Chapter 2 microeconmics provisioning

Allocation and Provisioning

I Introduction to the Economic Problem
Finite resources
and a given
technology
combined with
“unlimited” wants
results in scarcity
The allocative
question is how to
allocate scarce
resources to
maximize the
satisfaction of
wants
Economics as a
study of
provisioning deals
with the nature of
wants, the social
institutions and
technology as well
as the allocation
problem.

S

ociety is confronted with a finite set of resources and a given state of
technology at any given point in time. As a result, there is a finite
amount of goods and services that can be produced in that time frame.
Given human desires and need for food, clothing and shelter, it is not
always possible to produce everything that everyone would like to have.
When individuals want more than can be produced, the most obvious
question is: “How can relatively scarce recourses be allocated to satisfy as
many unlimited wants as possible?” This question is the basis for orthodox
microeconomics.

Provisioning is process that by which individuals in societies provide
themselves with the means for survival and betterment. From this
perspective, many other questions may be addressed. What is the nature of
wants? What forces shape individual wants? Are these wants consistent
with community values? What are the alternative social mechanisms that
individuals may use to allocate resources? To what extent do moral values
guide the allocative process? What social institutions are necessary for
different allocative mechanisms to function? Which allocative mechanisms
are most appropriate for specific allocation tasks? What forces determine
what we define as resources or inputs? What is the nature of resources or
inputs? What is the nature of technology and what is its role in the
economic system? Do changes in technology influence social institutions?
To what extent do social institutions influence technology? The answers to
these and other questions provide the background to help frame the
question and answers about optimal allocation.
The questions about allocation and provisioning are interrelated. It is possible
to address the allocation problem without making the provisioning problem
explicit. A particular set of social institutions, property rights, income
distribution and other circumstances may be taken as given and not made
explicit. It is not possible to deal with the questions about provisioning
without dealing with the allocation problem.

Individuals and
societies try to
solve the scarcity
problem through
social interaction
and knowledge.

Every society faces the problems of allocation and provisioning. There are
two broad approaches to these economic problems: social interaction and
the advancement of knowledge.
Individuals acting together can often accomplish more than when they act
alone. This is one of the reasons that humans are social. They work
together in groups, tribes, firms or other organizational forms for protection
and producing the means of sustenance.
Knowledge about how the natural and built environments can be manipulated

© R. Larry Reynolds 2005

Alternative Microeconomics – Part 1, Chapter 2 – Problem of Provisioning

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to satisfy wants is another way to minimize the scarcity problem.
Propositional knowledge is knowledge or beliefs about natural phenomena:
knowledge about the basic nature of things. Propositional knowledge
provides the basis for instructional or prescriptive knowledge. (Mokyr, pp 46) Technology or prescriptive knowledge is a set of instructions to about
how to use resources to attain objectives. Advances in knowledge improve
the techniques by which individuals seek to achieve objectives. The process
by which societies acquire knowledge and adapt it to their use is an
important part of the both the allocation and provisioning processes.

II The Allocation Problem
The allocation
problem can be
addressed by;
1) Increasing the
output
2) altering the mix
of goods produced
3) altering wants
and preferences.

T

here are three possible approaches to the narrow allocation problem.
First, an increase in the output of goods and services is the most
simplistic and most obvious answer. A second approach is to alter the mix
(relative amounts) of goods and services produced, so that more highly
valued goods are produced by reducing the output of lower valued goods. A
third strategy would be to alter or reduce individuals’ wants.

In modern, neoclassical, economic analysis (we will call this “orthodox”
economics), the problem is usually structured so the wants are taken as
given and the problem is to produce the goods that satisfy the greatest
wants. The line of reasoning follows:
•

The objective or goal of society is to maximize utility (welfare or
wellbeing) of the members of society;

This can be expressed as a mathematical statement, US = f(UA, UB, . . . , UN)
Where US represents the total utility of society, UA is the utility of individual A (Adam), UB
is the utility of individual B (Barbara) and UN is the utility of the Nth individual. “The utility
of society is a function (f) of the utilities of the individuals.”

•

The utility of society is the sum of the individuals’ utilities.

If the welfare of the community (US) is the sum of the individuals’ utility we can be more specific:
US = UA + UB + . . . +UN “the welfare or utility of society is the sum of the utility
obtained by each individual.” If the individuals’ utility functions are interdependent (my
welfare or utility is affected by your utility), the utilities cannot be summed.

•

Each person’s utility is a function of the quantity of goods and services
consumed.

Where QXA is the amount of Xebecs (good X) and QYA is the amount of Yawls (good Y) received by
individual A (Adam). (QiA is the ith good received by Adam), then Adam’s preferences (tastes or
utility function) can be expressed:

UA = fA(QXA, QYA, . . . QiA)

Barbra’s utility function could be expressed: UB = fB(QXB, QYB, . . . QiB)
The utility of the Nth individual would be UN = fn(QXN, QYN, . . . QiN)
And the output of good X would be QX = QXA+QXB+ . . . +QiN

•


Since the utility or welfare of the community is a function of the
welfare of the individuals and the utility of the individuals is a function
of the goods they consume, the utility of the community is a function
of the quantity of goods and services available: more is preferred to


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less. The more goods and services available, the greater the welfare of
society: US = f(QX +QY +. . . +Qi)
This chain of reasoning assumes that the utility of an individual is determined
by the goods consumed. Aesthetics, personal relationships, health, security
and other variables are not explicitly included in the orthodox model. A
study of provisioning would include non-market values. The orthodox line of
reasoning also leads to the conclusion that economic growth is a major goal
for macroeconomic policies. A few years ago, a popular T-shirt slogan
expressed this idea; “He who dies with the most toys WINS”
A less obvious set of conclusions is that the welfare of society as measured
by US can be altered by changing the relative amounts of the goods
produced or by altering the relative amounts of each good that each person
receives.
Ceteris Paribus
is used to indicate
that there are
implicit variables
that are to be held
constant.

Opportunity cost
is the value of the
best alternative
that is given up or
sacrificed when a
choice is made

The economist uses the concept of ceteris paribus to deal with the
problem. Ceteris paribus is a Latin expression which notifies the reader that
there are other things to consider but they will not be changed and remain
implicit so that we can focus on the relationship described.
The second approach is to increase the output of goods that individuals value
most and reduce the output of goods that are less desirable. Scarcity
requires that the individual or agent make choices about which goods to
produce. If resources are fully employed and the best technology is used,
increased production of one good (Xebecs, QX) requires a reduction in the
production of some other good (Yawls, QY). The sacrifice of the reduced
production of Yawls is the opportunity cost of the additional amount of
Xebecs. Opportunity cost is one of the major tools used to make decisions
about what and how much to produce.
The third approach is to alter the nature and level of wants. One approach to
the good life is to simplify one’s desires and possessions. By eliminating the
extraneous or superfluous goods in their lives, an individual can appreciate
more fully the important things or aesthetics. Religious groups often take
this approach. St. Francis of Assisi and Buddhist monks shared a desire for
a more meaningful life by reducing wants or desires for material
possessions. In the secular, industrialized world, this approach is not often
mentioned.

ALLOCATIVE MECHANISMS
The allocative process requires that rights to control and use
Property rights define
the rights of an
individual or group to
specify the control or
use of a good or
resource.

resources and goods be defined and enforced. The concept of
property rights is multifaceted and will be described in more detail
later in the text. For current purposes, property rights will be
described as the right to control the use of a good or resource. If
these property rights are held by individuals, they are called
private property rights. Organizations, governments, corporations
and other institutions may hold property rights. In some cases,
such as air, property rights may be held in common; these are
called common property rights. For an economic system to
function, it is necessary that property rights be defined and
enforced whether they are private, public or common property
rights.

Society must devise a process by which the control and use of



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resources and goods can be assigned to an agent who controls its
use. An agent is an individual who has the authority to evaluate,
select, and act on an alternative to achieve an end.
Allocative mechanisms
are the methods by
which societies to shift
the property rights to
different uses.

Exchange is a quid
pro quo; the terms of
the transfer of
property rights is
clearly specified. A
specific property right
is traded or exchanged
for another specific
property right, the
terms of trade are
known to both parties.

Reciprocity is a
system of obligatory
gifts. A gift from one
individual to another
establishes an
obligation for the
recipient to do
something for the
other individual.

Eminent domain is
an assignment of
property rights by an
authority..

Philanthropy is a
transfer of property
rights with nothing
expected in return.


The process of assigning and enforcing property rights to goods and
resources is a social process. If the allocative problem is to allocate
resources to maximize the utility of the community then the
property rights should be assigned to the agents who get the most
utility from them. It is necessary for society to devise allocative
mechanisms to facilitate the assignment of property rights to
different agents and uses. There are a number of allocative
mechanisms, these include; exchange, reciprocity, eminent
domain, philanthropy, inheritance and theft.
EXCHANGE
Exchange involves a quid pro quo, i.e. an exchange of private
property rights between individual agents. The terms of the
exchange are clearly specified: “I will give you this if you will give
me that.” The goods to be exchanged are clearly specified, as are
the terms of the exchange.
The participants in the exchange do not need to know each other;
they only need to know the terms of the exchange. The information
requirements are quite low. In many cases, the exchange may be
made easier by social institutions. Laws that protect buyers and
sellers may facilitate the exchange. Trust may be an important
element as well.
RECIPROCITY
Reciprocity is a system of obligatory gift giving: I will do you a favor
or give you a gift, but you are then obligated to do an unspecified
favor or give me a gift at some (possibly unspecified) point in the
future.
Reciprocity requires a sense of community. Kinship ties or
membership in the community is needed so that the obligation of
returning a favor is enforced by social forces. If a friend helped you
move apartments one weekend and then helped you fix your car
the next weekend, your refusal to help that person at some point
in the future would have social repercussions. The friends you have
in common might come to regard you as a freeloader. Social
pressure may induce you to return the favor.
EMINENT DOMAIN
Eminent domain is a redistribution of private property rights through
the authority of some organization. The individual is required to
give up their claims to private property by an authority. Usually the
process of eminent domain is legitimized by government, religion
or some other authority.
PHILANTHROPY
The act of giving a gift with nothing expected in return is called
philanthropy. This is an important method of distribution in blood
drives and the donation of organs for transplantation.


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Inheritance is the
transfer of property
rights from a deceased
person to an agent.
Theft is the
illegitimate transfer of
property rights.

INHERITANCE AND THEFT
Inheritance is the process transferring private property rights from a
person who has died to an agent. The form that the inheritance
laws take may greatly influence the accumulation of wealth in a
society. In countries where primogeniture (the eldest son inherits
the estate) is practiced, the size of land holdings may be
maintained. Where the property is divided among all surviving
children, the land holdings may be divided up into smaller and
smaller units.

Theft is the process of transferring property rights by illegitimate
force. Few societies can function if theft is widely used.

These allocative mechanisms appear in almost all societies to a greater or
lesser degree. The relative emphasis that a society places on each of these
mechanisms is an important characteristic of that society’s economic
system. The allocative mechanism used for specific goods and resources
may alter their nature.

III Provisioning

E

conomics as a provisioning problem includes the allocation problem but
includes and analysis of the social infrastructure, knowledge and
ideological framework in which economic behavior occurs. Individuals
pursue their objectives in a social context. The values, beliefs and ideology
that influence economic choices are framed by society. What individuals
believe and value is an input into their preferences and the process by
which they make choices.

The origin and
nature of
knowledge is
related to the
economic
functions in a
society.
Social values and
beliefs may
influence the uses
of knowledge in
economic
activities.

The infrastructure
provides a
foundation for
individual
economic
activities.

Knowledge is seldom acquired as an individual effort in isolation. There is a
common body of knowledge that each person accepts (or rejects) and
builds upon. The origins and nature of knowledge greatly influences the
economic functions of a society. Science and technology determine the
known feasible alternatives that compose the choice set.
The social values often promote or restrain the uses of knowledge. Religious
and moral beliefs may alter the way in which knowledge is used. Max
Weber (The Protestant Ethic and the Spirit of Capitalism, 1904-05) and
Robert Tawney (Religion and the Rise of Capitalism, 1926) both hypothesize
that the rise of the capitalist system was predicated on protestant beliefs.
These works have been controversial and the role of religion in the
operation of economies is not accepted by everyone.
Each individual is influenced by the infrastructure of society. Roads, books,
tools, telephones, the Internet, the legal system, property rights, double
entry bookkeeping, dams, energy plants and distribution systems are
examples elements of the infrastructure which facilitates individual effort.
What may appear as a major individual accomplishment is often one step in
a social process. Wrights’ powered flight depended on the existence of
internal combustion engines, bicycles, fabric, gliders, metallurgy, and a
host of other items. The flight of the Wright Brothers contributed to landing
on the moon and the thousands of commercial flights each day.

THE ROBINSON CRUSOE EXAMPLE
Many early economists used Robinson Crusoe as an example of the
allocation problem. The story of Robinson Crusoe


(1719)

was written by an


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Robison Crusoe
was the sailor who
was marooned on a
desert island. He
had to make
choices about what
goods should be
salvaged from the
shipwreck and was
then confronted
with choices about
how to live.

Robinson Crusoe
began his stay on
the island with the
tools and
knowledge of the
English society..

Opportunity cost
is one of the
criteria that
guides Crusoe’s
economic
behavior.

Englishman, Daniel Defoe (1659-1731). It is the story of a young man who
was born in York, England. He was educated to enter the law profession but
yearned to go to sea. Against the advice of his family, he went to sea, was
successful in trading but was captured by a Turkish ship and made a slave.
Crusoe escaped in a stolen boat, was rescued by a Portuguese ship and
ultimately became a plantation owner. Seeking another adventure, he was
shipwrecked on a desert island in 1659. Defoe’s story is that of survival and
isolation. Robinson Crusoe was confronted with the problems of allocation
and provisioning.
As an individual in isolation (Defoe’s Robinson Crusoe before Friday) would
have to make choices since time and resources are limited. His first set of
choices is what to salvage from the wrecked ship. Guns, powder,
carpenter’s tools, paper and ink are valued more highly than money. It is
these things, not money that will allow Crusoe to provide for himself. His
choice about which things to salvage (he cannot get all of the resources of
the ship to shore on makeshift rafts) is partly an allocation problem and
partly provisioning. The natives of the neighboring islands have different
beliefs, values and infrastructure (tools, knowledge, etc). They have a
different social structure and their approach to provisioning and the
allocation problem is different. The allocation choices they make are not the
same as those made by Crusoe. His English education, beliefs, training as a
sailor and the tools he saved are part of his provisioning process; he
salvaged a good deal of the infrastructure of the British society.
Once ashore and the ship washed out to sea, it became necessary to choose
whether time was to be spent catching fish, gathering coconuts, reading or
building shelter. These choices are shaped by the tools and knowledge he
brought to the island. If the choice were to catch fish, he would have to
choose between making a net, a fishing pole or trying to catch fish by hand.
The choice to spend an hour fishing implies that that hour cannot be used
to gather coconuts. The sacrifice of coconuts is called “opportunity cost.”
Even Robison Crusoe’s world of isolation did not last long. When Friday came
to the island, it became necessary to decide who did what and who got
what. It is necessary to coordinate the preferences and activities of Crusoe
and Friday. Since the story of Robinson Crusoe was written by an
Englishman, Daniel Defoe (1659-1731), Crusoe’s values are dominant and he
has a greater influence on the decisions than Friday. In 1719, the
perspective of an English writer was that aboriginals of various lands were
subordinate. Still, it is necessary to coordinate their activities.

SOCIAL INTERACTION
Individuals can often accomplish more by interacting than they can as
Social interaction
is constrained
and/or
coordinated by
both competition
and cooperation

individuals. In a society, this team or group behavior of individuals must be
coordinated through social interaction. This social interaction may take
many forms ranging from cooperation to competition. In the process of
resolving the allocation problem through social interaction, a set of
institutions, organizations, beliefs, principles, perspectives and commonly
held values are created. Society, guided by these values, perceptions and
beliefs and constrained by institutions, technology and resource
endowment, must solve the problem of provisioning. The specific uses of
goods and resources must be determined. These choices involve which
resources to use, which goods to produce, who will bear the costs and who



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will benefit.
The basic problem is the coordination of the choices and behavior of
individuals. The protection of the autonomy of the individual while
coordinating social behavior has been an important goal of most great
writers on social topics.

SPECIALIZATION
Specialization and
division of labour
can increase
production

When one person,
firm, or country
focuses on the
production of one
good, it has
“specialized”
Institutions are
habitual patterns
of behavior

Specialization and the division of labour are two important forms of social

interaction that allow two or more individuals to do what an isolated
individual cannot do. Both are means to increase the production of goods
and services.

Specialization is the case where an individual (firm, organization or country)
focuses on the production of a specific good (or group of goods). It can
increase the amount of goods that can be produced. It also requires some
form of social institution to coordinate the process. If one individual
produces food and the other clothing, the two individuals must interact if
both are to have food and clothing. This interaction may be facilitated
through an institution such as the market or a transfer based on kinship,
marriage, religion or government authority. Plato suggests that the citystate is a social construct that is used to facilitate specialization and to
improve the welfare of the members of that state.

Specialization
and justice in
Plato’s Republic

Specialization
requires social
interaction

In The Republic, Plato [427-347 B.C.] suggests specialization as an
explanation of the origins of the city-state. Plato describes a
conversation between Socrates and a group of students. They are
pondering the nature of justice. They conclude that justice is each
person doing that which they are best suited to do. The person
best suited to be a baker should be a baker; the person best suited
to be a shepherd should be a shepherd. Once individuals specialize,
the city-state arises to facilitate the transfer of goods and the
necessary interactions among the individuals. [The Republic, Book II]

Plato tries to identify the characteristics of the ideal society. One of the focal
points is justice that is achieved by “each person doing what they are best
suited to do.” Social interaction is required because each person depends
on the other members of the community. He devises a meritocracy that is
lead by philosopher kings. To prevent nepotism and greed from influencing
these philosopher kings, Plato does not allow the philosopher kings to hold
private property rights, all of their property is held in common.
David Ricardo (1772-1823), a classical economist formalized the concept of
comparative advantage as an argument for specialization and free trade
(and against the Corn Laws). He used an example of England and Portugal
producing wine and cloth. With equal amounts of labour Portugal can
produce more wine and cloth than can be produced in England. This may be
due to land (soil types, climate), tools (capital) or other factors. However,
Portugal can produce relatively more wine than cloth than England. When
England specializes in the production of cloth and Portugal the production of
wine, the same amounts of wine and cloth can be produced by the two
countries with less labour. The labour that is saved can be used to produce
more wine, cloth or other goods. Depending on how the additional goods
are distributed among the citizens of England and Portugal, some
individuals will be “better off” (have more goods) Ricardo did not address
the issue of how the gains from comparative advantage would be



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distributed. However, if the countries specialize, social interaction is
necessary. Free trade was the way in which Ricardo anticipated the benefits
from specialization would be distributed.

DIVISION OF LABOUR
The division of labour is another form of social interaction that allows
Division of labour
is the process of
breaking the
production
process into
individual steps.

individuals to do what the isolated person cannot. In the division of labour,
the production of a good is broken down into individual steps. One person
then performs one step in the process. No single person produces the good
alone. The actions of each individual in the production process must be
coordinated. In modern industrial societies, production often takes place in
a business firm. “Management” is the process of coordinating the activities
of the individuals within the production process. A specific application of
microeconomics to the process of production within a firm is called
“managerial economics.”

Division of
labour and
economic
growth in Smith

Adam Smith [1723-1790] in the Wealth of Nations proposes that the
division of labour is one of the major elements that contribute to
economic growth (the increased ability to produce goods and
services) [The Wealth of Nations, page 1]. The division of labour is the
process of dividing a task (work) into its component parts. Smith
argues that the division of labour increases production through
improved dexterity, saving time in moving from one task to
another and improvements in tools.
Smith cautions about the effects of unrestrained use of the division
of labour,

Smith’s concern
about ill effects
of specialization

"In the progress of the division of labour, the employment of the
far greater part of those who live by labour, that is, of the great
body of the people, comes to be confined to a few very simple
operations, frequently to one or two. But the understandings of the
greater part of men are necessarily formed by their ordinary
employments. The man whose whole life is spent in performing a
few simple operations, of which the effects too are, perhaps,
always the same, or very nearly the same, has no occasion to
exert his understanding, or to exercise his invention in finding out
expedients for removing difficulties which never occur. He naturally
loses, therefore, the habit of such exertion, and generally becomes
as stupid and ignorant as it is possible for a human creature to
become….But in every improved and civilized society this is the
state into which the labouring poor, that is the great body of the
people must necessarily fall, unless government takes some pains
to prevent it. [Smith, Wealth of Nations, p 734-735]

Smith, a professor of moral philosophy, constructed a system to explain a set
of forces that would guide social and economic behavior. In The Theory of
Moral Sentiments [1759] he showed the need for justice and a system of
morality. In An Inquiry into the Nature and Causes of the Wealth of Nations
[1776] he describes the role of self-interest and markets. In a third book
that was destroyed at his request at the time of his death, he describes the
need for a system of jurisprudence. Two sets of students’ notes have been
used to show these basic arguments in Lectures on Jurisprudence [1762-63
and 1766 published in 1978]. Smith describes a social system that requires
morality, markets and jurisprudence to guide and constrain individual



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action in a social context.
Coordination of
human activities
as an objective in
economics and
social science

Once humans use the division of labour and specialization, it is necessary for
them to coordinate their efforts. They must interact on a variety of levels.
Society is a complex set of interactions among groups and individuals.
These interactions give rise to social institutions. The study of these
interactions and institutions is “social science.” Human interaction can be
studied from a variety of perspectives. Sociology, political science, law,
history, psychology, religion, anthropology and economics are examples of
social sciences. These are often studied as separate disciplines. However,
we should remain aware they are all interrelated perceptions of human
behavior. While economics specializes in the study of the processes that
coordinate human behavior as it allocates scarce resources to satisfy
unlimited wants, its relationship to other social sciences should not be
overlooked.

IV Economic Activities

P

roduction, distribution and consumption are clearly economic activities.
Each of these activities is interrelated with other aspects of society as
well as the natural and built environments.

It may be helpful to think of an economic system as a process that begins
with a set of inputs (or resources) that are used for production that must be
distributed for ultimate consumption.
Input or
Resources
[Land, labour,

Consumption

capital and
entrepreneurial
ability or
energy, matter,
time and tech]

Production

Distribution
or Allocation

The ability of
goods and
services to satisfy
wants is called
“utility.”

Figure I.1

In Figure I.1, the economy is shown as a process of altering a set of inputs to
satisfy individual wants. In this example, the steps in the economic process
are production, distribution and consumption.

INPUTS OR RESOURCES
The economic process begins with a set of inputs. These inputs are often
referred to as resources or “factors of production.” Typically, these
resources are classified as labour, capital, land, and entrepreneurial ability.
This taxonomy reflects the evolution of the social structure in the industrial
economies. During the medieval era (500-1500 by many accounts but there is no
consensus as to exact dates), there were three major social classes; serfs,
nobility and the clergy. The serfs provided labour. The nobility and clergy
were the landholders. Labour and land were the two major inputs. After the
Crusades (1095-1270), trade became more widespread and a merchant class
developed. It took time to go to the East to acquire goods (spices, silk and
the like), bring them back and exchange them for money. The merchants
were the beginning of the commercial class. With the development of
manufacturing, the commercial class expanded and was characterized by
their ownership of the means of production, capital. Textiles, pottery,
printing books and a host of industries moved from the home to the
factory. This social class of the owners and manufacturers became the



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capitalists.
Land, labour and capital reflected the social classes. The fourth factor of
production, entrepreneurial ability was added much later. The return to land
was called rent. Labour earned wages and capital (at least until
entrepreneurial ability was added as the fourth factor of production) earned
profit and interest. Entrepreneurial ability was added to explain the
existence of profits.
Land is a “gift of
nature.” The
return to land is
rent

LAND
Land is a resource or input that is a “gift of nature” It exists
independently of human activities. Soil, a forest, a deposit of oil,
coal, rain, a river, the climate are a few examples of land. In
economics the payment for land is often called rent. There are
many categories of land.
Some resources, like solar or wind, are referred to as “flow
resources.” If the resource is used for one purpose, there is no
significant impact on the availability of the resource for other uses.

Land resources
can be flow,
renewable or
exhaustible.

Other land resources are called “renewable.” A forest, fishery, herd
of buffalo, whales, water quality and the like are renewable
resources. Trees may be harvested from a forest at a maximum
rate equal to the growth rate of new trees. This is called the
maximum sustainable yield. Fish, whales and buffalo (and other
wildlife) can be harvested and if a large enough population is left it
will “renew” or replenish.
Other resources are called exhaustible resources. There is a finite
amount available and once used it is gone, it cannot be replaced.
Coal and oil are examples of these resources. In practice, society
does not know about all deposits of those resources. As one
deposit of coal is mined out, new deposits may be discovered.

Labour his human
effort to produce
goods and
services.

Capital is any
good that is made
by humans to be
used for the
further
production of
goods and
services.
Entrepreneurial
ability is the
creative and
innovative
process in the
economy.


LABOUR
Labour is any human effort to produce goods and services. The
payment for labour is usually called wages (payments might be
commissions, salary, bonus or whatever). Labour can be physical
or mental. A person digging a ditch, managing a firm, or
performing accounting functions is providing labour.
CAPITAL
Capital is a means of production that is made by human labour and
used for the further production of goods and services. Drill presses,
dams, roads, irrigation canals and buildings are examples of things
that may be considered as capital if they are used to produce other
goods. The payment for capital is usually measured as interest.
ENTREPRENURIAL ABILITY
The term entrepreneur was first used in economics by Richard
Cantillon (1680-1734). The term was later popularized by JeanBaptiste Say (1767-1832). Joseph Schumpeter (1883-1950) further
developed the concept of the entrepreneur. For Schumpeter, the
term was applied to those persons who were innovators and
creators of new goods and processes. The act of creating
something new is fundamental to the concept of the entrepreneur.
The person who provides the capital for a new venture is not an


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entrepreneur. The person who manages a project after its creation
is not an entrepreneur. The process of creating new goods or
processes is usually accompanied by risk. Innovation and risk are
important elements of the entrepreneurial function. The return to
the entrepreneur is usually thought of as profit.
The taxonomy of resources or factors of production is not always clear. A
stand of old growth timber should be classified as land. Yet, a reforested
area may be more like capital. An individual may play the role of a manager
(labour) and an entrepreneur. An automobile may be capital for a traveling
salesperson or a consumer good for someone else.
There are other ways to categorize the factors of production. Time,
knowledge, energy and matter is another taxonomy. A different system of
categorizing inputs may result in different questions and/or different
perspective of the economic problem. When the factors of production are
identified with social classes, the questions are framed with regard to the
power and influence of those classes. If resources are associated with
physical concepts like energy, matter, time and technology, the questions
(and answers) are less likely to be influenced by political power and
stakeholders.

PRODUCTION
Production is the
process of
altering inputs to
increase their
ability to satisfy
human wants

Production can
result from;
1) a change in
physical
characteristics
2)a change in
location
3) a change in
time
4) a change in
ownership

Production is the process of altering inputs to increase their ability to satisfy
human wants. Production can occur if inputs are physically altered to
increase their ability to satisfy wants (utility). Steel that has been made
into a pan may provides more utility that a sheet of steel or an iron ingot.
The iron has been physically altered to increase its ability to satisfy wants.
A change in the location of a good can increase its ability to satisfy wants.
Lobster is moved from Maine to Arizona because it will satisfy more wants
in Arizona than in Maine. Changes in time or ownership are other types of
productive activities.

Physical production is the most obvious and easiest to measure. Units of
automobiles, cans of peaches, pizzas and bottles of wine can be counted. A
variation in the quality of these goods is often ignored. (Relative prices paid
for goods may be an indicator of quality.) Airlines measure their production
by passenger-miles. Trucking companies use ton-miles to measure output.
Services are often more difficult to measure. A police department may
produce safety or security. How is that measured? A teacher produces
education. How is that measured? Is the output of a fire department
measured as the number of fires they put our or the number of fires they
prevented?

DISTRIBUTION
Distribution usually describes the process of allocating the property rights to
goods and services that have been produced. Societies have used market
exchange, reciprocity, eminent domain, inheritance, theft and philanthropy
to distribute these property rights. The primary means of distribution or
allocative mechanisms that are used in most societies are exchange,
reciprocity and eminent domain. The techniques used to

CONSUMPTION
The end purpose of economic activity is to provide for the survival and

betterment of the conditions for individuals in a society. One aspect of this



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is the production of goods and services that can be consumed by individuals
to satisfy needs and wants. Modern, neoclassical economists generally do
not like to use the word “needs.” The use of the word “wants” is an attempt
to take subjective judgment out of the analysis.
Consumption iins
influenced by
tastes, income,
wealth,
alternatives,
prices, etc.

Consumption
includes more
than just goods
and services that
are exchanged in
a market.

Consumption patterns are influenced by preferences (tastes), income,
wealth, and the relative prices of goods. Preferences cannot be measured
directly. The choices that individuals make give some indication as to
preferences. The consumption choices are often correlated with variables
that can be measured. Age, gender, ethnicity, religion and other
characteristics may be related to preferences and consumption choices. In
orthodox microeconomics, demand analysis is one approach to summarizing
the consumption choices.
Consumptive activities may include more than goods and services that are
exchanged in a market. Individuals value security, aesthetics, creativity,
leisure, a sense of belonging, and other non-market phenomena. These
consumption activities should be considered in the study of the provisioning
problem. The role of these things frequently arises in the allocation process
because individuals may trade market goods for non-market values. An
artist may give up some income to engage in creative activities. Income or
goods that can be purchased with that income may be given up for leisure
of job security. Societies may tradeoff electricity or irrigation to have a free
flowing river.

INTERRELATION OF ECONOMIC ACTIVITIES
Production,
distribution and
consumption are
interrelated
processes

Production, distribution and consumption are interrelated. What to produce is
influenced by what individuals want to consume. What people want to
consume is influenced by the distribution process and what can potentially
can be produced. This coordination may come in the form of cooperative
activities, such as the creation of a business firm. The firm usually
organizes production internally as a cooperative process but must compete
externally. Alternatively, the coordination of activities may be accomplished
by competition or some combination of cooperation and competition.

V Technology

T

echnology is knowledge about how resources, individuals and social
organization can be used to accomplish objectives. Technology is what
Joel Mokyr calls instructional or prescriptive knowledge. This prescriptive
knowledge is based on propositional knowledge about the nature of things.
(Mokyr, pp 4-6)

The study of the nature and limits of knowing (or knowledge) is called
epistemology. Technology is one small piece of knowledge. Here the role of
technology in the economic process will be considered. Epistemology and
the dual problems of (1) What do I know? and (2) How do I know? will be
presented in the section on Methodology.
Technology is the
knowledge about
how resources can
be used to satisfy
human wants.

Technology is more than a set of skills to do things. It is a perspective about
the relationships between humans and their world. Technology is the sum
total of the ways in which human societies interact with natural and built
environments. Humans seek to understand these interactions and develop
technology by combining and reorganizing existing technologies.
In economics, technology is the knowledge about the manipulation of
resources, people and social institutions to produce goods and services that



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satisfy human wants. Prescriptive knowledge about how we do things,
“technology,” is not limited to machines. The discovery of a calendar or the
realization that crops can be planted on a three field rotation may be as
important as the invention of the padded horse collar, the steam engine or
the PC. Prescriptive knowledge about the use of organizational structure to
achieve an objective is, in a sense, a form of technology.

Technology and
society are
interrelated

Technological
change is a
pervasive process

Technology may
be driven by
profits
Technology may
be a selfgenerating
process
Technology
influences what
we perceive as
resources.

Factor endowment
can alter the
modes of
technology that
are used.

The values and structure of society are connected to the state of technology.
Society is shaped by technology and at the same time is an important force
in the determination of the course of technological change. This relationship
between technology, society and the individual can be driven by curiosity
and/or material gain.
Technological change is pervasive. During some periods of history,
technology changes at a slow pace. At other times, the rate of change is
more rapid and more dramatic. During the medieval period, technological
change was slow. With the development of mechanical clocks, the plague,
moveable type, gunpowder, new techniques in art and other innovations,
the “Renaissance” (usually thought of as the 14th-17th centuries) was a period of
dramatic change. During the 17th and 18th centuries, the “age of
Enlightenment” was fueled by technological change. The “Industrial
Revolution” (which is often dated as about 1750) is another term used to identify a
period of rapid technological change. Each of these periods involves
changes in ideas, values, knowledge and social institutions. Each altered
economic and social processes.
There are opposing views as to the process of technological change. One
view is the Thomas A. Edison perspective. In this case, technological
development is driven by profits. If a technology is profitable, it will be
invented. The other view is that technology is a self-generating process.
New technology is the result of old technology(ies) being recombined in
new ways and used for new purposes. In the second view, profits cannot
create the development of technology but determines its uses.
What an individual perceives as a resource is influenced by the nature of
technology. In the 18th century, obsidian was an important resource among
the inhabitants of the western United States; uranium was not. In the 21st
century, obsidian is not normally regarded as a very important resource
while uranium has become a resource.
Factor endowment may influence the direction that technology develops. In a
society with an abundance or arable land and a shortage of labour may
produce (and consume) different goods and seek different technologies to
produce them.

In the Edison view, the light bulb was invented because there was a demand
for it and it could be developed and produced for a profit. In the second
view, it is not possible to invent high-pressure steam engines, even though
Technological
change can be
they may be profitable, until the technology of metallurgy develops metals
influenced by
to contain the higher pressure. Either view supports the argument that
profits, curiosity,
technology builds upon itself. The creation of an internal combustion engine
factor endowment,
depended on its connections to cannons, oil, Maybach’s spray carburetor,
and existing
technology(ies) as levers and gears. Each of these in turn depended on other technologies.
well as social
When Daimler and Maybach built the automobile, it was the result of a
institutions.
series of connections between technologies that had been developed by
many people over a long period. (see Burke, Connections, pp 175-183)



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Technological
change involves
1) invention
2) innovation
3) dissemination

It is useful to think about technological change as a process. First, a piece of
knowledge emerges or an “invention” occurs. Second, some one finds an
application for the new knowledge (innovation) and uses it. Third is the
process of dissemination, i.e. the use of the idea is spread through out the
social system. Each stage of technological change may produce or require
significant changes in values and social institutions. Changes in social
structure or the natural environment may encourage technological change.
Technology and the social system are interconnected. Technology has a
strong influence on the structure of society and individual behavior. The
Industrial Revolution may be thought of as a fundamental change in
technology of production that altered society. The development of the
mechanical clock was driven by the clergy’s desire to satisfy the institution
of prayers at specific times of the day.

VI Allocation, Provisioning and the Economic
System
Economics as a study of the allocation problem is straightforward. Given a
set of resources, a state of technology, a group of individuals who have a
set of preferences and a set of social (including economic) institutions, what
is the optimal allocation of those resources. There are the five basic
allocation questions;
1) What goods (and services) should be produced?
2) How many units of each good should be produced?
3) How should those goods be produced?
4) When should those goods be produced?
5) Who should get the goods produced?
The ways individuals and societies choose to answer to each of these
questions is dependent on the philosophical and social context of the
society. The answers as well as the approaches taken evolve and change
over time. Economics as a study of provisioning is the study of how
individuals and societies evolve over time. Knowledge, beliefs, values,
principles, social institutions and economic behavior change.
Provisioning is concerned with the social structure and the alternative ways in
which the allocation problem is approached. The concern of provisioning is
with the economic actors (agents), the context in which their choices are
made and the criteria used to make and evaluate those choices.
In the next chapter the nature of knowing, technology and the methods used
by economists will be explored.



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Chapter 2 microeconmics provisioning

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