Chapter 3 -what or output question: asks what goods and services the economy will produce and in what quantities; one of the four fundamental economic questions that every society must answer. -how or input question: asks how the economy will produce its goods and services; one of the four fundamental economic questions that every society must answer. -production technology: a blueprint or method for transforming inputs into outputs -for whom or distribution question: asks who will receive the various goods and services that are produced; one of the four fundamental economic questions that every society must answer. -now versus the future question: asks whether the society will favor the current generation over future generations, or the reverse; one of the four fundamental economic questions that every society must answer -production possibilities: the economy’s capacity for producing goods and services, assuming that it produces them efficiently -production possibilities frontier: a graphical representation of the economy’s capacity for producing goods and services, assuming that it produces them efficiently ♥demand pull inflation: price inflation resulting from the attempt to purchase more goods and services than the economy is capable of producing. -long run economic growth: a persistent increase in the economy’s potential for producing goods and services -labor force participation: the percentage of the population that joins the labor force -capital: the amount of plant and equipment in place at a given time in private businesses and government run enterprises, plus buildings used as residences. The non- residential capital is most directly relevant to economic growth. -investment: a flow variable that refers to the increase in the stock of capital during the year -flow variable: a variable that can be measured only with reference to a period of time -stock variable: a variable that can be measured at a given point in time -labor productivity: the amount of output produced per worker -investment in human capital: expenditures on education, both formal education received in school and on-the-job training provided by business firms- may well be the single most important determinant of long-run economic growth -human capital: the market value of all accumulated knowledge and skills -economic system: the set of decision-making mechanisms, organizational arrangements, and rules for allocating society’s scarce resources and determining the appropriate distribution of income -centralized economy: an economic system in which an agency of the national government has authority over all economic decisions and full access to all relevant economic information -fully decentralized economy: an economic system in which individuals and business firms make all economic decisions and are responsible for generating and processing all relevant economic information -national economic plan: a plan developed by the central authority that sets national economic objectives regarding the four fundamental economic questions and instructs lower level decision-making units on how to carry out the plan -market: any institutional arrangement through which buyers and sellers engage in the voluntary exchange of goods, services, and factors of production -property rights: the ownership of the factors of production- property rights to land and capital may be private, public or cooperative (collective) -private ownership: the government owns the capital and land and receives all the income earned by these factors -public ownership: the government owns the capital and land and receives all the income earned by these factors- defining characteristic of socialism -socialism: an economic system with public ownership of capital and land -collective ownership: a variant of public ownership under which the property rights to capital and land are held collectively by the citizens who vote on how to use and distribute the earnings from these factors. -moral incentives: incentives that encourage behavior for the good of society and may be enforced with legal sanctions -material incentives: incentives that appeal to economic self-interest by allowing individuals and business firms to keep the gains from their exchanges -pure market capitalism: an economic system characterized by fully decentralized decision making, the use of markets to process economic information and coordinated exchange, private ownership of capital and land, and the use of material incentives. -centrally planned socialism: an economic system characterized by centralized decision making, the use of a national economic plan to process information and coordinate exchange, public ownership of capital and land, and the use of both moral and material incentives Summary: Chapter 3 began with a discussion of society’s economic problem, consisting of objectives, alternatives, and constraints. The economic objectives of a humanistic society are efficiency and equity. Economists express the alternatives as four fundamental economic questions that all societies must answer. These questions also incorporate the objectives of efficiency and equity. The What or Output question: What goods and services will society produce and in what amounts? The How or Input question: How will firms produce each of the goods and services: what factors of production and production technologies should they use? The For Whom or Distribution question: Who will receive the goods and services? The Now versus the Future question: Will society favor the current generation at the expense of future generations, or vice versa? This is the question of long-run economic growth. The constraints that ultimately limit how well of a society can be consist of the quantity and quality of the nation’s resources and the production technologies available for turning inputs into outputs. The production possibilities frontier is a two-dimensional diagram representing the constraints of society’s economic problem. The frontier shows the combinations of goods and services that the society is potentially able to produce, assuming that production is efficient. An economy operates under its production possibilities frontier if its resources are either misallocated or unused. No society can operate beyond its frontier. The production possibilities frontier exhibits increasing opportunity cost services. Increasing opportunity cost means that producing more of one output requires ever-increasing sacrifices of the other output. The second section of the chapter described the process of long-run economic growth. Long-run economic growth refers to persistent increases in the potential of an economy to produce goods and services. It is represented as a continuing shift of the production possibilities frontier away from the origin. Long-run economic growth requires a change in the quantity of quality of a nation’s resources or the introduction of new production technologies. Investment in physical and human capital (education) is the key to economic growth because it meets all three requirements for growth. Capital is an important factor of production, new capital tends to make all factors of production more productive, and new production technologies are usually embodied in new capital. The opportunity cost of growth is that more investment comes at the expense of consumption. The sacrifice of consumption is very costly for poor countries. The final section of Chapter 3 discussed society’s choice of an economic system to solve the economic problem. The four principal characteristics of an economic system that determine how an economy performs are the delegation of the decision-making authority, the way in which economic information is processed and coordinated, the ownership of capital and land, and the incentives used to encourage consumers and producers to pursue society’s objectives. Pure market capitalism and centrally planned socialism are stylized economic systems that lie at the endpoints of the spectrum of economic systems. All real world economies are blends of these two systems. Pure market capitalism decentralized the decision-making authority to individuals and business firms, uses markets and prices to process and coordinate economic information, allows private ownership of capital and land, and relies entirely on material incentives. Its principal strengths are individual freedom, responsiveness to consumers’ desires, and efficiency in the allocation of scarce resources. Centrally planned socialism centralized the decision making authority in an agency of the national government, used a national plan to process and coordinate economic information, has public ownership of capital and land, and relies on both material and moral incentives. Its principal strengths are the ability to formulate and pursue national objectives, a fairly equal distribution of income, and a virtual guarantee of full employment. In 1989 seven Eastern European countries (Bulgaria, Czechoslovakia, East Germany, Hungary, Poland, Romania, and Yugoslavia) announced that they were going to transform their economies. They would replace systems designed along the lines of centrally planned socialism with systems designed along the lines of pure market capitalism. The Soviet Union broke apart shortly thereafter and followed them in this experiment. The transition has proved difficult as these countries face a number of obstacles in transforming their economies. Most of the states of former Soviet Union suffered huge economic losses in the 1990s.