A premier source of classroom tested, Internet-based economic lesson materials for K-12 teachers and their students
CyberTeach
Frequently Asked Questions—Part 1
By : Lynn Huselton
Plano East Senior High
Plano, TX
Q.What is capital?
A.There are two types of capital, one being financial capital, which is the transfer of ownership of assets called stocks and bonds. With financial capital there is no new good produced. When economists discuss the factors of production, land, labor, capital and entrepreneurs, the capital they are referring to is real capital. This is the second type of capital. Real capital is the production of tools, machines and factories. When entrepreneurs purchase new machines, tools or factories, they are adding to what is known as the capital stock of the economy. This makes it possible for that economy to now push its production possibilities curve outward to the right. This is known as economic growth. The economy can now have more consumer goods and more capital goods. Thus when discussing the purchase of real capital, economists speak of business investment; Investment meaning a country's production of new real capital goods that will allow growth for that economy.
Q.Doesn't scarcity simply mean that a good is in short supply?
A.Scarcity in economic terms is a little more complicated. Scarcity results because natural resources, human resources and capital resources are not available in sufficient quantity to satisfy all wants for them. In other words resources are limited and wants are unlimited. Only "free goods" like air are in most cases not scarce. For example, with production choices come decisions concerning what to produce from a particular natural resource. If the choice is made to produce paper for textbooks from a stand of trees, then no other product can be produced from that particular stand of timber. Yet, many other products are desired. Thus an opportunity cost decision must be made. That means that the next best alternative good cannot be produced. Therefore economic resources are scarce.
Q.What is opportunity cost of production?
A.Opportunity cost is a result of scarcity. Because resources are scarce, producers making decisions to produce a certain good sacrifice the next best alternative good that could be produced with that resource. The good given up is the opportunity cost. This might be better understood by students when viewing the hungry student's choices concerning the purchase of an after school snack from a vending machine. Assume that the student has $1 and the cost of the drink is $1. The cost of a candy bar is also $1. The student can have a drink or a candy bar. He can't have both. By choosing the drink, the student has given up the chance to have a candy bar. The real cost of the drink was the candy bar he could not purchase. The same is true of the decisions made concerning production with scarce resources. There is always a next best alternative good sacrificed. In other words, there is always an opportunity cost decision made when production choices are determined.
Q.Why is profit a cost of production?
A.More than one half of all new companies fail in their first two years. Entrepreneurs starting new companies take great risk with their financial investment as well as their time. Profit is the income earned by the entrepreneur. If a person chooses to remain an employee throughout his career and not take the risk of starting a business, he cannot earn the profit that is the reward for his bearing risk.
Q.Why must a country give up consumer goods in order to produce more capital goods?
A.This is best understood by looking at a Production Possibilities Frontier.
If a country is producing at any point along its production possibilities curve X1 to X2 on such as points A or B, it is using all of its resources efficiently and completely. In other words there are no idle machines, no unemployed labor, no empty factories. Suppose that this country is currently producing at point B on curve X1 to X2. If this country wanted to reach point C, lying along curve Y1 to Y2 which is outside its current production possibilities, it would need to either create new technology, develop new resources or engage in international trade. If the country chooses to develop new resources it could move to point A. In doing so the country would have to move labor, machines and factories from the production of consumer goods into the production of capital goods (new resources). Thus the country would have to give up the current level of production of consumer goods in order to produce more capital goods, enabling the later production of both more consumer and more capital goods at a point like C.
