

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
In this particular instance, the opportunity cost
of gaining one unit of guns was five units of
butter

A
B
C

12
10

8
6

4
2
0

F
1

Units of guns

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

2-25

As we shift from butter to guns, we have to give Production Possibilities Curve

up increasing units of butter for each additional
16
unit of guns
A
14

Hypothetical Production Schedule

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

B
C

12
10

8
6

4
2

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.

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

F
1

Units of guns

2-26

When you are on the curve, to get more of one thing you have to give up
some of the other thing
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
When you are at a point that is inside the line (PPF) it is possible to get
more of both
16
14

A
B
C

12
10

8
6

4
2
0

F
1

Units of guns

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

2-27

Points Inside and Outside the Production Possibilities Curve Frontier

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

16
14

A
B

W
C

12
10

Where we usually are

A Recession
A Depression

D
X

E
Z

4
2
0

F
1

3
4
Units of guns

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

2-28

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

2-29

Economic Growth
Best available technology
Expansion of labor
More or better trained labor

Expansion of capital
More or improved plant and
equipment
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

2-30

Production Possibilities Curves

15

PPC 3
PPC 2

10

PPC 1

10
Units of guns

15

A move from PPC1 to PPC2 to PPC3 represents economic growth

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

2-31

Production Possibilities Curves Over Time

Country B

Country A
A.

B.
25

25

20

20

15

15

10

PPC 2001

PPC 2001

10
B

PPC 1991

PPC 1991
A

5
10
15
Units of consumer goods

Country A represents slower

economic growth than Country B
Country A capital goods is 3.8 units

5
10
15
Units of consumer goods

Country B represents much faster

economic growth than Country A
Country B capital goods is 7.0 units

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

2-32

The Production Possibilities Frontier

during World War II

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

2-33