Econ 1A chapter 2

Barter requires that you

find a person who has what you want and a person who needs what you have to offer.

What each individual or firm believes is best for itself and seeks to obtain

self interest

How will the system change?

Changes in consumer tastes Changes in technology Changes in resource prices

Laissez-faire

Idea that government should play as small a role as possible in economic affairs.

how will the system progress?

1. tech advance 2. capital accumulation

command system

A method of organizing an economy in which property resources are publicly owned and government uses central economic planning to direct and coordinate economic activities; command economy; communism

Assume that a business firm finds that its profit is greatest when it produces $40 worth of product A. Suppose also that each of the three techniques shown in the table below will produce the desired output: LO3 a. With the resource prices shown, which technique will the firm choose? Why? Will production using that technique entail profit or loss? What will be the amount of that profit or loss? Will the industry expand or contract? When will that expansion or contraction end? b. Assume now that a new technique, technique 4, is developed. It combines 2 units of labor, 2 of land, 6 of capital, and 3 of entrepreneurial ability. In view of the resource prices in the table, will the firm adopt the new technique? Explain your answer. c. Suppose that an increase in the labor supply causes the price of labor to fall to $1.50 per unit, all other resource prices remaining unchanged. Which technique will the producer now choose? Explain. Chapter 02 - The Market System and the Circular Flow 2-4 d. "The market system causes the economy to conserve most in the use of resources that are particularly scarce in supply. Resources that are scarcest relative to the demand for them have the highest prices. As a result, producers use these resources as sparingly as is possible." Evaluate this statement. Does your answer to part c, above, bear out this contention? Explain. Resource Units Required Resource Price per Unit of Resource Technique 1 Technique 2 Technique 3 Labor $3 5 2 3 Land 4 2 4 2 Capital 2 2 4 5 Entrepreneurial ability 2 4 2 4

To calculate the cost of each technique, multiply the price per unit of resource by the amount of the resource employed by the technique and add these together. For example, the cost of technique 1 equals $3 x 5 (labor cost) + $4 x 2 (land cost) + $2 x 2 (capital cost) + $2 x 4 (entrepreneurial cost) = $15 + $8 + $4 + $8 = $35. The same process is applied to Techniques 2 and 3. The firm will choose technique 2 because it produces the output at the least cost ($34 compared to $35 for techniques 1 and 3). Economic profit will be $6 (= $40 - $34), causing the industry to expand. Expansion in this industry will continue until prices decline to where total revenue equals total cost of $34 and no additional firms will want to enter the industry. (b) The firm will adopt technique 4 because its cost is now lowest at $32. (c) The firm will choose technique 1 because its cost is now lowest at $27.50. (d) The statement is logical. Increasing scarcity of a resource causes its price to rise. Firms ignoring higher resource prices will become high-cost producers. Firms switching to the less expensive inputs become lower-cost producers and earn higher profits than high-cost producers. The market system, therefore, forces producers to conserve on the use of highly scarce resources. Question 7c confirms this: Technique 1 was adopted because labor had become less expensive.

With current technology, suppose a firm is producing 400 loaves of banana bread daily. Also assume that the least-cost combination of resources in producing those loaves is 5 units of labor, 7 units of land, 2 units of capital, and 1 unit of entrepreneurial ability, selling at prices of $40, $60, $60, and $20, respectively. Assume the firm can sell these 400 loaves at $2 per unit.

What is its total revenue? 800 What is its total cost? 760 What is the firm's profit or loss? profit of 40 Will it continue to produce banana bread? yes If this firm's situation is typical for the other makers of banana bread, will resources flow toward or away from this bakery good? Resources will flow towards this bakery good.

In a command economy, scarce goods are allocated by

a government-appointed planning board based on the board's long-term priorities.

The presence in a market of independent buyers and sellers who compete with one another and who are free to enter and exit the market as they each see fit

competition

The freedom of resource owners to dispose of their resources as they think best; of workers to enter any line of work for which they are qualified; and of consumers to spend their incomes in whatever way they feel is most appropriate

freedom of choice

The freedom of firms to obtain economic resources, decide what products to produce with those resources, and sell those products in markets of their choice

freedom of enterprise

The use of capital in the production process

improves efficiency, increases output, and provides for growth.

An institution that brings buyers and sellers together

market

In a market system, scarce goods are allocated through the operation of

market prices that are determined by consumers and producers acting in their own self-interest.

Consider the statement: "We want money only to part with it." When people express a desire to have money, they really want

the goods and services that money can buy.

Economic transactions willingly undertaken by both the buyer and the seller because each feels that the transaction will make him or her better off

mutually agreeable

The right of private persons and firms to obtain, control, employ, dispose of, and bequeath land, capital, and other property:

private property

market system

private property freedom of enterprise freedom of choice self interest competition market and prices

Millions of economic resources tend to get arranged logically and productively rather than haphazardly and unproductively because

private property owners are motivated to protect and maximize the benefits from their property.

The use of money

provides a common value that makes buying and selling transactions simpler than would be the case with barter.

"Division of labor" means that workers

specialize in tasks that take advantage of their individual abilities and skills.

Ted and Fred are the owners of a gas station. They invested $150,000 each and pay an employee named Lawrence $35,000 per year. This year revenues are $900,000, while costs are $940,000. Who is legally responsible for bearing the $40,000 loss?

ted and fred

When an economy relies on specialization

trade enables individuals to obtain the goods in which they do not have a specialization.

The key features of the market system help explain how market economies respond to five fundamental questions:

• What goods and services will be produced? • How will the goods and services be produced? • Who will get the goods and services? • How will the system accommodate change? • How will the system promote progress?