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The Functions of An Economic
System
These Functions Must Be
Performed Regardless of the
Type of Economic System
Practiced
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Determine WHAT to Produce,
and HOW MUCH
uOnly those commodities for which
consumers are willing to pay a price
per unit sufficiently high enough to
cover at least the full cost of
production will be supplied by
producers in the long run.
(Cost Curves)
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Determine WHAT to Produce,
and HOW MUCH
u By offering a higher price, consumers
can normally induce producers to
increase the quantity of a commodity
that they will supply per unit of time.
(The SUPPLY Curve)
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Organize the Production Process
How are we going to produce ?
uRefers to the choice of the
combination of resources and the
particular technique to use
(technology) in producing a good or
service. (Production Function)
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Organize the Production Process
uA good or service can normally
be produced with different input
combinations, and different
techniques (technology).
(Factor Substitution)
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Organize the Production Process
BASIC PROBLEMS:
uWhich inputs, and which
technology do we use?
uWhat quantity of the different
inputs do we use?
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Organize the Production Process
Alternative Technologies Must be
Evaluated
T1 T2 T3
Where Tx are alternative production
technologies
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Organize the Production Process
Price reflects Quality of output from technology
P output x Q output = Total Revenue
T1Q land x P land = Cost landQ capital x P capital = Cost capitalQ labor x P labor = Cost labor
Q mgmt x P mgmt = Cost mgmt.
Total Cost of T1
Each alternative technology must be evaluated to determine the profitmaximizing technology. First we must determine the quantity and quality ofoutput that will be produced by each technology. The quality of the outputwill affect the price we can sell the output for in the market place. Price of
output multiplied by the quantity of output determines the total revenue thatcan be derived from the technology.
Next, we must determine the cost of producing the output. We must determinethe cost of each input (land, labor, capital, mgmt.) and sum them together to
determine production cost.
To determine profitability, we subtract total cost from total revenue.
We would do this for each technology, then choose the technology that resultsin the highest profit. What we have done here is a simple budgeting exercise.
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Organize the Production Process
In other words, what combination
of available resources and
technology will produce a given
commodity for the the greatest
profit ?
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Organize the Production Process
For Example:
You want to control downy mildew (blue
mold) on your crop.
What combination of resources and
technology will get you the control
necessary to minimize crop losses for the
least possible cost ?
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Organize the Production Process
1.Choose a resistant variety or cultivar.
Cost? Vigor?
2.Control environment to minimize
incidence and spread.
Cost? Relative risk of disease?
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Organize the Production Process
3. Utilize a fungicide spray program.
Preventative or reactive?
Which fungicide?
Application cost?
Timing of application?
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N.C.S.U. Blue Mold Forecast
http://www.ces.ncsu.edu/depts/pp/bluemold/
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Organize the Production Process
Since resources are limited in every
economy, when more of them are used to
produce certain goods and services,
Less resources are left to produce
other goods and services.
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Organize the Production Process
Therefore, there is a problem of choosing
the technique (Technology) which results
in the least possible cost
(in terms of resources used)
to produce each unit of the good or service
society wants.
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Organize the Production Process
This problem is solved by the price
mechanism.
u The price of an input normally
represents its relative scarcity.
u The best technique to use in the
production process is the one that results
in the least cost of production c.p.
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u If the price of an input increases in
relation to the price of other inputs used
in the production of a commodity,
u producers will switch to a technique
which uses less of the more expensive
input in order to minimize their costs of
production.
Organize the Production Process
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Organize the Production Process
For Example:
u fuel prices increase----- minimum tillage
practices,
u corn prices increase----- shift to wheat in feed
u landscape maintenance labor price increases
-------wider mower decks ------ dwarf turf
u greenhouse labor price increases
-----automated watering
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Organize the Production Process
u The opposite will occur when the relative
price of an input decreases.
(Factor Substitution)
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Distribute Resources, Commodities
and Proceeds from Production
1.The price mechanism solves this problem
also.
a. Resources are distributed to producers
who have the money to pay for them.
b. Commodities are distributed to
consumers who have the money to pay
for them.
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Distribute Resources, Commodities
and Proceeds from Production
c. Proceeds are paid to producers for
commodities efficiently provided.
d. Proceeds are paid to consumers for
resources provided.
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Distribute Resources, Commodities
and Proceeds from Production
2.This is where government usually pokes
its nose in to provide for "equitable
distribution."
a. Tax wealthy individuals and business
enterprises, redistribute the funds to
the poor (subsidies).
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Distribute Resources, Commodities
and Proceeds from Production
b. Tax in order to provide certain
"public goods & quasi-public goods
e.g. Public education, national defense,
law and order, Ag. Extension
service, Ag. commodity programs.
NOTE: A, B, and C involve Resource
Allocation.
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Provide for Maintenance and
Growth of the System
1.Accomplished by providing for the
replacement of the machinery, buildings,
etc., that are used up in the course of
producing the current outputs. (ARF)
2. In a free enterprise economy, output
prices are usually high enough to allow
producers to cover their day to dayproduction expenditures, and also allow
for depreciation of capital goods.
ARF stand for Asset Replacement Fund. AnAsset Replacement Fundis used by businessowners to save money for the replacement of worn out capital goods. Business ownersshould place a certain amount of money in their Asset Replacement Fund each year. Theirgoal is to accumulate enough money in their Asset Replacement Fund to be able to buy
new capital goods when the old ones wear out. The money that is put in an AssetReplacement Fund comes from the profits of the business. How much money should beput into this fund each year? In the simplest case, the amount of money that you should putin an Asset Replacement Fund is equal to the annual, straight-line depreciation. Annualdepreciation is the decrease in the value of machinery or equipment due to age, wear,obsolescence, and market conditions.
Assume we have purchased a used front-end loader with back hoe for $22,000. We expectthis machine to have a remaining useful life of ten years, and at the end of that ten year lifeit will have a salvage value of $2,000. We calculate depreciation as follows:
(Cost - Salvage Value) / Useful Life =
($22,000 - $2,000) / 10 years = $2,000 per year
This is the amount you should pull out of the profits from the business each year and placein your ARF so that you will be better able to replace this machine when it is wore out.Depreciation is a deductible, non-cash expense for income tax purposes. If you are in the28% federal income tax bracket and the 7% state income tax bracket (35% total), youwould save $2,000 x .35 = $700 in income taxes due to this deduction. Therefore, pulling$1,300 from profits and applying the $700 tax savings will generate the $2,000 required forthe ARF.
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Provide for Maintenance and
Growth of the System
3.Economic growth refers to increases in
real per capita income or GDP.
The economy's rate of economic growth
depends on the rate of growth of its
resources, and on the rate of
improvement in its techniques of
production or technology.
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Provide for Maintenance and
Growth of the System
a.In a free enterprise economy, the price
mechanism to a large extent determines
the rate of economic growth.
i.e. Prospect of higher wages motivates
labor to acquire more skills. This is
why you are probably here.
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Provide for Maintenance and
Growth of the System
b. Expectations of profit stimulates
technological improvements.
This is the driving force behind computer
research, biological engineering, and
DNA recombination,
the search for a cure for AIDS, cancer,
etc.
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Provide for Maintenance and
Growth of the System
4. Governments often use tax incentives
and subsidies, and sponsor basic
research to stimulate economic growth.
5. Government allows legal monopolies
through the Patent System.
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Provide for Maintenance and
Growth of the System
Will the U.S. get any more LAND
resources?
Can the U.S. get more CAPITAL?
Yes, we can build more capital
We can improve efficiency (productivity) ofcapital
P.E. = units of output / units of input
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Provide for Maintenance and
Growth of the System
Can we get more LABOR?
U.S. population is growing less than 1% per
year through natural increases and
immigration
Can we get more PRODUCTIVE LABOR?
Yes, it is developed through education anddevelopment of skills. (increasing ~ 1.5%
per year)
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Provide for Maintenance and
Growth of the System
Can we get more ENTREPRENEURIAL
TALENT?
Yes, it is developed through education and
experience !!!
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Rationing
Restrict consumption to the supply ofresources and commodities available
over time
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Rationing
1.System must first restrict the total level
of consumption to the total available
output.
2.Second, the system must restrict the
CURRENT level of consumption so that
the commodity will last for the entire
time period over which its supply is fixed.
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Rationing
e.g. Corn, wheat, soybeans, redtips,
poinsettias, etc.
3.Rationing is made possible by the ability
of prices to respond to changes in
consumption and production levels.
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Rationing Process
What to Produce?
Consumers Producers
Distribution
FinancialPhysical
Organize Prodtn.
Process
Maint. & Growth
Functions of Any Economic System
Above you see the five functions of any economic system illustrated above.What are all those arrows up there relating to?
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Rationing Process
What to Produce?
Consumers Producers
Distribution
FinancialPhysical
Organize Prodtn.
Process
Maint. & Growth
Functions of Any Economic SystemPayments for G&S
and Consumer Sovereignty
In a capitalist economy, consumers determine what is produced throughconsumer sovereignty. Therefore the arrow from consumers to the What toproduce function illustrates the payments that consumers make for goods andservices. Remember that only those goods and services that can be sold for a
price greater than or equal to their cost of production will survive in the marketplace over the long run.
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Rationing Process
What to Produce?
Consumers Producers
Distribution
FinancialPhysical
Organize Prodtn.
Process
Maint. & Growth
Functions of Any Economic SystemReceipts for G&S
sold to consumers
This arrow represents the receipts producers receive from goods and servicessold to consumers. A consumers expenditure becomes a producers receipt.
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Rationing Process
What to Produce?
Consumers Producers
Distribution
FinancialPhysical
Organize Prodtn.
Process
Maint. & Growth
Functions of Any Economic System
Information
Flows betweenconsumers and
producers
Information
Flows betweenconsumers and
producers
These are the information flows between consumers and producers. Themarket in capitalism is the rationing process. The market is where consumersand producers talk to each other and negotiate the prices for goods andservices.
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Rationing Process
What to Produce?
Consumers Producers
Distribution
FinancialPhysical
Organize Prodtn.
Process
Maint. & Growth
Functions of Any Economic System
Resource flows from
consumers to producer
Resource flows from
consumers to producer
Before a producer can start to produce a good or service, we know that theproducer must acquire resources. In capitalism, the producer obtains thoseresources form consumers who privately own the resources (land, capital,labor, and management). These resources flow through a physical distribution
system. When you own a piece of land and desire to sell it, where would youtypically look for help? Yes, a real estate agency. The real estate agency willhelp facilitate matching buyers and sellers and assist in the transfer of landfrom one party to the next. What is an employment agency? What are thewant ads in a newspaper? What is the CALS Career Planning andPlacement Center? These are all labor distribution mechanisms. What is aJohn Deere machinery and equipment dealer? A capital distribution center.
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Rationing Process
What to Produce?
Consumers Producers
Distribution
FinancialPhysical
Organize Prodtn.
Process
Maint. & Growth
Functions of Any Economic System
Payment to consumers
for the resources
provided
Payment to consumers
for the resources
provided
When owners of resources sell those resources, we know they receive apayment. Most payments go through the financial distribution system. Whenproducers buy resources from consumers, a payment is made. Often thatpayment is made with a check. Where does the consumer go to transform that
check into MONEY? Right, the bank, a financial distribution system. Whenyou are paid for an honest weeks work, you receive a check that you usuallytake to the bank and deposit or cash. When you are a little short of funds, thebank can often provide you a loan to tide you over. How do corporations raisemoney to conduct their business? They can sell company stock in the stockmarket. Again, a financial distribution system.
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Rationing Process
What to Produce?
Consumers Producers
Distribution
FinancialPhysical
Organize Prodtn.
Process
Maint. & Growth
Functions of Any Economic System
G&S purchased by
consumers from producers
G&S provided by
producers for consumers
Once the producer has acquired and paid for the resources necessary forproduction, production begins. Well, how do all those goods and services getfrom the producer to the consumer? Well, they usually go through a physicaldistribution system. What are all the interstates, state highways, county roads,
and paths on a road map? Part of the physical distribution system. What areall those tractor-trailers doing riding up and down all those interstates, statehighways, county roads and paths? They are physically moving goods fromone geographical location to another. What is a WalMart, Kmart, Sears, orCVS pharmacy? They are physical distribution centers! They are where youand I go to get our goods and services.
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Rationing Process
What to Produce?
Consumers Producers
Distribution
FinancialPhysical
Organize Prodtn.
Process
Maint. & Growth
Functions of Any Economic System
Producers are responsiblefor in capitalism
Producers are responsible
for in capitalism
In a capitalistic society, producers are responsible for organizing theproduction process, and for maintaining the economy as well as for helping theeconomy grow by developing new technology that will enhance productivity.
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