Lesson 3: The Three Basic Economic Questions

3 Key (Basic) Economic Questions

1. What to produce (What will be produced)?

2. How to Produce (How (what method) will things be produced)?

3. For whom to produce (who gets goods & services?)

Consumer Sovereignty

In a market economy, consumers decide what goods and services should be produced (they are in command since they spend their income on the goods and services they are most willing to buy)

C.E.L.L

Capital

Entrepreneur

Land

Labor

Entrepreneur

A person who decides how to combine resources to create a good or service to make a profit (self-interest). They bear the risks of losing money, wasting time/effort, threatening their reputation

The three types of resources/inputs (factors of production) a Entrepreneur combines

1. Land

2. Labor

3. Capital

Land

includes all “gifts of nature” that we use to produce goods and services; what we normally call “natural resources”; can be renewable and non-renewable

Renewable

Natural resources that can be drawn indefinitely if used wisely (ex. trees, air, animals, solar and wind energy)

Non-renewable/ exhaustible

Natural resources that dont renew itself so it’s available in limited supply (ex. oil, minerals, natural gas)

Labor

work time and work effort that people devote to producing goods and services (this is as HUMAN RESOURCE)

2 Ways to Improve Labor

1. Quantity of Labor: increased laborers population (births or immigration)

2. Quality of labor: depends on how skilled people are

Human Capital

Knowledge and skill that people obtain from education, on-the-job training, and work experience. Countries that invest in this are more advanced

Capital (physical capital or capital goods)

consists of the tools, instruments, machines, buildings, and other items that have been produced in the past and that businesses now use to produce goods & services (ex. man-made resources)

Money, stocks, and bonds are..

financial capital, but NOT productive resources (not used to produce goods & services (NOT capital)

Stock certificate

ownership in a publicly owned company

Money

cash; convenient method to get productive resources; mostly in form of checkable deposits

Bond

lending instrument which returns your principal with interest

Two types of efficiency

1. Productive

2. Allocative

Productive efficiency

Type of efficiency- optimal method of producing goods; producing at the least cost (ex. healthcare resources are put to best use possible and produce as much healthcare as they can; produce 100K shoes all same pattern)

Allocative efficiency

Type of efficiency- concerned with optimal distribution of goods & services in the economy (ex. Right share of resources is being devoted to healthcare vs other goods/services in the economy; produce 100K shoes, 50K left & 50K right)

In a market-type economy goods and services are purchased..

based on the ability the buyer to pay for them (higher income=more goods and services can be purchased)

What determines one’s income?

1. Quantities of property and human resources one supplies

2. Prices of those resources in command in resource market

   (raises question of fairness)

Households

level at which we see income; consists of one or more persons occupying a housing unit and are both the ultimate suppliers of all economic spenders and the major spenders in the economy; about 128 million of them in the US

2 Types of Distribution of Incomes

1. Functional Distribution

2. Personal Distribution

Functional Distribution of Income

Indicates how the nation’s earned income is apportioned among the 4 types of income:

1. Wages/Salaries

2. Rental income (rent)

3. Interest

4. Profit

Wages/Salaries

Type of income; associated with labor; makes up about 70% of nation’s earned income

Rental Income (rent)

Type of income; associated with land (property-owners); makes up about 1% of nation’s earned income

Interest

Type of income; associated with capital (property-owners); makes up about 5% of nation’s earned income

Profit

Type of income; associated with entrepreneurship (business owners); makes up about 23% of nation’s earned income (Propiertors (small business owner) income (9%) + Coporate profit (14%))

What’s the largest source of income for households?

Wages/Salaries (about 70%)

What’s the percentage of income from profits in the economy?

23%

Personal Distribution of Income

Indicates how the nation’s money income is divided among individual households divided into five numerically equal groups or quintiles

Major Conclusion from Personal Distribution of Income

Top 20% of households earn half of all income in US, while bottom 80% of households earn other half. There’s a significant income gap in this country and it continues to widen

What to Produce?

A society cannot have everything its people want, so it must decide WHAT to produce. This typically depends on the values of the society (ex. should they produce more military goods or hospitals?)

How to Produce?

Will often depend on types of resources available to a society. No matter what, the ideal method is one that’s most efficient and least-cost production.

For whom to produce?

Who gets the goods & services after they are produced?