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Chapter 2
Resource Utilization
E
conomics is defined in various ways, but scarcity is always part of the definition.
We bake an economic pie each year, which is composed of all the goods and
services we have produced. No matter how we slice it, there never seems to be
enough. Some people feel the main problem is how we slice the pie, while others say
we should concentrate on baking a larger pie.
LEARNING OBJECTIVES
In this chapter you’ll learn:
1.
2.
3.
4.
The definition of economics.
The central fact of economics.
The four economic resources.
The concepts of full employment,
full production, and
underemployment.
5. The concept of the production
possibilities curve.
6. Productive efficiency.
7. What enables an economy to grow.
8. The law of increasing costs.
9. The concept of opportunity cost.
Economics Defined
Economics is the efficient allocation of the scarce means of production toward the satisfaction of human wants. You’re probably thinking, What did he say? Let’s break it down
into two parts. The scarce means of production are our resources, which we use to produce all the goods and services we buy. And why do we buy these goods and services?
Because they provide us with satisfaction.
The only problem is that we don’t have enough resources to produce all the goods
and services we desire. Our resources are limited while our wants are relatively unlimited. In the next few pages, we’ll take a closer look at the concepts of resources, scarcity,
and the satisfaction of human wants. Keep in mind that we can’t produce everything
we’d like to purchase—there’s scarcity. This is where economics comes in. We’re attempting to make the best of a less-than-ideal situation. We’re trying to use our resources so
efficiently that we can maximize our satisfaction. Or, as François Quesnay put it back
in the 18th century, “To secure the greatest amount of pleasure with the least possible
outlay should be the aim of all economic effort.”1
Economics is the efficient
allocation of the scarce means
of production toward the
satisfaction of human wants.
Economics is the science of
greed.
—F. V. Meyer
1
François Quesnay, Dialogues sur les Artisans, quoted in Gide and Rist, A History of Economic Doctrines,
1913, pp. 10–11.
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The Central Fact of Economics: Scarcity
He who will not economize will
have to agonize.
—Confucius
If there were no scarcity, we
would not need to economize.
Scarcity and the Need to Economize
Most of us are used to economizing; we save up our scarce dollars and deny ourselves
various tempting treasures so we will have enough money for that one big-ticket item—
a new car, a sound system, a trip to Europe. Since our dollars are scarce and we can’t
buy everything we want, we economize by making do with some lower-priced items—a
Cadillac instead of a Rolls Royce, chicken instead of steak, or an education at a state
university rather than at an Ivy League college.
If there were no scarcity, we would not need to economize, and economists would
have to find other work. Let’s go back to our economic pie to see how scarcity works.
Most people tend to see scarcity as not enough dollars, but as John Maynard Keynes2
pointed out more than 70 years ago, this is an illusion. We could print all the money we
want and still have scarcity. As Adam Smith noted in 1776, the wealth of nations consists
of the goods and services they produce, or, on another level, the resources—the land,
labor, capital, and entrepreneurial ability—that actually produce these goods and services.
The Economic Problem
John Kenneth Galbraith, American
economist and social critic
Our necessities are few but
our wants are endless.
—Inscription found in a
fortune cookie
Land
Labor
Capital
In the 1950s, John Kenneth Galbraith coined the term the affluent society, which implied
that we had the scarcity problem licked. Americans were the richest people in the world.
Presumably, we had conquered poverty. But within a few years, Michael Harrington’s
The Other America3 challenged that contention.
The economic problem, however, goes far beyond ending poverty. Even then, nearly
all Americans would be relatively poor when they compared what they have with what
they would like to have—or with what the Waltons, Gateses, Buffetts, Allens, and Ellisons
have.
Human wants are relatively limitless. Make a list of all the things you’d like to have.
Now add up their entire cost. Chances are you couldn’t earn enough in a lifetime to even
begin to pay for half the things on your list.
The Four Economic Resources
We need four resources, often referred to as “the means of production,” to produce an
output of goods and services. Every society, from a tiny island nation in the Pacific to
the most complex industrial giant, needs these resources: land, labor, capital, and entrepreneurial ability. Let’s consider each in turn.
As a resource, land has a much broader meaning than our normal understanding of
the word. It includes natural resources (such as timber, oil, coal, iron ore, soil, and water)
as well as the ground in which these resources are found. Land is used not only for the
extraction of minerals but for farming as well. And, of course, we build factories, office
buildings, shopping centers, and homes on land. The basic payment made to the owners
of land is rent.
Labor is the work and time for which employees are paid. The police officer, the computer programmer, the store manager, and the assembly-line worker all supply labor. About
two-thirds of the total resource costs are paid to labor in the form of wages and salaries.
Capital is “man”-made goods used to produce other goods or services. It consists
mainly of plant and equipment. The United States has more capital than any other country
in the world. This capital consists of factories, office buildings, and stores. Our shopping
2
Keynes, whose work we’ll discuss in later chapters of Economics and Macroeconomics, was perhaps the
greatest economist of the 20th century.
3
Michael Harrington, The Other America (New York: Macmillan, 1962).
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malls, the Empire State Building, and automobile plants and steel mills (and all the
equipment in them) are examples of capital. The return paid to the owners of capital is
interest.
Entrepreneurial ability is the least familiar of our four basic resources. The entrepreneur sets up a business, assembles the needed resources, risks his or her own money,
and reaps the profits or absorbs the losses of this enterprise. Often the entrepreneur is
an innovator, such as Andrew Carnegie (U.S. Steel), John D. Rockefeller (Standard Oil),
Henry Ford (Ford Motor Company), Steven Jobs (Apple Computer), Bill Gates (Microsoft),
and Sam Walton (Wal-Mart).
We may consider land, labor, and capital passive resources, which are combined by
the entrepreneur to produce goods and services. A successful undertaking is rewarded
by profit; an unsuccessful one is penalized by loss.
In the American economy, the entrepreneur is the central figure, and our long record
of economic success is an eloquent testimonial to the abundance of our entrepreneurial
talents. The owners of the over 30 million businesses in this country are virtually all
entrepreneurs. The vast majority either work for themselves or have just one or two
employees. But they have two things in common: Each runs a business, and each risks
his or her own money.
Sometimes entrepreneurs cash in on inventions—their own or someone else’s. Alexander
Graham Bell and Thomas Edison were two of the more famous inventors who did parlay
their inventions into great commercial enterprises. As you know, tens of billions of dollars
were earned by the founders of America Online, Amazon, eBay, Yahoo!, Google, and
the thousands of other so-called dot-coms when they went public. These folks were all
entrepreneurs. But have you ever heard of Tim Berners-Lee, the creator of the World
Wide Web? Berners-Lee worked long and hard to ensure that the Web remained a public mass medium in cyberspace, an information thoroughfare open to all. He came up
with the software standards for addressing, linking, and transferring multimedia documents over the Internet. And most amazing, Tim Berners-Lee did not try to cash in on
his years of work.
Is this man an entrepreneur? Clearly he is not. He is an inventor of the first
rank—like Bell and Edison—but the act of invention is not synonymous with being an
entrepreneur.
Perhaps nothing more typifies American entrepreneurial talent than the Internet,
which The New York Times termed the “Net Americana.” Steve Lohr observed that “all
ingredients that contribute to the entrepreneurial climate in the United States—venture
capital financing, close ties between business and universities, flexible labor markets, a
deregulated business environment, and a culture that celebrates risk-taking, ambition, and
getting very, very rich”—fostered the formation of the Internet.4
What factors explain why so many of the world’s greatest innovations have originated in the United States? Thomas Friedman produces a summation:
America is the greatest engine of innovation that has ever existed, and it can’t be
duplicated anytime soon, because it is the product of a multitude of factors: extreme
freedom of thought, an emphasis on independent thinking, a steady immigration of new
minds, a risk-taking culture with no stigma attached to trying and failing, a noncorrupt
bureaucracy, and financial markets and a venture capital system that are unrivaled at taking
new ideas and turning them into global products.5
Resources are scarce because they are limited in quantity. There’s a finite amount
of land on this planet, and at any given time a limited amount of labor, capital, and
entrepreneurial ability is available. Over time, of course, the last three resources can be
increased.
4
Steve Lohr, “Welcome to the Internet, the First Global Colony,” The New York Times, January 9, 2000, Section 4,
p. 1.
5
Thomas Friedman, “The Secret of Our Sauce,” The New York Times, March 7, 2004, Section 4, p. 13.
Entrepreneurial ability
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Our economic problem, then, is that we have limited resources available to satisfy
relatively unlimited wants. The reason why you, and everyone else, can’t have three cars,
a town house and a country estate with servants, designer clothing, jewelry, big screen
TVs in each room, and a $50,000 sound system is that we just don’t have enough
resources to produce everything that everyone wants. Therefore, we have to make choices,
an option we call opportunity cost.
Opportunity Cost
The opportunity cost of any
choice is the forgone value of
the next best alternative.
Even children learn in growing
up that “both” is not an
admissible answer to a choice
of “which one?”
—President Warren G. Harding
on the web
There was an accounting professor nicknamed “the phantom,” who used to dash from
his last class to his car, and speed off to his office. During tax season, he was almost
never seen on campus, and certainly not during his office hours. One day a student managed
to catch him in the parking lot. Big mistake. As he climbed into his car, the professor
asked scornfully, “Do you realize how much money you’re costing me?”
Unknowingly, the phantom was illustrating the concept of opportunity cost. “Every
minute I waste answering your questions could be spent in my office earning money. So
if I spend five minutes with you, that just cost me $10.” Perhaps if the student had handed
him a ten dollar bill, he could have bought a few minutes of his professor’s time.
Because we can’t have everything we want, we must make choices. The thing we
give up (that is, our second choice) is called the opportunity cost of our choice. Therefore,
the opportunity cost of any choice is the forgone value of the next best alternative.
Suppose a little boy goes into a toy store with $15. Many different toys tempt him,
but he finally narrows his choice to a Monopoly game and a magic set, each costing $15.
If he decides to buy the Monopoly game, the opportunity cost is the magic set. And if
he buys the magic set, the opportunity cost is the Monopoly game.
In some cases the next best alternative—the Monopoly game or the magic set—is
virtually equal no matter what choice is made. In other cases, there’s no contest. If
someone were to offer you, at the same price, your favorite eight-course meal or a Big
Mac, you’d have no trouble deciding (unless, of course, your favorite meal is a Big Mac).
If a town hires an extra police officer instead of repaving several streets, the opportunity cost of hiring the officer is not repaving the streets. To obtain more of one thing,
society foregoes the opportunity of getting the next best thing.
Today, as we all know, people are living longer. This has set the stage for an ongoing generational conflict over how much of our resources should be devoted to Medicare,
Social Security, nursing homes, and old age homes, and how much to child care, Head
Start, and, in general, education. If we are to be a humane society, we must take care of
our aging population. But if our economy is to be competitive in the global economy,
we need to devote more dollars to education.
What are some of the opportunity costs you have incurred? What is the opportunity
cost of attending college? Owning a car? Or even buying this economics text? There’s
even an opportunity cost of studying for an exam. How would you have otherwise spent
those precious hours?
What is the opportunity cost of the war in Iraq? Because the conduct of the war
costs taxpayers about $10 billion a month, the opportunity cost of the war is how that
money might have otherwise been spent. Possibilities include reducing the federal budget
deficit, a tax cut, more students loans, research for a cure for breast cancer, and a high
speed rail system between pairs of major cities.
I’m sure you can think of at least a few other examples of the opportunity cost of
the Iraq War. My own preference would be to spend some of these resources on the
reconstruction of New Orleans. It seems inconceivable that it is somehow more important
to rebuild Baghdad than to rebuild that great American city.
If you’d like to read what I really think about our neglect in helping New Orleans to
rebuild, go to http://www.tucsoncitizen.com/ss/opinion/41952.php.
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29
Full Employment and Full Production
Everyone agrees that full employment is a good thing, even if we don’t all agree on
exactly what full employment means. Does it mean that every single person in the United
States who is ready, willing, and able to work has a job? Is that full employment?
The answer is no. There will always be some people between jobs. On any given
day thousands of Americans quit, get fired, or decide that they will enter the labor force
by finding a job. Since it may take several weeks, or even several months, until they find
the “right” job, there will always be some people unemployed.
If an unemployment rate of zero does not represent full employment, then what rate
does? Economists cannot agree on what constitutes full employment. Some liberals insist
that an unemployment rate of 4 percent constitutes full employment, while there are
conservatives who feel that an unemployment rate of 6 percent would be more realistic.
Similarly, we cannot expect to fully use all our plant and equipment. A capacity
utilization rate of 85 or 90 percent would surely employ virtually all of our usable plant
and equipment. At any given moment there is always some factory being renovated or
some machinery under repair. During wartime we might be able to use our capacity more
fully, but in normal times 85 to 90 percent is the peak.
In a global economy, not only has it become increasingly difficult to define which
goods and services are made in America and which originate abroad, but one may even
question the relevance of a plant’s location. If our steel industry were operating at full
capacity, we could get still more steel from Germany, Japan, South Korea, Brazil, and
other steel-producing nations. In the context of the global economy, our capacity utilization ratio is clearly much less important than it was just a few decades ago.
As long as all available resources are fully used—given the constraints we have just
cited—we are at our production possibilities frontier. A few additional constraints should
also be considered because they too restrict the quantity of resources available. These
are institutional constraints, the laws and customs under which we live.
The so-called blue laws restrict the economic activities that may be carried out in
various cities and states, mainly on Sundays. Bars and liquor stores must be closed
certain hours. In some places, even retail stores must be closed on Sundays.
State and federal law carefully restricts child labor. Very young children may not
be employed at all, and those below a certain age may work only a limited number
of hours.
Traditionally, Americans dislike working at night or on weekends, particularly on
Sundays. Consequently, we must leave most of our expensive plant and equipment idle
except during daylight weekday hours. We don’t consider that plant and equipment unemployed, nor do we consider those whose labor is restricted by law or custom unemployed.
All of this is already allowed for in our placement of the location of the production possibilities frontier (shown in Figure 1 in the next section).
By full production, we mean that our nation’s resources are being allocated in the most
efficient manner possible. Not only are we using our most up-to-date technology, but we
are using our land, labor, capital, and entrepreneurial ability in the most productive way.
We would not want to use the intersection of Fifth Avenue and 57th Street in
Manhattan for dairy farming, nor would we want our M.D.s doing clerical work. But
sometimes we do just that.
Until very recently in our history blacks, Hispanics, and women were virtually
excluded from nearly all high-paying professions. Of course, this entailed personal hurt
and lost income; this discrimination also cost our nation in lost output. In the sports
world, until 1947, when Brooklyn Dodger owner Branch Rickey defied baseball’s “color
line” and signed Jackie Robinson for the team, major league baseball was played by
whites only (see the box titled, “The Jackie Robinson Story”). At that time, only a tiny
handful of Hispanic players were tolerated. Today there are several black and Hispanic
players on every team. Today, professional basketball would hardly be described as a
“white man’s sport.” Nor, for that matter, would the National Football League be accused
If economists were laid end to
end, they would not reach a
conclusion.
—George Bernard Shaw
Full production: Our nation’s
resources are being allocated
in the most efficient manner
possible.
Employment discrimination
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The Jackie Robinson Story
Blacks had always been banned from professional sports,
but most notoriously by the “American
sport”—major league baseball. For decades there was a parallel association for
blacks called the Negro leagues. Finally,
the color barrier was broken in 1947
when Jackie Robinson began playing for
the Brooklyn Dodgers.
Looking back, then, to all those
years when black ballplayers were not
permitted to play major league baseball
(and basketball and football), we see that
hundreds of athletes were underemployed.
Not only did they suffer economically
and psychologically, but the American
public was deprived of watching innumerable talented athletes perform.
Jackie Robinson
In 1991 I met a few of the men who played in the Negro
leagues when I was visiting Kansas
City, where the Negro League Baseball
Museum is located. They all knew
Satchel Paige, a legendary pitcher whose
fastball was so fast, the batters often
couldn’t even see it, let alone hit it.
Sometimes Paige would wind up and
pretend to throw a pitch. The catcher
pounded his glove and the umpire called
a strike. Then the catcher, who had the
ball all along, threw it back to Paige. As
great as he was, Satchel Paige didn’t
play in the major leagues until the twilight of his career, when he was in his
late forties.
of discrimination, at least at the level of player personnel. But until the late 1940s, blacks
were almost entirely banned from those professional sports.
As late as the 1950s, only a few stereotypical roles were available to blacks in the
movies and on TV. And, except for Desi Arnaz (Ricky Ricardo of “I Love Lucy”), there
were virtually no Hispanic Americans in these entertainment media. That was America
not all that long ago, when employment discrimination was the rule, not the exception.
Until recently only a tiny minority of women employed in the offices of American
business were not typists or secretaries. In the 1950s and even into the 1960s, virtually
every article in Fortune was written by a man and researched by a woman. What a waste
of labor potential!
I can still picture one ad that appeared in several business magazines back in the
1950s. Four or five young women were on their knees on an office carpet sorting through
piles of papers. This was an advertisement for a collator. The caption read, “When your
office collator breaks down, do the girls have to stay late for a collating party?”
This ad said a great deal about those times. Forget about political correctness! Every
woman (but almost no men) applying for office jobs was asked, “How fast can you type?”
because those were virtually the only jobs open to women in corporate America—even
to college graduates. Typing, filing, and other clerical positions were considered “women’s
work.” The high-paying and high-status executive positions were reserved for men. So
when the collator broke down, it seemed perfectly logical to ask the “girls” to stay late
for a “collating party.”
These are just a few of the most blatant examples of employment discrimination, a
phenomenon that has diminished but has not yet been wiped out. Employment discrimination automatically means that we will have less than full production because we are not
efficiently allocating our labor. In other words, there are millions of Americans who really
should be doctors, engineers, corporate executives, or whatever but have been condemned
to less exalted occupations solely because they happen not to be white Protestant males.
But, in the words of Bob Dylan, “the times, they are a’ changin’.” The civil rights
revolution of the 1960s and the women’s liberation movement a decade later did bring
millions of blacks and women into the economic mainstream. Elite business schools
began admitting large numbers of women in the mid-1970s, and today there are hundreds
of women occupying the executive suites of our major corporations.
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Perhaps the most visible evidence of the employment advances of minorities and
women may be seen in President George W. Bush’s cabinet. We have certainly come a
long way since President Franklin Roosevelt appointed Labor Secretary Frances Perkins
as the first woman cabinet member in history, and, some three decades later, when
President Lyndon Johnson made Housing Secretary Warren Weaver the first black cabinet member. It would be a fair description to say that the Bush administration represents
the face of America a whole lot better than those of presidential administrations just one
generation ago.
Finally, there is the question of using the best available technology. Historically, the
American economy has been on the cutting edge of technological development for almost
200 years; the sewing machine, mechanical reaper, telephone, airplane, automobile,
assembly line, and computer are all American inventions.
Now it’s the computer software industry. Not only are we on the cutting edge in this
rapidly expanding industry, but we produce and export more software than the rest of
the world combined. Microsoft, Cisco, Oracle, and a host of other American companies
are household names not just in the United States but all across the globe.
Let’s tie up one more loose end before moving on to the main focus of this chapter,
the production possibilities frontier. We need to be clear about distinguishing between
less than full employment and underemployment of resources.
If we are using only 70 percent of our capacity of plant and equipment, as we do
during some recessions, this would be a case of our economy operating at less than full
employment of its resources. Anything less than, say, an 85 percent utilization rate would
be considered below full employment.
More familiarly, when the unemployment rate is, say, 10 percent, there is clearly a
substantial amount of labor unemployed. But how much is full employment? We never
really answered that one.
As a working definition, we’ll say that an unemployment rate of 5 percent represents full employment. Why not use 4 percent, as the liberal economists suggest,
or the 6 percent figure favored by the conservatives? Because 5 percent represents a
reasonable compromise. So we’ll be working with that figure from here on, but keep
in mind that not everyone agrees that a 5 percent unemployment rate represents full
employment.
Unemployment means that not all our resources are being used. Less than 95 percent
of our labor force is working, and less than 85 percent of our plant and equipment is being
used. It also means that our land and entrepreneurial ability are not all being used.
What is underemployment of resources? To be at full production, not only would
we be fully employing our resources, we would also be using them in the most efficient
way possible. To make all women become schoolteachers, social workers, or secretaries
would grossly underuse their talents. Equally absurd—and inefficient—would be to make
all white males become doctors or lawyers and all black and Hispanic males become
accountants or computer programmers.
Similarly, we would not want to use that good Iowa farmland for office parks, nor
would we want to locate dairy farms in the middle of our cities’ central business districts.
And finally, we would certainly not want to use our multimillion-dollar computer mainframes to do simple word processing.
These are all examples of underemployment of resources. Unfortunately, a certain
amount of underemployment is built into our economy, but we need to reduce it if we
are going to succeed in baking a larger economic pie.
This brings us, at long last, to the production possibilities curve. As we’ve already
casually mentioned, the production possibilities frontier represents our economy at full
employment and full production. However, a certain amount of underemployment of
resources is built into our model. How much? Although the exact amount is not quantifiable, it is fairly large. But to the degree that employment discrimination has declined
since the early 1960s, underemployment of resources may still be holding our output to
10 or 15 percent below what it would be if there were a truly efficient allocation of
resources.
31
Using the best technology
Full employment and
underemployment
The production possibilities
frontier represents our economy
at full employment and full
production.
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The Production Possibilities Curve
Guns and butter
Since scarcity is a fact of economic life, we need to use our resources as efficiently as
possible. If we succeed, we are operating at full economic capacity. Usually there’s some
economic slack, but every so often we do manage to operate at peak efficiency. When
this happens, we are on our production possibilities frontier (or production possibilities
curve).
Often economics texts cast the production possibilities curve in terms of guns and butter. A country is confronted with two choices: It can produce only military goods or only
civilian goods. The more guns it produces, the less butter and, of course, vice versa.
If we were to use all our resources—our land, labor, capital, and entrepreneurial
ability—to make guns, we would obviously not be able to make butter at all. Similarly,
if we made only butter, there would be no resources to make any guns. Virtually every
country makes some guns and some butter. Japan makes relatively few military goods, while
the United States devotes a much higher proportion of its resources to making guns.
You are about to encounter the second graph in this book. This graph, and each one
that follows, will have a vertical axis and a horizontal axis. Both axes start at the origin
of the graph, which is located in the lower left-hand corner and usually marked with the
number 0.
In Figure 1 we measure units of butter on the vertical axis. On the horizontal axis
we measure units of guns. As we move to the right, the number of guns increases—1,
2, 3, 4, 5.
The curve shown in the graph is drawn by connecting points A, B, C, D, E, and F.
Where do these points come from? They come from Table 1. Where did we get the
numbers in Table 1? They’re hypothetical. In other words, I made them up.
Table 1 shows six production possibilities ranging from point A, where we produce
15 units of butter and no guns, to point F, where we produce 5 units of guns but no
butter. This same information is presented in Figure 1, a graph of the production possibilities curve. We’ll begin at point A, where a country’s entire resources are devoted
to producing butter. If the country were to produce at full capacity (using all its resources)
but wanted to make some guns, they could do it by shifting some resources away from
butter. This would move them from point A to point B. Instead of producing 15 units of
butter, they’re making only 14.
Figure 1
Production Possibilities Curve
16
This curve shows the range of
possible combinations of outputs 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.
A
B
14
C
Units of butter
12
10
D
8
6
E
4
2
F
0
1
2
3
4
Units of guns
5
6
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TABLE 1 Hypothetical Production Schedule for
Two-Product Economy
Point
Units of Butter
Units of Guns
A
B
C
D
E
F
15
14
12
9
5
0
0
1
2
3
4
5
Before we go any further on the curve, let’s go over the numbers at points A and B.
We’re figuring out how many guns and how much butter are produced at each of these
points. Starting at the origin, or zero, let’s check out point A. It’s directly above the
origin, so no guns are produced. Point A is at 15 on the vertical scale, so 15 units of
butter are produced.
Now we’ll move on to point B, which is directly above 1 unit on the guns axis. At B
we produce 1 unit of guns and 14 units of butter (shown vertically). Incidentally, to locate
any point on a graph, first go across, or horizontally, then up, or vertically. Point B is
1 unit to the right, then 14 units up.
Now locate point C: 2 units across and 12 up. At C we have 2 guns and 12 butters.
Next is D: 3 across and 9 up (3 guns and 9 butters). At E: 4 across and 5 up (4 guns
and 5 butters). And finally F: 5 across and 0 up (5 guns and no butter).
The production possibilities curve is a hypothetical model of an economy that produces only two products—in this case, guns and butter (or military goods and civilian
goods). The curve represents the various possible combinations of guns and butter that
could be produced if the economy were operating at capacity, or full employment.
Since we usually do not operate at full employment, we are seldom on the production possibilities frontier. So let’s move on to Figure 2, which shows, at point X, where
we generally are. Sometimes we are in a recession, with unemployment rising beyond
8 or 9 percent, represented on the graph by point Y. A depression would be closer to the
origin, perhaps shown by point Z. (Remember that the origin is located in the lower
left-hand corner of the graph.)
The production possibilities
curve represents a two-product
economy at full employment.
Figure 2
16
14
Points Inside and Outside the
Production Possibilities Curve
A
B
C
12
Units of butter
Since the curve represents output of
guns and butter at full employment,
points X, Y, and Z, which lie inside
or below the curve, represent output
at less than full employment.
Similarly, point W represents output
at more than full employment and
is currently unattainable.
W
10
D
X
8
Y
6
E
Z
4
2
0
F
1
2
3
4
Units of guns
5
6
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A D V A N C E D
WORK
The Law of Increasing Costs
The production possibilities curve below reproduces
Table A. You may notice that, as we shift production from
guns to butter, we have to give up increasing units of guns
for each additional unit of butter. Or, shifting the other way,
we would have to give up increasing units of butter for each
additional unit of guns we produce.
16
A
B
14
C
Units of butter
12
10
D
8
6
E
4
2
F
0
1
2
3
4
5
6
Units of guns
Note that as you move from A to B you produce an
extra gun at the expense of 1 unit of butter, but when you
move from E to F, you produce an extra gun at the expense
of 5 units of butter.
We will be calling this “the law of increasing costs.”
Stated formally, this law says that as the output of one good
expands, the opportunity cost of producing additional units
of this good increases. In other words, as more and more of
a good is produced, the production of additional units of
this good will entail larger and larger opportunity costs.
The law of increasing costs is based on three concepts:
(1) the law of diminishing returns, (2) diseconomies of
scale, and (3) factor suitability. We’ve already alluded to
factor suitability when we talked about using our resources
in the most efficient way possible. One example was to use
34
our computer mainframe for sophisticated data analysis
rather than for simple word processing.
The law of diminishing returns, which we’ll take up
more formally in a later chapter, is defined this way: If units
of a resource are added to a fixed proportion of other resources, eventually marginal output will decline. Suppose
one farmer working with one tractor can produce 100 bushels of wheat on one acre of land. Two farmers, working
together, can produce 220 bushels. And three, working together, can produce 350.
The marginal output of the first farmer is 100. (In other
words, the first farmer added 100 bushels to output.) The
marginal output of the second farmer is 120. And the marginal output of the third farmer is 130. So far, so good. We
call this increasing returns.
If we keep adding farmers, do you think we’ll continue
to enjoy increasing returns? Won’t that single acre of land
start getting a little crowded? Will that one tractor be sufficient for four, five, and six farmers? Suppose we did add
a fourth farmer and suppose output rose from 350 to 450.
By how much did marginal output rise?
It rose by only 100. So marginal output, which had
been rising by 120 and 130, has now fallen to 100. We call
this diminishing returns.
Diseconomies of scale is a new term. As a business
firm grows larger, it can usually cut its costs by taking
advantage of quantity discounts, the use of expensive but
highly productive equipment, and the development of a
highly specialized and highly skilled workforce. We call
these economies of scale. But as the firm continues to
grow, these economies of scale are eventually outweighed
by the inefficiencies of managing a bloated bureaucracy,
which might sometimes work at cross-purposes. Most of
the day could be spent writing memos, answering memos,
and attending meetings. Labor and other resources become increasingly expensive, and not only are quantity
discounts no longer available, but now suppliers charge
premium prices for such huge orders. As costs begin to
rise, diseconomies of scale have now overcome economies of scale.*
Let’s look at some increasing costs. We have already
seen how we have had to give up the production of some
guns to produce more butter and vice versa. We’ll now take
this a step further. To produce additional units of guns—
one gun, two guns, three guns—we will have to give up
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Table A
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Production Shifts from Butter to Guns
Shift from
Point to Point
Change in Gun
Production
Change in Butter
Production
A to B
B to C
C to D
D to E
E to F
⫹1
⫹1
⫹1
⫹1
⫹1
⫺1
⫺2
⫺3
⫺4
⫺5
increasing amounts of butter. Similarly, to produce additional units of butter, we will have to give up increasing
numbers of guns.
How many units of butter would we have to give up to
produce each additional gun? This is shown in the table
above, which is derived from the figure in this box, or, if
you prefer, from Table 1 earlier in this chapter.
In the table above, as we begin to switch from butter to
guns, we move from point A to point B. We give up just one
unit of butter in exchange for one unit of guns. But the
move from B to C isn’t as good. Here we give up two butters for one gun. C to D is still worse: We give up three
butters for one gun. D to E is even worse: We give up four
units of butter for one gun. And the worst trade-off of all is
from E to F: We lose five butters for just one gun.
This is why we call it the law of increasing relative
costs. To produce more and more of one good, we have to
give up increasing amounts of another good. To produce
each additional gun, we have to give up increasing amounts
of butter.
There are three explanations for the law of increasing
relative costs. First, there’s diminishing returns. If we’re
increasing gun production, we will need more and more
resources—more land, more labor, more capital, and more
entrepreneurial ability. But one or more of these resources
may be relatively limited. Perhaps we will begin to run out
of capital—plant and equipment—or perhaps entrepreneurial ability will run out first.
Go back to our definition of the law of diminishing
returns. If units of a resource are added to a fixed proportion of other resources, eventually marginal output will
decline. Had we been talking about farming rather than
producing guns, the law of diminishing returns might have
set in as increasing amounts of capital were applied to the
limited supply of rich farmland.
A second explanation for the law of increasing costs is
diseconomies of scale. By shifting from butter to guns, the
firm or firms making guns will grow so large that diseconomies of scale will eventually set in.
The third explanation, factor suitability, requires more
extensive treatment here. We’ll start at point A of Table A
where we produce 15 units of butter and no guns. As we
move to point B, gun production goes up by one, while butter production goes down by only one. In other words, the
opportunity cost of producing one unit of guns is the loss of
only one unit of butter.
Why is the opportunity cost so low? The answer lies
mainly with factor suitability. We’ll digress for a moment
with the analogy of a pickup game of basketball. The best
players are picked first, then the not-so-good ones, and
finally the worst. If a couple of players from one side have
to go home, the game goes on. The other side gives them
their worst player.
If we’re shifting from butter to guns, the butter makers
will give the gun makers their worst workers. But people
who are bad at producing butter are not necessarily bad at
making—or shooting—guns.
When all we did was make butter, people worked at
that no matter what their other skills. Even if a person were
a skilled gun maker, or a gun user, what choice did he have?
Presumably, then, when given the choice to make guns,
those best suited for that occupation (and also poorly suited
for butter making) would switch to guns.
As resources are shifted from butter to guns, the labor,
land, capital, and entrepreneurial ability best suited to guns
and least suited to butter will be the first to switch. But as
more resources are shifted, we will be taking resources that
were more and more suited to butter making and less and
less suited to gun making.
Take land, for example. The first land given over to
gun making might be terrible for raising cows (and hence
milk and butter) but great for making guns. Eventually,
however, as nearly all land was devoted to gun making,
we’d be giving over fertile farmland that might not be well
suited to gun production.
*Economies and diseconomies of scale are more fully discussed in a later
chapter.
35
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E X T R A
HELP
Finding the Opportunity Cost
F
igure A shows us how many apples and oranges we
can produce. The more apples we produce, the fewer
oranges we can produce. Similarly, the more oranges we
produce, the fewer apples we can produce.
Opportunity cost tells us what we must give up. So
if we increase our production of oranges by moving from
point B to point C, how many apples are we giving up?
We are giving up 1 apple. Next question: If we
move from point F to point D, how many oranges are
we giving up?
We are giving up 2 oranges. Now, let’s take it up a
notch. What is the opportunity cost of moving from
A to D?
It’s 3 apples, because at point A we produced
5 apples, but at point D we’re producing only 2. One more
question: What is the opportunity cost of moving from
E to B?
It’s 6 oranges, because at E we produced 10 oranges
and at B, only 4.
6
A
5
B
Apples
4
C
3
D
2
E
1
F
0
1
2
3
4
5
6
7
8
9
10
11
12
Oranges
Figure A
What if we were at the origin? What would that represent? Think about it. What
would be the production of guns? How about the production of butter? They would both
be zero. Is that possible? During the Great Depression in the 1930s, the U.S. economy
sank to point Z, but no economy has ever sunk to the origin.
Move back to the production possibilities curve, say, at point C, where we are producing 2 units of guns and 12 units of butter. Is it possible to produce more guns?
Certainly. Just move down the curve to point D. Notice, however, that we now produce
fewer units of butter.
At D we have 3 units of guns and 9 units of butter. When we go from C, where we
have 2 guns, to D, where we have 3, gun production goes up by 1. But at the same time,
butter production declines from 12 at C to only 9 at D (a decline of 3).
If we’re at point C, then, we can produce more guns, but only by sacrificing some
butter production. The opportunity cost of moving from C to D (that is, of producing
1 more gun) is giving up 3 units of butter.
Let’s try another one, this time moving from C to B. Butter goes up from 12 to
14—a gain of 2. Meanwhile, guns go down from 2 to 1, a loss of 1. Going from C to B,
a gain of 2 butters is obtained by sacrificing 1 gun. The opportunity cost of producing
2 more butters is 1 gun. If you need a little more practice, please work your way through
the accompanying Extra Help box.
36
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Resource Utilization
37
Except at point A, we can go somewhere else on the production possibilities curve
and increase our output of butter. Similarly, anywhere but at point F, we can go somewhere else on the curve and raise our output of guns. It is possible to increase our
output of either guns or butter by moving somewhere else on the curve, but there is an
opportunity cost involved. The more we produce of one (by moving along the curve),
the less we produce of the other. It is not possible, then, if we are anywhere on the curve,
to raise our production of both guns and butter. Of course, over time it is possible to
produce beyond our current production possibilities curve as our economy grows. We’ll
get to economic growth in a few minutes.
What if we’re somewhere inside the production possibilities curve? Would it be
possible to produce more guns and more butter? The answer is yes. At point Z we have
an output of 2 guns and 4 butters. By moving to point D we would have 3 guns and
9 butters. Or, by going to point E, output would rise to 4 guns and 5 butters.
We are able to increase our output of both guns and butter when we move from Z
to D or E because we are now making use of previously unused resources. We are moving from depression conditions to those of full employment. But when we go from C to D,
we stay at full employment. The only way we can produce more guns is to produce less
butter, because resources will have to be diverted from butter to gun production. As we
divert increasing amounts of resources to gun production, we will be able to understand
the law of increasing costs (see the box titled “The Law of Increasing Costs”).
Productive Efficiency
So far we’ve seen that our economy generally falls short of full production. Now we’ll
tie that failure in to our definition of economics.
At the beginning of this chapter, we defined economics as the efficient allocation of
the scarce means of production toward the satisfaction of human wants. The scarce
means of production are our resources, land, labor, capital, and entrepreneurial ability.
So how efficiently do we use our resources?
An economy is efficient whenever it is producing the maximum output allowed by
a given level of technology and resources. Productive efficiency is attained when the
maximum possible output of any one good is produced, given the output of other goods.
This state of grace occurs only when we are operating on our production possibilities
curve. Attainment of productive efficiency means that we can’t increase the output of
one good without reducing the output of some other good.
As we’ve seen, our economy rarely attains productive efficiency, or full production.
We have managed this state of grace from mid-1997 through mid-2001, when the unemployment rate dipped below 5 percent. Since the summer of 2005 it hovered around
5 percent. The previous time our economy actually operated on its production possibilities
frontier was during the Vietnam War, in 1968 and 1969.
Productive efficiency is attained
when the maximum possible
output of any one good is
produced, given the output of
other goods.
Economic Growth
If the production possibilities curve represents the economy operating at full employment,
then it would be impossible to produce at point W (of Figure 2). To go from C to W would
mean producing more guns and more butter, something that would be beyond our economic capabilities, given the current state of technology and the amount of resources
available.
Every economy will use the best available technology. At times, because a country
cannot afford the most up-to-date equipment, it will use older machinery and tools. That
country really has a capital problem rather than a technological one.
As the level of available technology improves, the production possibilities curve
moves outward, as it does in Figure 3. A faster paper copier, a more smoothly operating
assembly line, or a new-generation computer system are examples of technological
The best available technology
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38
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CHAP TER 2
The Production Possibilities Frontier during World War II
World War II was a classic case of guns and butter, or,
more accurately, guns or butter. Almost two years before
we became actively involved in the war, we began increasing our arms production and drafting millions of
young men into the armed services. Did this increase in
military goods production mean a decrease in the production of consumer goods?
Gee, that’s a very good question. And the answer is
found when you go from point A to point B on the first
figure shown here.
possible? Can we raise our production of both guns and
butter to a point beyond our production possibilities
frontier without jumping to a still higher production
possibilities curve?
20
15
Units of butter
20
Units of butter
15
C
10
D
B
A
5
10
B
A
0
5
0
5
10
Units of guns
15
20
How were we able to increase the production of both
guns and butter in 1940 and 1941? Because there was still
a great deal of economic slack in those years. It was the
tail end of the Great Depression described in Chapter 1,
and there were still millions of people out of work and a
great deal of idle plant and equipment that could be
pressed into use.
Now we’re in the war, and we’re at point B in the
first figure. Is it possible to further expand our output of
both guns and butter? Think about it.
Is there any way we could do it? How about if there’s
economic growth? In the second figure shown here, we
went from point B to point C by moving to a higher
production possibilities curve. Is this possible? Over a
considerable period of time, yes. But in just a couple of
years? Well, remember what they used to say: There’s a
war going on. So a move from point B to point C in just
a couple of years is possible during a war.
Now we’re really going to push it. How about a move
from point C to point D in the second figure? Is this move
5
10
Units of guns
15
20
Well, what do you think? Remember, there’s a war
going on. The answer is yes. In 1942, 1943, and 1944 we
did push our official unemployment rate under 3 percent,
well below the 5 percent rate we would consider full
employment today. Employers were so desperate for
workers that they would hire practically anybody, and
people who wouldn’t ordinarily be in the labor market—
housewives, retired people, and teenagers—were flocking
to the workplace.
Meanwhile, business firms were pressing older machinery and equipment into use, because it was almost
impossible to get new machinery and equipment built
during the war. And so we were operating not only at full
capacity but well beyond that point.
How long were we able to stay at point D? Only as
long as there was a war going on. Point D represents an
output of guns and butter that our economy can produce
temporarily if it operates beyond its production possibilities curve. It’s almost like bowling 300. You can’t expect
to go out and do it every night.*
*One can argue that we were temporarily operating on a higher production possibilities curve, and, at the end of the war, we returned to the
lower production possibilities curve.
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39
Figure 3
Production Possibilities Curves
15
A move from PPC1 to PPC2 and
from PPC2 to PPC3 represents
economic growth.
PPC3
Units of butter
PPC2
10
PPC1
5
0
5
10
Units of guns
15
advances. And increasingly, industrial robots and bank money machines are replacing
human beings at relatively routine jobs.
As you know, recent advances in information technology (or, IT, as it’s often called)
has boosted output per worker and cut costs. It costs FedEx $2.40 to track a package for
a customer who calls by phone, but only four cents for one who visits its website. FedEx
now gets about 3 million online tracking requests a day, compared with only 30,000 or
40,000 by phone.
Our economic capacity also grows when there is an expansion of labor or capital.
More (or better trained) labor and more (or improved) plant and equipment would also
push the production possibilities curve outward. This is illustrated in Figure 3, as we go
from PPC1 to PPC2, and from PPC2 to PPC3.
Imagine that in 1991 a hypothetical nation had two choices. It could either produce
a preponderance of consumer goods or a preponderance of capital goods. Which choice
would lead to a faster rate of growth?
On the left side of Figure 4 we see what would have happened to the nation if it
had chosen to concentrate on producing consumer goods; on the right side we see what
would have happened if it had concentrated on producing capital goods. Obviously by
concentrating on capital goods production, that nation would have had a much faster rate
of economic growth.
The main factors spurring growth are an improving technology, more and better
capital, and more and better labor. Using our resources more efficiently and reducing the
unemployment of labor and capital can also raise our rate of growth. This topic is discussed more extensively in Chapter 16 of Economics and Macroeconomics.
Current Issue: Will You Be Underemployed When
You Graduate?
Every spring newspaper reporters ask college placement officials about the job prospects of
that year’s graduating class. During good years corporate recruiters are lining up to interview
the new grads. But in bad years, it’s the other way around. The years 2006 and 2007 were
pretty good and, 2008, not so good. Hopefully, by the time you graduate, the job outlook
will be much brighter.
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CHAP TER 2
B
25
25
20
20
Units of capital goods
Units of capital goods
A
15
PPC2001
10
15
PPC2001
10
B
PPC1991
PPC1991
5
5
A
0
0
5
10
Units of consumer goods
15
5
10
15
Units of consumer goods
Figure 4
I happened to graduate during a bad year. My only job offer was from the recruiter
from Continental Baking Company to drive a bakery truck. “But how will I use my
economics?” He told me I could economize on the gasoline.
Had I taken the truck-driving job, I would have been underemployed. When you
graduate, you may face the same problem. It turns out that one in five college graduates
ends up in a job that does not require a college degree. In addition, many employers require
a degree just as a credential. So when you start interviewing, ask yourself, “I need a degree
to do this? ”
There are millions of college grads who are asking themselves this very question.
Some 37 percent of all flight attendants hold bachelor’s degrees, as do 19 percent of the
theater ushers, lobby attendants, and ticket takers. In addition, 13 percent of all bank tellers
and 14 percent of all typists and word processors are college graduates.6
From time to time you’ll hear reports of PhD’s driving cabs, lawyers typing their
own briefs, and doctors bogged down in paperwork. Perhaps there’s some degree of
under-employment in almost everyone’s future. All you can really do is avoid taking a
job in which you are clearly underemployed. So when you’re interviewing with prospective employers at your college placement office and that guy with the bakery truck shows
up, just say no.
6
Louis Uchitelle, “College Still Counts, Though Not as Much,” The New York Times, October 2, 2005,
Section 10, p. 4.
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Resource Utilization
Questions for Further Thought and Discussion
1. If you were in a position to run our economy, what steps would you take to raise our
rate of economic growth?
2. Under what circumstances can we operate outside our production possibilities curve?
3. Give an example of an opportunity cost for an individual and a nation.
4. Would it be harder for a nation to attain full employment or full production? Explain.
5. Could a nation’s production possibilities curve ever shift inward? What might cause
such a shift to occur?
6. What is the opportunity cost you incurred by going to college?
7. Although the U.S. is one of the world’s wealthiest nations, some of the federal government’s budget decisions are severely constrained by scarcity. Can you think of
one such decision that was in the recent economic news?
8. Why is scarcity central to economics?
9. Can you think of any decisions you have recently made that incurred opportunity
costs?
10. Do you know any entrepreneurs? What do they do?
11. Why is entrepreneurship central to every business firm?
12. Explain the law of increasing costs, using a numerical example.
13. Discuss the three concepts on which the law of increasing costs is based.
14. Practical Application: Underemployment of college graduates is a growing problem.
If you were appointed to the board of trustees of your college, what measures would
you suggest to alleviate this problem for the graduates of your school?
41
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Workbook
for Chapter 2
Name
Date
Multiple-Choice Questions
Circle the letter that corresponds to the best answer.
1. The word that is central to the definition of
economics is
a) resource
b) wants
. (LO1)
c) scarcity
d) capital
2. We would not need to economize if
a)
b)
c)
d)
. (LO2)
the government printed more money
there was no scarcity
there was less output of goods and services
everyone received a big pay increase
. (LO1)
3. Human wants are
a) relatively limited
b) relatively unlimited
c) easily satisfied
d) about equal to our productive capacity
4. Which of the following is an economic
resource? (LO3)
a) gold
c) labor
b) scarcity
d) rent
5. Each of the following is an example of capital
except
. (LO3)
a) land
c) a computer system
b) an office building
d) a factory
6. The opportunity cost of spending four hours studying
a review book the night before a final exam would
be
a)
b)
c)
d)
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. (LO9)
the cost of the review book
missing four hours of TV
a higher grade on the exam
the knowledge gained from studying
8. The full-production level of our economy implies
a)
b)
c)
d)
. (LO4, 6)
an efficient allocation of our resources
zero unemployment
our plant and equipment being operated at
100 percent capacity
a high unemployment rate
9. Underemployment means
. (LO4)
a) the same thing as unemployment
b) underutilization of resources
c) a recession
d) slow economic growth
10. The production possibilities curve represents
. (LO5, 6)
a) our economy at full employment but not full
production
b) our economy at full production but not full
employment
c) our economy at full production and full
employment
11. If we are operating inside our production possibilities
curve
. (LO5)
a) there is definitely recession going on
b) there is definitely not a recession going on
c) there is definitely less than full employment
d) there is definitely inflation
12. The closer we are to the origin and the farther away
we are from the production possibilities curve
a)
b)
c)
d)
. (LO5)
the more unemployment there is
the less unemployment there is
the more guns we are producing
the more butter we are producing
7. An economy operating its plant and equipment at
full capacity implies a capacity utilization rate
of
. (LO4)
a) 40 percent
b) 70 percent
c) 85 percent
d) 100 percent
43
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13. Economic growth will occur if any of the following
. (LO7)
occur except
a) a better technology becomes available
b) the level of consumption rises and the savings
rate falls
c) more capital becomes available
d) more labor becomes available
14. To attain a higher rate of economic growth, we need
to devote
. (LO7)
a) a higher proportion of our production to capital
goods and a lower proportion to consumer goods
b) a higher proportion of our production to consumer
goods and a lower proportion to capital goods
c) a higher proportion of our production to both
consumer goods and capital goods
d) a lower proportion of our production to both
consumer goods and capital goods
15. Which is the most accurate statement? (LO3)
a) Nearly every major economic innovation
originated abroad and was then applied in the
United States.
b) The United States provides a poor environment
for innovation.
c) Freedom of thought, a risk-taking culture, and a
noncorrupt bureaucracy have made the United
States very hospitable to innovation.
d) Although the United States was once the world’s
leading innovator, since we lost most of our
manufacturing base, we are no longer a major
innovator.
16. Which is the most accurate statement? (LO4)
a) Most Americans are underemployed.
b) Employment discrimination causes
underemployment of labor.
c) It is impossible for an economy to operate outside
its production possibilities curve.
d) There is no longer employment discrimination.
17. Statement 1: The old Negro leagues provide an
example of underemployment. (LO4)
Statement 2: Underemployment means basically the
same thing as unemployment.
a) Statement 1 is true and statement 2 is false.
b) Statement 2 is true and statement 1 is false.
c) Both statements are true.
d) Both statements are false.
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18. Employment discrimination is most closely related
to
. (LO4)
a) specialization
b) technology
c) unemployment
d) underemployment
19. Miranda Bowman, a Harvard MBA, is almost
definitely
if she is working as a
secretary. (LO4)
a) unemployed
b) underemployed
c) both unemployed and underemployed
d) neither unemployed nor underemployed
20. On the following list, the most serious problem facing
today’s college graduate is
. (LO4)
a) outsourcing of jobs to foreign countries
b) employment discrimination
c) unemployment
d) underemployment
21. Which statement is true? (LO2, 3)
a) America has always had a shortage of entrepreneurs.
b) Our economic problem is that we have limited
resources available to satisfy relatively unlimited
wants.
c) America has less economic resources today than
we had 40 years ago.
d) Aside from a few million poor people, we have
very little scarcity in the United States.
22. Suppose you had $1,000 to spend. If you spent it on a
vacation trip rather than on new clothes, your second
choice, or 1,000 lottery tickets, your third choice,
what was your opportunity cost of going on a
vacation trip? (LO9)
a) $1,000
b) the vacation trip itself
c) not buying the new clothes
d) not buying the lottery tickets
e) missing out on the $10 million lottery prize
23. Which of the following best describes the role of an
entrepreneur? (LO3)
a) the inventor of something with great commercial
possibilities
b) anyone who made a fortune by purchasing stock
in a dot-com before its price shot up
c) inventors who parlay inventions into commercial
enterprises
d) any employee earning at least $200,000 at a
Fortune 500 company
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24. As we produce increasing amounts of a particular
good, the resources used in its production
. (LO8)
a) become more suitable
b) become less suitable
c) continue to have the same suitability
D
C
25. The law of increasing costs is explained by each of
B
. (LO8)
the following except
a) the law of diminishing returns
b) diseconomies of scale
c) factor suitability
d) overspecialization
26. As a firm grows larger,
. (LO8)
a) economies of scale set in, then diseconomies of
scale
b) diseconomies of scale set in, then economies of
scale
c) economies of scale and diseconomies of scale set
in at the same time
d) neither economies of scale nor diseconomies of
scale set in
27. The law of increasing costs states that, as
a)
b)
c)
d)
. (LO8)
output rises, cost per unit rises as well
the output of one good expands, the opportunity
cost of producing additional units of this good
increases
economies of scale set in, costs increase
output rises, diminishing returns set in
28. If Figure 1 shows our production possibilities frontier
during World War II, at which point were we
operating? (LO5)
a) point A
b) point B
c) point C
d) point D
29. If Figure 1 shows our production possibilities frontier
during the Great Depression, at which point were we
operating? (LO5)
a) point A
b) point B
c) point C
d) point D
A
Figure 1
Fill-In Questions
1. A PhD driving a cab would be considered
. (LO4)
2. The central fact of economics is (in one word)
. (LO2)
3. Human wants are relatively
, while
economic resources are relatively
. (LO2, 3)
4. The law of increasing costs states that, as the output
of one good expands,
. (LO8)
5. The law of diminishing returns, diseconomies of
scale, and factor suitability each provide an
explanation for the law of
. (LO8)
6. If you went into a store with $25 and couldn’t decide
whether to buy a pair of jeans or a jacket, and you
finally decided to buy the jeans, what would be the
opportunity cost of this purchase?
. (LO9)
7. Full employment implies an unemployment rate of
about
percent. (LO4)
8. List some constraints on our labor force that prevent
our fully using our plant and equipment 24 hours a
day, seven days a week. (LO4)
(1)
;
(2)
;
and (3)
.
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4. Fill in the following points on Figure 3. (LO5)
Point X: where our economy generally operates
Point Y: a serious recession
Point Z: a catastrophic depression
Point W: economic growth
9. Employment discrimination results in the
of our labor force. (LO4)
10. When we are efficiently allocating our resources and
using the best available technology, we are operating
on our
. (LO5, 6)
11. Most of the time our economy is operating
its production possibilities frontier. (LO5)
16
12. Economic growth can be attained by: (LO7)
and
(2)
.
Problems
1. If we were at point C of Figure 2 below, could we
quickly produce substantially more houses and more
cars? (LO5, 7)
14
12
Units of butter
(1)
10
8
6
4
2
15
0
Units of houses
10
1
2
3
4
Units of guns
5
6
Figure 3
J
5. In Figure 4, fill in a new production possibilities
frontier representing substantial economic
growth. (LO5, 7)
C
M
5
6. In Figure 4, place point M where there is 100 percent
unemployment. (LO5)
0
10
20
30
Units of cars
Figure 2
2. If we were at point M of Figure 2, could we quickly
produce substantially more houses and more cars?
(LO5, 7)
3. If we were at point C on Figure 2, could we quickly
go to point J? (LO5, 7)
Figure 4
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7. Fill in the following points on Figure 5. (LO5)
Point A: an unemployment rate of 100 percent
Point B: an unemployment rate of 20 percent
Point C: an unemployment rate of 2 percent
9. Use Figure 6 to answer these questions: (LO5, 9)
a) What is the opportunity cost of going from point B
to point C?
b) What is the opportunity cost of going from point D
to point C?
c) What is the opportunity cost of going from point B
to point A?
d) What is the opportunity cost of going from point C
to point D?
180
A
B
C
D
150
E
Figure 5
8. Given the information in Table 1, below, what is the
opportunity cost of going from point B to point C?
And of going from point D to point C? (LO9)
Units of VCRs
120
90
60
30
TABLE 1 Hypothetical Production Schedule for
Two-Product Economy
Point
Units of Butter
Units of Guns
A
B
C
D
E
F
15
14
12
9
5
0
0
1
2
3
4
5
F
30
60
90
120
150
180
Units of camcorders
Figure 6
10. Use the data in Figure 6 to illustrate the law of increasing
costs numerically. (Hint: Start at point E and move
toward point A.) (LO5, 8)
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