Advancements in technology can expand the economy’s production possibilities. Technology determines the maximum amount of output an economy can produce given the resources it has. New and better technology makes it possible for us to get more output from our resources. An important form of technological change is intention the use of science and engineering to create new products or processes. In recent years, for example, inventions have allowed us to develop photographs faster and more cheaply, process data more rapidly, get more oil from existing fields, and send information instantly and cheaply by satellite. Such technological advances increase our production possibilities, shifting our economy’s entire production possibilities curve outward.
An economy can also benefit from technological change through innovation -the practical and effective adoption of new techniques. Such innovation is commonly carried out by an entrepreneur-a person who introduces new products or improved techniques to satisfy consumers at a lower cost. To make a profit, an entrepreneur must convert or rearrange resources in a way that increases their value. This also pushes the production possibilities curve outward.
Take, for example, Henry Ford, an entrepreneur who changed how cars were made by pioneering the assembly line. With the same amount of labor and materials, Ford made more cars, more cheaply. Another entrepreneur, the late Ray Kroc, purchased a hamburger restaurant from Richard McDonald and built it into the world’s largest fast-food chain. Kroc revolutionized fast food by offering attractive food at economical prices. He also developed a franchising system that resulted in uniform quality across the many different McDonald’s restaurants worldwide. More recently, entrepreneurs like Steven Jobs (Apple Computer) and Bill Gates (Microsoft) helped develop the personal computer and software programs that dramatically increased their usefulness to businesses and households. It is interesting to think about how a few famous entrepreneurs have improved our productivity and changed our lives so much.
July 2009
Technology and market
Production possibilities curve
People try to get the most from their limited resources by making purposeful choices and engaging in economizing behavior. This can be illustrated using a conceptual tool called the production possibilities curve. The production possibilities curve shows the maximum amount of any two products that can be produced from a fixed set of resources, and the possible trade-offs in production between them. Admittedly, this is an oversimplified model because economies obviously produce more than just two products. Nonetheless, the production possibilities curve can help us understand a number of important economic ideas.
Private ownership and markets
Private ownership and competitive markets provide the foundation for cooperative behavior among individuals. When private-property rights are protected and enforced, the permission of the owner must be sought before anyone else can use the property. Put another way, if you want to use a good or resource, you must either buy or lease it from the owner. This means that each of us must face the cost of using scarce resources. Furthermore, market prices give private owners a strong incentive to consider the desires of others and use their resources in ways others value.
F. A. Hayek, the winner of the 1974 Nobel Prize in economics, used the expression “the extended order” to refer to the tendency for markets to lead perfect strangers from different backgrounds around the world to cooperate with one another. Let’s go back to the example of the property owner who has the choice of leaving her land idle or building housing to benefit students. The landowner might not know any students in her town nor particularly care about providing them housing. However, because she is motivated by market prices, she might build an apartment complex and eventually do business with a lot of students she never intended to get to know. In the process, she will purchase materials, goods, and services produced by other strangers.
Things are different in countries that don’t recognize private-ownership rights or enforce them. In these countries, whoever has the political power or authority can simply seize property from whomever might have it without compensating them. In his book The Mystery of Capital, economist Hernando DeSoto argues that the lack of well-defined and enforced property rights explains why some underdeveloped countries (despite being market based) have made little economic progress. DeSoto points out that in many of these nations, generations of people have squatted on the land without any legal deed giving them formal ownership. The problem is these squatters cannot borrow against the land to generate capital because they don’t have a deed to it, nor can they prevent someone else from arbitrarily taking the land away from them.
Private ownership and markets can also play an important role in environmental protection and natural-resource conservation. Ocean fishing rights, tradable rights to pollute, and private ownership of endangered species are just some examples. The accompanying Applications in Economics feature, “Protecting Endangered Species and the Environment with Private-Property Rights,” explores some of these issues.
Freddie Mac and Fannie Mae
When Applying to Freddie Mac or Fannie Mae, the Rule is You Need Good Credit and a lot of Cash
When the housing bubble burst this past fall and the government had to bail out Freddie Mac and Fannie Mae, getting a loan for a new home became just a little harder for homeowners. With the two largest lenders being in a government conservatorship, rules have tightened to reduce the risk to mortgage lenders. Potential homeowners should now be prepared to offer large amounts of cash for a down payment and be able to prove that they have a good credit score. This is the new reality in these hard economic times.
A recent article in the Wall Street Journal estimated that buyers need approximately 20% cash down plus a credit score of 740 to qualify for a low down payment. With a credit score and cash on hand like this, a buyer could qualify for a mortgage with an interest rate of 4.75% plus origination fees. If your credit score is lower, count on having to put down more cash plus spending a lot more in fees.
With private institutions not keen on making mortgage loans in the current financial climate, Freddie Mac and Fannie Mae may be the only avenue to turn to for a mortgage for many home buyers. Potential homeowners need to be prepared to part with a lot of cash in terms of a down payment in order to qualify for a mortgage. The FHA is still working with people who have poor credit, but there is not a lot of mortgage money to go around. The best way to get a mortgage is to have a good credit score and to have plenty of cash on hand to make a down payment and pay the fees. There’s just no way around the new rules at the moment.
The housing market collapse has created a glut of homes that are waiting for buyers, but low selling prices have scared off sellers. Economic experts have said that there is a need to balance safe lending with stabilizing the housing market. Many people are applying for mortgages and are being turned down because they do not have a lot of cash on hand to make a down payment or they don’t qualify due to bad credit. This is creating an economic catch 22 where there isn’t enough money to lend to prospective buyers and there is a backlog of homes waiting to be sold.
While things probably won’t change in the short term, there probably needs to be some loosening of the purse strings and willingness to take on more risk by Freddie Mac and Fannie Mae to get more people qualified for mortgages. People will need to realize that no matter what, good credit and a lot of cash may be the order of business for getting a mortgage and buying a home today.