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Chapter 3

Chapter 3 Full Notes

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Boston College
ECON 1131

Chapter 3: Society’s Economic Problem Objectives  The primary goal of a nation’s economy is to improve the economic well being of its citizens  The law of substitution must eventually apply no matter what choices are made among the various alternatives simply because resources are limited  Although a humanistic society cannot try to make everyone as well off as possible, it can strive to be efficient, to ensure that the Law of Substitution holds  Equity is a fundamental economic objective of all humanistic societies Alternatives  The What or Output Question: asks what goods and services the economy will produce and in what quantities o Different people have different tastes o To be fully efficient and equitable, therefore, an economy must be responsive to individual preferences o The pursuit of profits leads firms to respond to consumers desires as they decide what, and how much, to produce  The How or Input Question: asks how the economy will produce its goods and services o Involves choosing a production technology: a blueprint or method for transforming inputs into outputs  Inputs are factors of production (labor, land, natural resources, capital, semi-finished material inputs), outputs are the g/s o All societies have an economic interest in producing each unit of output with the least expenditure of their scarce resources o How question directly reflects society’s concern for efficiency  The For Whom or Distribution Question: asks who will receive the various goods and services that are produced o Determined primarily by the quantity and quality of the resources that each individual owns in a market economy o Incomes people earn for their labor, land, and capital reflect how scarce their resources are relative to the demand for them  People want to supply what is scarce because they will get more $ for it- but firms want to stay away from what’s scarce because its more expensive  The Now versus Future Question: asks whether society will favor the current generation over future generation or the reverse Constraints  Production possibilities: the economy’s capacity for producing goods and services, assuming that it produces them efficiently o Depends on (1) the quantity and quality of a nation’s primary factors of production and (2) the technologies available for turning these resources into g/s  Regarding FOP’s, larger countries can produce more than smaller countries can simply because they are larger, OTE The Production Possibilities Frontier  Agraphical representation of the economy’s capacity for producing goods and services, assuming that it produces them efficiently  To construct it, everything that is produced must be placed into one of two categories so that production can be represented in two dimensions (usually specific output on y axis and all other output on x axis) The Production Possibilities Frontier and the Constraints  The distance on the frontier from the origin is the most direct representation of the underlying constraints that limit how well off a society can be Increasing Opportunity Costs along the Frontier  PPF is bowed outward because it is said to represent increasing cost production in the sense of increasing opportunity cost  The Law of Substitution holds at all points along the frontier  Points inside the frontier can be made more efficient until they actually hit the frontier  Why might an economy be producing beneath its production possibilities frontier? o Society is not using all of its scarce resources o It is not allocating the resources it is using in the best possible manner (this always exists to some extent)  “There is no such thing as a free lunch” only if decisions are made efficiently Price Inflation and the Frontier  Countries do occasionally try to reach beyond their means, and then they suffer price inflation  Once the economy reaches its production possibilities frontier, the extra money only drives up prices  Demand pull inflation: price inflation resulting from the attempt to purchase more goods and services than the economy is capable of producing Long Run Economic Growth  Long run economic growth: a persistent increase in the economy’s potential for producing goods and services  In terms of the PPF, long-run economic growth refers to a persistent march of the frontier away from the origin The Growth Standard  Most countries are not very successful at it  Achieving vigorous long-run economic growth is a complex process requiring just the right blend of social, cultural, demographic, political, and economic factors Strategies for Economic Growth  Expanding the frontier necessarily involves: (1) increasing the quantity of the primary factors of production, (2) improving the quality of these resources, and (3) inventing and employing new production technologies- need these changes for sustained economic growt
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