Your first reading assignment is introductory and includes pages 5 through 20 in your Colander text.

On page 6 you’ll notice some definitions. There may not be a good and short definition for economics but here is one possibility: Economics is the study of how a society allocates the scarce resources of labor, land (also known as natural resources), and capital. These are the three major factors of production. We’re all familiar with the commercial labor force and so we understand that labor is an important factor of production. Labor may be the most important factor since the majority of the earnings or returns to the various factors of production go to labor. It is also true that high unemployment rates are associated with certain social costs, such as higher crime, divorce rates, and child abuse.

The second factor of production listed above, land, may be referred to as natural resources. In economics, land includes minerals underneath the land (e.g., oil and gas), water flowing over the land, and trees growing on the land. Natural resources seems to be a more inclusive and descriptive label, but land is the standard term that is used.

Capital as a factor of production refers to capital goods and includes items such as tools, machinery, equipment, and factories. These items allow us to increase production beyond what could be done with our bare hands alone or, more realistically, they provide for improvements in productivity compared to an older set of equipment and machinery. Note that in economics capital normally refers to capital goods, although it is also true that capital may refer to money that is required to purchase new tools or build a new factory. Capital goods are instruments of production.

There is a fourth factor of production, entrepreneurship, which is a subset of labor but is considered as a separate factor. An entrepreneur performs a risk taking function as he or she combines the three major factors of production in order to successfully bring a good or service to the marketplace. A small sole proprietorship or a huge corporation such as Ford Motor Company may perform this risk taking activity. If the new product or service fails and money is lost, then clearly a risk taking business activity occurred. Large companies have deeper pockets and can better afford to take a loss than a small business firm, but both accept the monetary risk of introducing new goods to the market. This is entrepreneurship.

The what to produce (and how much of it) question posed on page 6 is determined by the marketplace in the U.S. economy. In other words, the US has a decentralized economy. Every day millions and millions of decisions by consumers and business firms are processed through a price system. These decisions provide signals to business firms as to whether firms should produce more or less of specific goods and models. In some cases, the market result may be that a certain good should not be produced any more because a new product (e.g., a CD versus an LP) is superior and can be produced economically.

Note that the what to produce question doesn’t have to be answered by a decentralized marketplace system, although that is how we do it and most of us would prefer to keep it that way. In the old Soviet economic system, for example, government bureaucrats decided in advance how may cars, televisions, etc. would be produced. This was a system of authoritarian centralized planning, quite different from the American democratic political and economic approach.

The second question presented on page 6, how to produce it, is determined in factor markets in the U.S. economy. These factor (or resource) markets are those involving labor, land, and capital, as discussed above. Business firms hire needed labor and purchase equipment in factor markets for labor and capital. In the U.S. system, these are also free markets (subject to some government regulation) and the principles of supply and demand are applicable. If computer programmers are needed in large numbers by business firms, then their compensation goes up. If college professors are not needed as much as they were in past years, then their wages go down. Factor markets in the US economy are decentralized in this way.

The how to produce it question could be answered differently. In the old Soviet approach to factor markets, government workers determined how much labor and how much capital would be needed to build a car or a television set. This was part of the centralized Soviet economy. For American firms, if labor costs go up, more machinery (automation) may be substituted for labor and if the cost of machinery increases, the production process may become more labor intensive. In other words, in the US economy government does not determine it the allocation of resources in factor markets.

The third question posed on page 6, for whom to produce it, is an income distribution question. We are well aware that certain occupations such as movie stars and major league baseball players are highly compensated. Other jobs are less well paid. In our system the forces of supply and demand determine these compensation results. They are free market results, although at times the differentials in pay between different jobs may be difficult to understand and accept.

Going back to the centralized Soviet system one more time, government decided the for whom question. The government would set the pay rates for physicians, plumbers, professors, etc. This was not a market system.

On the top of page 8 and at the bottom of page 9, you’ll see references to costs and benefits. Cost-benefit analysis is an approach to evaluating expenditure options for individuals, companies, and government. For instance, if the federal government is deciding whether to proceed with a flood control project, it could compare the initial cost of building a dam and lake as well as the estimated ongoing maintenance cost with the benefits of saved properties that would no longer sustain flood damage. Perhaps insurance industry records could provide a basis for making an estimate of the value of saved properties. This omits attaching a value to lost human life since there is no way to do that. If the estimated benefits exceed the estimated costs, then government should go ahead with the project. Alternatively, if the costs exceed the benefits, then the expenditure should not be made.

On pages 11 and 12 there is a reference to opportunity cost. This may be thought of as the choice you did not make, or an implied cost. That is, when you choose a course of action, there may be some explicit costs, such as paying tuition and buying the text for this course, and there may be implied or opportunity costs. An implied cost of taking this course might be giving up some additional time to be with your family or giving up the opportunity to put in a few extra hours each week at work. For government, the implied cost of spending more money on social programs such as food stamps or supplemental security income is the opportunity to spend more money on military needs. You could also reverse this example and say that the implied cost of spending more money on tanks and jet fighter planes is the opportunity to spend more on social programs.

On pages twelve through fifteen you’ll notice some discussion on rationing and invisible forces of the marketplace. This is fairly intuitive because an increase in supply, such as a glut of crude oil, if not offset by an increase in demand, will result in a surplus and drive down the price. But if the twelve OPEC countries agree to significantly restrict production and demand stays the same, then a shortage occurs and the price mechanism rations the oil by increasing the price per barrel. If supply stays the same and demand increases as economies perform well and need more oil and oil related products, then the extra demand results in higher prices. But if supply stays the same and demand diminishes due to insufficient economic activity in various countries, then a surplus occurs and price drops. This is the invisible hand of the marketplace at work.

You’ll have no problem with the remainder of this chapter. You may want to look at the chapter summary at the bottom of page 20.

You are now ready to work on the Problems and Exercises for Unit One, Assignment One.