Modern economies are highly complex. In the United States economy in 2006, for example, 145.8 million workers combined their labor with $23.1 trillion worth of capital to produce $13.2 trillion worth of goods and services. Fortunately, the concepts and principles that guide economists' understanding of economic activity are relatively simple. In this chapter we explain selected aspects of the economics of production such as the production function, scarcity, production possibilities, opportunity cost, efficiency, comparative advantage, and gains from trade. We then apply these principles to better understand the economic costs of conflict, the effects of defense spending on economic growth, and the depressed state of North Korea's militarized economy.

Production Possibilities Model

Production Function

Assume that an economy produces two types of goods: military (M) and civilian (C). Military goods include tanks, fighter aircraft, and the like, while civilian goods encompass food, clothing, shelter, and so on. In economics, military goods are often called “guns,” while civilian goods are called “butter.” The production of military and civilian goods requires inputs such as labor (L) and capital (K), where the latter refers to physical assets like buildings and machines. A production function specifies the maximum amount of a good that can be produced with any given combination of inputs under the current state of technology. Technology is the scientific and organizational knowledge available to transform inputs into outputs.