Economics is part
of everyone’s life. This is because any individual
can consume, save, work, produce, invest, acquire
debts, and pay taxes, among many other activities
studied by economics. That’s why information
regarding economics appears in newspapers, television,
the internet and other media which is associated with
fundamental variables in order to take proper decisions.
Some of these variables relate to prices, interest
rates, salaries, jobs, exchange rates, etc. Being
able to know and understand these variables is even
more important for people who manage businesses since
their success is based on an appropriate understanding
of the present and future economic environment.
This chapter tries
to describe the economic problem, which gives origin
to economics, and also studies some models that will
illustrate this problem and the way in which society
organizes itself to solve it.
ECONOMICS:
It’s the science that studies the way
in which limited resources are assigned among the
diverse uses that compete for them, with the purpose
to satisfy part of the individual’s unlimited
desires.
The
Economic Activity
The economic activity
is the interaction between production units, consumers,
and interchange. In this sense it’s possible
to point out three basic elements of the economic
activity: the resources, the needs and the goods.
Now,
each of the components of the economic activity will
be analyzed: recourses, needs and goods.
Resources:
are all the means used for the production of goods
and services.
Resource
classification:
Classic
Version
Land:
It refers to all the means of production
that are found in nature, such as terrains
for agriculture, mineral reserves, rivers,
etc..
Work: Consists of
the time and effort (physical or mental)
that people assign to the production of
goods and services.
Capital: It refers to the means created
by human beings and work for production,
such as machinery, a physical plant of a
company, production equipment, among others.
Alternate
Version
Natural
resources of value: It refers to the factors
that intervene in the production, and are
obtained from nature, such as land, rivers,
etc.
Economically
active population or labor force: It refers
to the work that can be accomplished by
the total of workers with physical and mental
capacity, included occupied and unoccupied.
Capital:
refers to the means created by human beings
and work for production, such as machinery,
physical plant of a company, production
equipment, among others.
Technology:
Any method to produce a good or service.
Business
Capacity: consists of a group of abilities
and skills that allow coordination for the
rest of recourses (land, work, capital and
technology). In other words, the capacity
to design and create new products, to develop
new production processes, etc.
Characteristics
of resources:
Limited: resources
are not enough to supply all the possible requirements
and needs of the individuals.
Changeable: resources
may have more than one possible use. For example:
a piece of land may be used to plant coffee or build
a factory.
Partially replaceable:
in determined circumstances, a resource may replace
another in the production of a good or service. For
example: in an industrial plant, tasks may be carried
out manually, but they can also be done automatically
by certain machinery. In this case work is substituted
by capital.
Needs:
A need is “any
internal state that makes certain results seem attractive.”
(Robbins)
It’s that which can’t be disregarded.
It manifests a lack of something.
On
the contrary of resources, which are scarce, needs
are unlimited (and more on the desires) since in a
lifetime we need to supply our needs of food, clothing,
transportation, communication, housing among many
other.
Goods:
A good is anything that satisfies needs.
By
their abundance or relative shortage
Free
goods: They are so abundant that no one
would be willing to pay for them. For
example: air.
Economic
goods: they are relatively scarce and
therefore, have a more elevated cost,
such as a book, a pant, etc.
By
their destination
Consumer
goods: Final goods destined for a buyer
and found in the market. Such is the case
of a finished shirt ready to be worn by
someone.
Production
or capital goods: they are goods that
are used to produce other goods, for example
a sewing machine.
Intermediate
goods: are goods used in any of the different
stages of production and are partially
finished such as cloth, string, etc.
By
their degree of elaboration
Finished goods: products that have reached
the final stage of production and are
ready to be consumed. For example an automobile,
a shirt, etc.
Unfinished goods: are the ones that need
other stages of production to be concluded.
For example only having the sleeves of
a shirt.
By
their nature
Tangible good: goods that represent material
objects: a compact disc or a notebook.
Intangible goods: it refers to the services
we use but can’t be perceived, as
a doctor’s appointment or an economics
class.
By
their possession
Private goods: their
use is limited to its owner or producer.
For example an automobile.
Public
goods: they can be consumed by everyone
in a simultaneous manner, even without
paying for the good and no one can be
excluded from their use. This is the case
of street lighting, roads, etc.
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As mentioned before, the resources are limited and
the needs unlimited. Therefore the economic problem
will consist of:
How
to use the limited resources to produce enough
goods and services in order to satisfy unlimited
needs?
That’s why ECONOMICS is the science that studies the way in
which the limited resources are assigned among the
different uses that compete for them.
Key
questions of economics: The economic problem may be
expressed by three basic questions that must be answered
by any system of economic organization:
What to produce and how much?
In other words: What goods and services must be
produced and in what amounts? Due to the existence
of needs and that these must be satisfied accordingly,
it’s necessary to determine what needs are
going to be fulfilled and what goods satisfy these
needs. This question is of economic nature.
How to produce? Meaning, How to produce
goods? This question is of technical nature and
it refers to what technology will be used in the
production, what are the necessary materials,
what type of workforce, the production process,
etc..
For whom should one produce? Meaning.
Who obtains what’s being produced? This
question is of social nature and its solution
depends on the model that the social organization
follows, for example, in a market economy it will
depend on the buying capacity of the different
consumers.
Model of the Transformation
Curve:
Due to the shortage
of resources, it’s necessary to choose the resource
distribution according to the needs, likes and preferences.
This is why the model of transformation curve or production
frontier is presented.
A model in this context
is a simplified representation of reality and its
behavior. In order to build the model, it’s
necessary to formulate hypothesis since reality is
regularly more complex.
Assumptions of the
model of curve transformation:
Society produces
two goods or goods basket.
Economics is autarkic.
The curve is traced
by a time unit.
Technology is
given and it’s the best.
Production factors
are given.
Production factors
are versatile, but are not equally productive in different
activities.
There is full
use of factors.
Individuals act
rationally
Definition
of production frontier or curve transformation
Curve transformation
or production frontier can be defined as:
The group of all
the different maximum alternative combinations of two
goods or services that might produce in a determined
period, when there’s an unlimited availability
of factors and technology.
For example, imagine
an economy that produces coffee of shirts according
to the following data, where the amount of coffee
is given in thousands of sacks per month , and the
shirts in thousands of units:
Quantities
by time unit
Coffee
Shirts
A
15
0
B
14
1
C
12
2
D
9
3
E
5
4
F
0
5
Graphically it would be represented like this, where
the transformation curve is concave downwards:
It’s
of great importance to point out some of the conclusions
obtained from this model which are:
The curve illustrates
the shortage problem and by that, it explains the
economic problem. If there were no lack, then a frontier
or maximum limit wouldn’t exist.
It
illustrates the OPPOURTNITY COST: this is because
shortage implies the need of choice, therefore obtaining
the highest production requires a reduction in the
production (chance loss) of one or more goods. The
cost of an opportunity in a determined action is the
value of the best sacrificed alternative. In the example,
if the economy is in point A and whishes to be transferred
to point B, then to opportunity cost is 1, since it
scarifies one unit of coffee to obtain one unit of
shirts. Shifting from B to C scarifies two units of
coffee and obtains another of shirts; therefore the
opportunity cost is 2.
Law of growing
opportunity cost: the highest obtaining of a good
in equal amounts requires giving up higher quantities
of the alternative good. This is because the resources
are not equally productive in different areas. The
graph illustrates the opportunity cost (O.P.) of moving
point A to B, then B to C and so on until it reaches
F:
All the points in the curve are equally efficient
(there’s a full use of factors and the best
technology possible is used), it all depends on
the combination that wants to be made.
Any point in the interior’s frontier means
that the resources are not fully used or are used
in an ineffective manner. For example in the following
graph, points M and N are equally efficient, but
point Q is not, because it’s producing less
than the maximum as for coffee or shirts.
The highest points in the curve are desirable,
but unreachable according to the present conditions.
The frontier’s expansion occurs when there
is a higher income of resources (capital accumulation,
workforce increase, better technology) or an increase
in their productivity, which triggers an economic
growth, therefore reaching points that were not
possible to reach before. It’s also possible
that the curve may move left. This could happen
in a natural disaster, war, or any other situation
that may reduce the maximum capacity of economic
production..
Market
mechanisms (capitalist model): the offer
and demand determine the price. The owners assign
the resources to obtain the highest monetary rewards.
Centralized
Economy (socialist model): the central
authority determines the price and assigns the
resources for goal achievement.
Mixed:
an economy that uses signs from the market and
not, to assign goods and resources..
The
following table summarizes the way in which each model
of economic organizations answers to the three basic
economic questions. It also shows the way in which
production is organized and it establishes the properties’
regime for the resources:
Socialist
Capitalist
Mixed
Property
regime
The material resources
are subject to the social property regime. The
collective social property and the consumption
social property coexist in some degree, with
a relative freedom of hiring and with possibilities
of employment.
The regime of
resource private property prevails. The resources
acquired by the government would be relatively
small compared to private property.
Productive resources
of state and private property exist. There are
also companies where capital is co-owned by
the state and regular businessmen.
Production
Organization
A planning entity
designs an economic plan that contains general
objectives and specific goals with a stock of
available resources. The production units and
the direction of technical bodies carry out
the task.
The market is
the fundamental institution that acts as a coordinating
mechanism for economic activity. As the market
establishes the prices and amounts of interchange
it determines the assignment of productive resources.
The government
does not control totally, but it actively participates
as a producer, consumer and regulator of the
economic activity. Free markets coexist with
others with funding conditioned by state intervention.
What
to produce?
This decision
is taken by the political high level, were the
most important thing is how many resources will
be meant for capital formation and then which
ones will be destined for consumer goods.
The consumer autonomy
prevails, meaning that the consumers will seek
the goods of there choice, according to their
income. In this way, they will determine what
goods should be produced and in what amounts.
The three
following situations are presented: 1. Goods
produced and exchanged in free markets. 2.
Goods produced in markets intervened by the
government. 3. Goods and services produced
directly by the government.
How
to produce?
The decision is
taken by the director of each production unit
according to the resources and technology available.
This decision
is taken by the producer according to the present
technical possibilities and the relative prices
of the productive resources.
The decision is
taken by the producer, being a businessman or
government, according to the technical criteria
and the rice of resources.
For
whom should one produce?
Capital goods
are assigned to the producers, while some consumer
goods are offered freely and others rationalized.
Production distribution
is carried on according to the buying capacity,
which depends on peoples’ income and the
prices of goods.
Some goods and
services are offered freely by the government,
while others are distributed according to the
buying capacity of the individuals.
MODEL
OF CIRCULAR FLUX OF ECONOMIC ACTIVITY:
The
model of circular flux of the economic activity illustrates
how a market economy works. Supposedly, there are
two economic agents in this economy: the consumers
and the producers. The government will be excluded
in this simple version. Also, the economy is closed
and consumers spend all their income, in other words,
they don’t save. There are two main markets:
the market of goods and services, and the market of
production factors. The model is illustrated in the
following diagram:
This diagram is
a schematic representation of how economies are organized
according to the market. Both consumers (households)
and producers (enterprises) need to make decisions.
This will make agents interact in the market of goods
and services (where consumers are buyers and producers
are sellers) and in the market of production factors
(where consumers are sellers, and the producers acquire
services).
It’s of equal importance to highlight that
within this scheme, an expense for one agent will
result in income for another. For example, the acquisition
of a chair results in an expense for homes, but
at the same time it will become and income for the
producer.
THE
ECONOMIC REASONING:
Economics
is a social science; this means it obtains its knowledge
from the scientific methods. The following diagram
illustrates the way in which economic knowledge is
formulated.
AREA
STUDIES OF ECONOMICS:
In economics it’s
possible to talk about facts and reality, which is
objective. This is what positive economics refers
to. But it’s also possible to formulate judgments
about facts. This is called normative economics. Positive
economics uses math, statistics and econometrics to
describe the different economic phenomena (descriptive
economics). It explains these phenomena through the
economic theory, which is divided in microeconomics
and macroeconomics. Macroeconomics is the study of
economic adds such as, national production and the
price level. Microeconomics is the study of consumer
and producer behavior that operates in the individual
markets of economy.
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