Costs of production. Opportunity costs. Tradeoffs.

Opportunities are chances to improve your situation. Opportunities, however, may cost you something. If you spend time watching television, you cannot spend the same time at the library. If you buy a car, you cannot spend the same money for a stereo.

All production involves a cost. This cost is not counted simply in terms of money but also in terms of resources used. The various resources used in producing a good or a service are the real costs of that product. In building a bridge, for example, the real costs of the bridge are the human, capital and natural resources in consumes. To build a bridge requires the labour of many people, including engineers and construction workers. The capital resources these people use include a variety of tools and machines. Building a bridge also requires natural resources, such as iron ore and coal. These natural resources are used to make the steel that is used in constructing the bridge.

Since resources are limited and human wants are unlimited, people and societies must make choices about what they want most. Each choice involves costs. The value of time, money, goods and services given up in making a choice is called opportunity cost.

When steel is used to make a bridge instead of a hospital, the loss in hospital is the opportunity cost of making the bridge. In fact, any resources used for the bridge are then no longer available for something else. When people make a choice between two possible uses of their resources, they are making a tradeoff between them.

To make choices that best satisfy human wants, people must be aware of all the tradeoffs. Then, society will understand the true costs of making one decision rather than another, and can make the decision that best fits its values and goals.

How can the concepts of opportunity costs and tradeoffs be used to help explain how the economy works? One way is construct a simple plan of the economy call an economic model. The simple plan helps economists to analyze economic problems, seek solutions, and make comparisons between the economic model and the real world. AN economic model is a little bit like a model airplane. It helps to explain how the real thing works, even if it doesn’t fly. When models are used to help solve economic problems, their usefulness depends on the assumptions made about the world.

One of the most important choices a society makes is between producing capital goods and producing consumer goods. If a nation increases its production of consumer goods, its people will better lives today. However, if a nation increases its production of capital goods, its people may live better in the future.

Choosing between home computers and industrial robots is an example of a choice a society must make. Society must decide what it wants and what it is willing to give to get it. The same applies to you individually. Since every economic decision requires a choice, economics is a study of tradeoffs. When you analyze each side of a tradeoff, you can make better decisions.

 

Utility and prices.

According to our basic needs and additional individual wants we require different kinds of commodities. Our basic needs are simple, but our additional individual wants are often vey complex. Commodities of different kinds satisfy our wants in different ways. A cake, a bottle of medicine and a textbook satisfy very different wants. This characteristic of satisfying a want is known in economics as “utility”. It is related to the number of factors and a utility change is concerned with the consumer’s relation to a commodity.

Utility, however, should not be confused with usefulness. For example, a submarine may or may not be useful in time of peace, but it satisfies a want. Many nations want submarines. Economists say that utility determines “the relationship between a consumer and a commodity”.

Utility varies between different people and between different nations. A vegetarian does not want meat, but may rate the utility of bananas very highly, while a meat-eater may prefer steak. A mountain-republic like Switzerland has little interest in submarines, while maritime nations rate them highly.

Utility varies not only in relation to individual tastes and to geography, but also in relation to time. In wartime the utility of bombs is high, and the utility of the pianos is low. Utility is therefore related to our decisions about priorities in production. The production of pianos falls sharply in wartime.

The utility of a commodity is also related to the quantity, which is available to the consumer. If paper is freely available, people will not be so much interested in buying too much of it. If there is an excess of paper, the relative demand for paper will go down. We can say that the utility of a commodity therefore decreases as the consumer’s stock of that commodity increases.

In most economic systems, the prices of the majority of goods and services do not change over short periods of time. In some systems it is of course possible for an individual to bargain over prices, because they are not fixed in advance. In general terms, however, the individual cannot change the prices of the commodities he wants. When planning his expenditure, he must therefore accept these fixed prices. He must also pay this same fixed price no matter how many units he buys. A consumer will go on buying bananas for as long as he continues to be satisfied. If he buys more, he shows that his satisfaction is still greater than his dislike of losing money. With each successive purchase, however, his satisfaction compensates less for the loss of money.

A point in time comes when the financial sacrifice is greater than the satisfaction of eating bananas. The consumer will therefore stop buying bananas at the current price. The bananas are unchanged: they are no better or worse than before. Their marginal utility to the consumer has, however, changed. If the price had been higher, he might have bought fewer bananas; if the price had been lower, he might have bought more.

It is clear from this argument that the nature of a commodity remains the same, but its utility changes. This change indicates that a special relationship exists between goods and services on the one hand, and a consumer and his money on the other hand. The consumer’s desire for a commodity tends to diminish as he buys more units of it. Economists call this tendency the Law of Diminishing Marginal Utility.

The interaction of buyers and sellers determines the price for goods and services. If the price is low, a shortage will develop, thereby driving up the price. If the price is too high, a surplus will develop and move the item’s price down. A society may interfere in market prices by means of price controls and ration stamps. Price controls are often used in times of severe shortages to make sure that the prices for important items, such as food and gasoline, do not go too high. The price of rental housing is controlled by law in some American cities today. During World War II, people were issued ration stamps for meat, butter, sugar, canned goods, shoes and gasoline. Such a person was thus able to get the minimum amount of these goods needed to survive. Price controls and ration stamps were also discussed in recent years as a way of dealing with temporary shortages in gasoline and heating oil.

In a market economy, prices are the result of the needs of both buyers and sellers. The sellers will supply more goods at higher prices than at lower ones. The buyers will buy more goods at lower prices than at higher ones. Some price is satisfactory to both buyers and sellers. At that price the supply – quantity offered for sale – equals the demand – quantity people are willing to buy. Since no surplus or shortage exists, there is no pressure on price to change. This point is called an equilibrium price. At the equilibrium price, the amount producers will supply and the amount consumers will buy are the same.

 

Income and spending

People’s incomes determine how many of the economy’s goods and services they can purchase. Income is the money a person receives in exchange for work or property. There are five basic types of income:

· employee compensation is the income earned by working for others. It includes wages and fringe benefits such as health and accident insurance.

· proprietor compensation is the income that self-employed people earn.

· corporation profit is the income corporations have left after paying all the expenses.

· interest is the money received by people and corporations for depositing their money in savings account or lending it to others.

· Rent is income from allowing others to use one’s property temporarily.

The total income is the sum of employee and proprietor compensation, corporation profit, interest and rent. In each category, people receive this income in return for providing goods or services.

One other type of income is a transfer payment – money one person or group gives to another, though the receiver has not provided a specific good or service. Gifts, inheritances, and aid to the poor are three examples of transfer payments.

During the past century, the percentage of people who work for themselves has generally declined. Increasingly, people are employees and not self-employed.

By the type of work people do workers fall into one of four broad categories:

1. White-collar workers are people who do jobs in offices, such as secretaries, teachers, and insurance agents.

2. Blue-collar workers are people who do jobs in factories or outdoors. Artisans, such as carpenters and plumbers, are blue-collar workers.

3. Service workers provide services to other individuals or businesses. Janitors, barbers, and police are service workers.

4. Farm workers are people who work on their own farms or those of others.

In the market system a person’s income is determined by how the market values that person’s resources and skills. Individuals, such as doctors, whose skills society values, receive high incomes. People who own valuable resources, such as capital to invest or land to develop, also receive high incomes.

Income is not the same as wealth. Wealth is any resource that can be used to produce income. An individual’s possessions, such as house, a car, or jewelry, are part of that person’s wealth. Each of these could be sold to produce income. Savings accounts and corporation stocks are types of wealth that usually produce income. Labour skills are not counted because they are difficult to measure. In addition, an individual’s debts are subtracted from personal wealth. A person with many valuable possessions but many debts may have no more wealth than a person with a few possessions but no debts.

People with similar incomes may have very different amounts of wealth. Consider two women who receive an income of $25000 a year. One earns all of her income working at a bank. The other receives her $25000 income from dividends on stock worth $250000. Aside from the stock the second woman owns, the possessions and debts of the two are similar. The difference in stock ownership, though, is large. The second woman is much wealthier than the first woman.

When individuals receive any income, whether as allowance, paycheque, or gift, most of that income is spent. Spending becomes income for someone else. The money each individual spends multiplies throughout the economy as others receive and spend parts of it. In addition, the choice you and others make can lead to investment spending. More things are made and more places are built. Thus spending results in changes throughout the economy.