Students Again

Economic Resources, Factors of Production – These are the five categories of inputs necessary to produce outputs. They are the next five terms, but usually we deal only with the first three.

Land (A) – any raw material – including the physical land that we produce on top of. This could include iron ore, minerals, oil in the ground etc. To abbreviate “Land” we use “A” because we are going to use “L” for Labor. I find thinking of it as standing for “Acres” reminds me that Land is “A”.

Labor (L) – the term Labor applies to all types of human effort that represents a cost to the employer. It can be measured in hours, salaries, wage rates, ergs (units of effort) etc. We use the capital “L” to represent Labor.

Capital (K) – This is the use of any product that is already been manufactured – everything from steel beams to paper clips, to the use of a delivery truck or a patent. The letter “C” is used for something else, so we use “K” to represent Capital. Think of it as “Das Kapital” and the use of “K” will seem to be more appropriate.

Entrepreneurial ability – This is a off-line cost to a firm, because it represents the risk taking behavior of the owner/entrepreneur. Without that risk-talking behavior, the plant, firm and jobs of others could not exist. While this is a factor of production is may not effect any change in production. For example, we don’t get more output just because the owner is feeling less risk-averse, but we do get more output with more labor input.

Human Capital – This one doesn’t fit in any of the three main categories exclusively – in fact it fits well in two (Labor and Capital). This is the value of increased output do to past effort – like education which makes you a better smarter worker, or experience that decreases the time required to produce. They are not current (compensated) effort, so they aren’t exactly labor – and they aren’t quite physical capital either, but they were produced in the past.

Payments to the Factors of Production – This is the cost or price of each of the three major factors of production.

Rent – Land is paid for through rental payments. Even if we own the land, we could have received rent payments from someone else if we weren’t using it – so it is still a rental cost to use land. The abbreviation PA is also used to represent the price of land.

Wages – All Labor is assumed to be hourly, so we use Wages as the price of Labor – even though we realize that many workers are paid by the day or week or year – or even piecemeal. . The abbreviation PL is also used to represent the price of labor.

Interest – We are going to assume that all capital s owned by households and therefore has to be borrowed by firms to use. The payments one makes for borrowed things is interest. Again, even if a firm owns the capital – someone owns the firm (many times
through stock) and the firm pays the owners for the right to use the capital (dividends, the increased value of the stock if they retain earnings, profits for the entrepreneur, or even interest payments to the bank if they do formally “borrow”). The abbreviation PK is also used to represent the price of Kapital.

Productive Efficiency – Producing at the lowest possible cost.

Allocative Efficiency – Producing the mix of goods people want most.

Production Possibilities Frontier or Curve (PPF or PPC) – A measure of how much of any two goods (or groups of goods) can be produced if society used all available resources to produce it.

Consumption Goods – Goods used by end-users – i.e. consumers for their own purposes. This means a truck used to get around town or to and from work is a consumer good, but a truck used in a small business is not.

Capital Goods – goods that were manufactured, and are used during the process of making other goods.

Opportunity Cost – What we must give up to do something else. I give up sleeping in to go play basketball. I give up the money I would have used to buy a car to buy a boat, etc. The more we must give up, the higher the opportunity cost of a good.

Law of Increasing Opportunity Costs – The more we want of a product, the less productive factors of production do we have to employ to make it. i.e. if we wanted lots of product “A”, we have to take expand the employee base that makes product “A”. Since we hired the best possible product “A” builder the first time, the only thing left is a less efficient product “A” builder to hire. This drives the opportunity costs up. At the same time, we have to pull somebody off a job that they are better suited for – causing society to give up more and more of product “W” as we employ more product “W” workers to make Product “A”.

Growth on a PPF – BY investing in capital goods, we can increase the amount of certain products (or even of all products) that we can make in the future. For example, today I take time off from catching fish to make a fishing pole – so my fish haul today is lower than usual. But tomorrow (using my new pole) I catch more fish than I could today. This shifts the PPF out, giving me more choices next round.

Market System Capitalism – A system where the choices are made by many individuals, each seeking to maximize their own self-interest. This system is more flexible than others because the market can have millions of directions at once.

Command System / Communism – A system where a central authority decides what gets made, who makes it and how it will be made regardless of the costs (opportunity or otherwise).

The Circular Flow Model – A model showing the interaction between the household and business sectors in two markets – the goods, output or product market (any of those terms is fine) where firms sell their outputs and services to households AND the resource market where households sell their services (labor), capital and land to firms so that firms can produce outputs.