![Answering the 3 basic economic questions in a Market Economy [i.e., U.S.] What to produce? What should we devote our resources to? What do the consumers want? How to produce? What methods should be used in production? What is most efficient? For whom to produce? Who can afford the product?](https://image.slidesharecdn.com/unit1studentnotes-110828132641-phpapp02/85/Unit-1-student-notes-5-320.jpg)
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Unit 1 student notes
- 1. Unit #1 BasicEconomic Principles
- 2. What is Economics?Is the study of how people choose to use their limited resources to satisfy their unlimited wants Important Parts of Economics– CHOICES SCARCITY
- 3. Scarcity The fundamentalproblem all societies face… Scarcity is the condition that results because people have limited resources but unlimited wants Wants > Resources Task! Identify a scarce resource. EVERYTHING IS SCARCE!
- 4. What to produce?How to produce? For whom to produce? Three Basic Economic Questions 3 Q’s are answered in order to make decisions about the ways limited resources will be used.
- 5. Answering the 3basic economic questions in a Market Economy [i.e., U.S.] What to produce? What should we devote our resources to? What do the consumers want? How to produce? What methods should be used in production? What is most efficient? For whom to produce? Who can afford the product?
- 6. How do wesatisfy our economic wants? We buy goods or services! Good – a physical object (tangible) that has been produced for sale Durable – last 3+ years Nondurable – last up to 3 years Servic e – work done by someone else for which someone is willing to pay
- 7. How do wemake goods & services? Use Factors of Production - The productive resources that go into producing goods and services Production Equation LAND + LABOR + CAPITAL = GOOD/SERVICE inputs output
- 8. Factors of Production LAND Also called Natural Resources Consider them “gifts of nature” such as air, soil, minerals, water, and plants LABOR Also called Human Resources Includes physical and mental activities that go into producing goods/services CAPITAL Includes tools, machines, buildings, and technologies ENTREPRENEUR Risk taker who is responsible for combining land, labor, and capital to produce goods and services Task! Why are entrepreneurs the driving force in our economy?
- 9. Economic Interdependence Whatdoes ‘interdependence’ mean? Is our world becoming economic interdependent or independent? Economic Interdependence: the actions of one part of the country (world) has an impact on what happens elsewhere
- 10. Circular Flow ofEconomic Activity Circular Flow of Economic Activity Flow of Money Flow of Resources & Products Revenue Consumer Spending Income Factor Payments Buy Factors of Production to Make Stuff Sell Goods & Services Buy Goods & Services Sell Factors of Production Product Market Individuals Households Factor Market Business Firms
- 11. Understanding how allparts fit together Circular Flow of Economic Activity Represents a market economy 2 main “markets” Product Market: Factor Market: where goods and services where the 4 factors of are bought/sold production are bought/sold Shows interdependence between businesses and individuals
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- 13. Making Choices toDeal With Scarcity People seek to maximize their utility when making decisions. This requires them to consider tradeoffs . Utility – the satisfaction of benefit a person receives from consuming a good or service Tradeoffs – the exchange of one benefit or advantage for another (alternate choices)
- 14. Examples… Some choicesare easy to make… Hmm… Should I have pizza or a hoagie for lunch today? Other decisions are agonizing… Should I get out of bed and go to school today or should I sleep in? ALL TRADEOFFS HAVE ADVANTAGES!
- 15. Opportunity Cost When comparing the top 2 choices, it is the BENEFIT of the next best alternative that must be sacrificed to satisfy a want. Opportunity Cost – The best thing we give up to get what we want
- 16. How Do YouMake Your Choices? People make decisions based on their marginal utility , or the extra satisfaction they gain from one additional unit of a good/service. Law of Diminishing Marginal Utility says that as we get more of something, the pleasure we derive from it tends to decrease and we usually stop buying it!
- 17. Why it MattersUnderstanding the opportunity costs/tradeoffs of different choices in life makes you a better decision-maker! You always have to give something up…”There’s No Such Thing As a Free Lunch” Individuals, Businesses, & Societies incur tradeoffs when making decisions
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- 19. How Can WeMeasure What We Gain and Lose When Making Choices?
- 20. Production Possibilities Frontier(PPF) An economic model that shows how an economy might use its resources to produce two goods Each point on the curve represents the use of all productive resources A PPF is used to calculate the opportunity cost of moving production from one point to another
- 21. The Classic Gunsand Butter example: B A C D E F Guns Butter 10,000 20,000 30,000 40,000 50,000 100,000 95,000 85,000 70,000 50,000 40,000 At point A, all resources are used for butter Moving from point A to point B requires shifting resources out of butter and into guns. At point F. all resources are used for Guns.
- 22. Productivity A PPFcan help us see how efficient our choices are. Productivity - measurement of how efficiently we are utilizing our resources An economy producing on the curve = using their resources to produce the MAXIMUM amount of goods/services
- 23. Locations on aPPF Efficient Point : place where an economy is achieving as much output as possible from a given amount of resources – occurs at any point on the curve . Inefficient Point – place where the economy is not functioning as it could be – occurs at any point inside the curve Unattainable Point – place where the economy cannot produce, given its current resources – occurs at any point outside the curve
- 24. Butter 10 86 4 2 0 2 4 6 8 10 Guns Q: How can an economy produce at the unattainable point? A: Be more productive/efficient and/or gain new resources (curve shifts outward) C D A B Efficient points Inefficient point Unattainable point, given current resources
- 25. Food Computer 43 2 1 1 2 3 4 O.C. between 1 and 2 computers = 1 Food Unit O.C. between 3 and 4 computers = 1 Food Unit Constantly giving up the same quantity of food to get additional computers STRAIGHT-LINE PPFs Constant O.C.
- 26. BOWED-OUT PPFs Varying/Increasing O.C. Principle of Increasing Costs: As a society produces more of one product, the O.C. of producing that product increases because we are using more resources that are poorly suited to produce it .
- 27. Economic Systems Aneconomic system is the way a society coordinates the production and consumption of goods & services. How a society answers the three basic economic questions determines which type of economic system they are! Three Types of Economic Systems: Command Traditional Market
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- 29. Review of EconomicSystems A traditional economy relies on custom and tradition to dictate production and consumption In a command economy , decisions about production and consumption are made by a powerful ruler or central authority In a market economy , individual producers and consumers coordinate economic activity.
- 30. The American EconomicSystem We have a mixed economy! COMMAND MARKET
- 31. Influence of AdamSmith 17 th Century Scottish Economist who wrote The Wealth of Nations Ideas – The Government should not interfere with the workings of the economy Based upon laissez-faire , meaning “let them do” Economic Freedom is essential for prosperity Based upon the invisible hand theory – an individual’s pursuit of economic self-interest can promote the well-being of society as a whole Credited with creating capitalism (a free market economy)
- 32. Capitalism/Market Economy Roots…Smith’s ideas were used in the 1700s-1800s: Entrepreneurs, known as capitalists , grew wealthy by accumulating capital & devoting them to industrial production Time period became known as the INDUSTRIAL REVOLUTION Results: Positive – more jobs, urban growth, more and better quality goods/services available, standard of living improved, technology expanding (ex. Railroads) Negative – work under harsh conditions, long hours, low wages, slums developing in cities, unsanitary conditions in factories and cities
- 33. Rise of CommandEconomies Workers blamed their poverty on the wealthy capitalists Caused new economic thinking to develop…rise of socialism and communism Karl Marx and Friedrich Engels published The Communist Manifesto in 1848
- 34. What type ofeconomy is best?
- 35. The U.S. mixedeconomy In a mixed economy… Individuals: Own the factors of production Possess freedom to produce or consume Must operate under confines of law Government: Protects workers and consumers Regulates business and preserves competition Provide public goods/benefits
- 36. Circular Flow ofEconomic Activity – Mixed Economy Flow of Money Flow of Resources & Products Government Revenue Consumer Spending Income Factor Payments Buy Factors of Production to Make Stuff Sell Goods & Services Buy Goods & Services Sell Factors of Production Product Market Individuals Households Factor Market Business Firms
- 37. U.S. Economic SystemCharacteristics (pages 50-53 ) 1. Economic freedom (“laissez-faire”) 2. Limited government 3. Equal opportunity 4. Competition 5. Profit motive 6. Property Rights 7. Binding Contracts
Editor's Notes
- #3 Choices – how people buy, sell, produce, and consume
- #4 People always want STUFF but that stuff has to come from somewhere Resources are needed to make STUFF All societies throughout the world suffer from scarcity, or the idea of finite resources Scarcity – Thus, stereos, hot dogs, education, lawn mowers, TV repair services, and bubble gum are scarce b/c many individuals desire these things that their availability is limited Scarce goods command a price in the marketplace (the price indicates how scarce a good is relative to other goods) example: gas prices Scarce: not freely available to individuals in unlimited quantities (things not scarce: sand, salt water, air) Candy example-offer a few pieces of candy to class – if individual want more of an item than is freely available then it is scarce & will command a price Not a shortage (this is usually temporary)
- #6 ECONOMIC DECISIONS MUST BE MADE IN ORDER FOR SOCIETY TO HAVE EFFICIENT PRODUCTION AND DISTRIBUTION OF GOODS/SERVICES Society must choose based on its needs. (make sure there is a demand) Society must choose based on its resources. (especially technology access) Society must choose based on its population and other available markets. (ability to pay to distribute or everyone equally?) How might the economic decisions of a mountainous island society differ from those of a mountainous landlocked society? Produce more military equipment or housing? More equipment used or workers? Who gets products (professionals, gov’t employees)
- #7 Economic products include goods and services since both are produced
- #9 Essentially economics studies how society uses limited resources – HERE ARE THESE RESOURCES Every society is endowed with resources which are used to produce the goods and services that enable it to survive and prosper Production Equation: land + labor + capital = goods & services (inputs = outputs) combined by entrepreneurs REMEMBER THESE RESOURCES ARE LIMITED! “ gifts of nature” such as air, soil, minerals, water, forests, plants, animals birds, fish Land resources are NOT created by human effort! 2. Labor – planting crops and building houses or programming videogames 3. Not financial capital (money) it’s physical capital/capital goods (if you buy a car to drive to school or social events then it is a consumer good, but if used to deliver pizzas then it is a capital good economists also include entrepreneurship as a factor of production. Like labor, entrepreneurship is a human input factor but it refers to more than just work; it refers to the creativity and initiative needed to start a business, develop new goods and services, or improve on development or distribution
- #11 HOW AN ECONOMY WORKS Households (assumed to own factors of production) sell resources to businesses & businesses pay for resources they buy from households (a business pays a worker a day’s wage) Businesses sell goods & services to households & households pay for goods and services they buy from businesses (a consumer buys a sofa from a furniture company) Factor markets (firms make factor payments)- Entrepreneurs hire labor for wages & salaries, land is provided for rent, & money is loaned by the people or invested Product markets - When individuals receive income they spend it on goods & services offered for sale Product markets - Businesses receive money from selling goods & services to individuals Factor Markets-This money pays for land, labor, & capital bought in these markets, then use this to produce more goods/services
- #14 Everyone cannot have everything they want! Therefore, who decides who gets what? Our choices, based upon utility help to decide!
- #16 There may be numerous tradeoffs to a decision, there is only one opportunity cost! (the cost of our decision)
- #18 Ex. Entrepreneur who uses a building to sell car insurance Ex. Homeowner purchases new carpet Ex. Government provides universal healthcare to its citizens Because limited resources, businesses could buy something else or consumer could have used time to do something else BECAUSE THERE ARE ALWAYS ALTERNATIVE USES FOR LIMITED RESOURCES, EVERY ECONOMIC DECISION HAS AN OPPORTUNITY COST As consumers, must realize the “cost” of buying an item is not really the price, rather it is the most valued item that cannot be bought As producers, the opportunity cost is the next most valuable good or service that is not produced as a result of the decision to produce something else Why It Matters Today Sometimes opportunity costs can vastly exceed the sticker price of an item. Imagine you scored a ticket to the Super Bowl. You paid $200 for your ticket, a stretch for your budget but worth it for a once-in-a-lifetime opportunity. You sit down in your seat next to some schmuck who admits he paid $5000 to a scalper for his ticket. Five grand! That's madness. But hold on. Your ticket just cost you five grand, too, even though only $200 in cash ever left your wallet. How's that work? Well, if the schmuck next to you was willing to buy a seat for $5000, then you could have sold yours at that price, too. The opportunity cost of you using your ticket is the five grand you didn't make by scalping it. Hope it was a good game! Trade-offs create opportunity costs , one of the most important concepts in economics. Whenever you make a trade-off, the thing that you do not choose is your opportunity cost. To butcher the poet Robert Frost, opportunity cost is the path not taken (and that makes all the difference). You bought that bike? Then the snowboard was your opportunity cost. Decided to work on the Fourth of July? Your opportunity cost was a relaxing day hanging out with the fam at the BBQ. Everything has opportunity costs. If you just bought something, you could have always chosen to buy something else instead. If you just chose to spend your time in a particular way, you could have always done something else. "Something else" is your opportunity cost.
- #21 Popular model used by economists to illustrate opportunity cost, the curve itself represents the best that this economy can do with its current factors of production Each national economy has a production possibility or a combination of goods and services that can be produced with the given amount of productive resources in that nation – classic example is the choice between military goods and consumer goods “guns & butter”. Since it is unlikely that a nation would produce either all consumer or military, choices must be made! Can’t have a point F outside the curve because sometimes we don’t have enough resources to produce it (scarcity to us we can’t have everything & the PPF illustrates that) How does a person or a company or an entire nation make smart decisions about tradeoffs and opportunity costs? Of course, in most countries, the production possibilities are far more numerous and complicated. But the essential fact remains the same: scarce amounts of money, time, land, capital, labor, technology, and entrepreneurship must be parceled out to produce some combination of goods and services
- #22 The classic example of the production possibility curve, which demonstrates the idea of opportunity cost. In a theoretical economy with only two goods, a choice must be made between how much of each good to produce. As an economy produces more guns (military spending) it must reduce its production of butter (food), and vice versa. If the society maximizes its security by producing guns, sacrifices the living standards by not producing enough butter (a consumer good)
- #23 Success in maximizing the allocation of our resources is also measured by productivity . For economists, this is a crucial measurement of how efficiently we are utilizing our resources. Productivity measures how much we produce for every unit of labor or capital that we invest—or as economists say, the value of our output for every unit of input. Suppose, for example, that in your one-man furniture shop you produce one chair every hour. With hopes of increasing productivity, you hire three assistants. Now you can produce four chairs per hour. But while your production may have increased, your productivity has not—you are still only producing one chair for every hour of labor invested. So you decide to buy some new machinery and soon discover that you and your three assistants can now produce eight chairs per hour. You have doubled productivity. Yeah technology! Entrepreneurs and countries’ leaders strive for greater productivity! Why? Productivity – the value of our output for every unit of input (in other words: how efficiently resources are being used!) To be more productive we must: Create more output with same inputs Create same output with less inputs How to increase productivity = 1. Division of Labor 2. Specialization 3. Investing in Human Capital Efficient use of productive resources is productivity (Productivity always goes up when same output can be produced with less inputs or more output is created with same inputs) Productivity – output/input Specialization (productive inputs do whatever talk they are able to do best - example carpenter specializes in building a house, not electrician or plumber)and division of labor (takes place when workers perform fewer tasks more frequently - assembly line technique) may improve productivity because they lead to more proficiency (and greater economic interdependence). Investing in human capital (sum of skills) improves productivity because when people’s skills, abilities, health, and motivation advance, productivity increases.
- #24 Inefficient points represent an attainable, production possibility but it is less efficient = due to natural disaster or slowdown in economy & more unemployment Unattainable because at curve all resources are being used to the max!
- #25 1. Specialization Productive inputs specialize in the task they do best 2. Division of Labor Workers perform fewer tasks more frequently PRACTICE MAKES PERFECT! Investment in Human Capital Sum of all skills, abilities, health, and motivation of people Examples – training, healthcare, motivational programs
- #27 That is, as we specialize more and more into one product, the opportunity costs of producing that product increase, because we are using more and more resources that are poorly suited to produce it As a society attempts to produce more of a good, the O.C. of additional units generally increases Since resources are specialized, we have to give up more of Good A to get additional units of Good B As you move along the curve you are giving up larger amounts of a good/service in order to produce an additional unit of the other good/service mainly because not all of the resources can be used in the exact same way Example – maybe we have land that used to house a computer factory and now cannot grow crops
- #29 Rarely do countries utilize just one of these categories, usually it is a mix of 2!
- #32 Wrote an Inquiry into the nature and cause in the wealth of nations - When people act in own self-interest, an invisible hand guides resources to their most productive use therefore can lead to greater well being for society as a whole = why? – COMPETITION -countries gain wealth only when gov’t release control of economy and people pursue own interests = ECONOMIC FREEDOM -competition = increase in productivity = produce more for society = lower prices
- #33 Smith’s ideas about limited gov’t role in econ and ultimate freedom for businesses were put into practice during IR Entrepreneurs started amassing Capital such as machinery, factories, railroads during Industrial Revolution and started massive industrial production Pros - more people work and they get better goods & services Cons – workers suffered under bad working conditions such as low wages, long hours, no disability, overtime, lived in slums etc. Workers blamed capitalists for their continued poverty = rise of socialism/communism/command economy
- #34 Socialism – political and economic philosophy that calls for property to be owned by society as a whole, rather than by individuals, for the equal benefit of all Communism (final phase of socialism) – system in which ALL property and wealth are owned by members of society – now no class differences and no need for government Manifesto advocated for the overthrow of capitalism – revolution of proletariat against bourgeoisie Soviet Union – Russia Revolution in 1917 did not lead to utopian society that was envisioned, instead revolutionaries formed an authoritarian gov’t that pursued socialist goals with brutal force (first modern command economy). Private ownership of property was forbidden and state owned factors of production. Economic planning was done by government committees. Answered all economic questions to provide for the people. Problems – shortages were common, choice was limited, wages paid to workers were predetermined and not based upon worker’s ability or output (no profit-incentive) = production slowed and those that were produced were of shoddy quality (little incentive to be innovative) COMMAND ECONOMIES STRUGGLE TO DO WHAT MARKET ECONOMIES DO EFFORTLESSLY BUT THEY DID INCREASE ECONOMIC EQUITY AND SECURITY OF PEOPLE
- #36 Protector – 40 hour work week, sensible working conditions, health benefits, agencies like FDA regulates medicine & food to protect consumer Regulator – Sherman Anti-Trust Act of 1890 prevents monopolies (wants to preserve competition), regulates SS/welfare/unemployment (these protect people too!)
- #37 HOW AN ECONOMY WORKS Households (assumed to own factors of production) sell resources to businesses & businesses pay for resources they buy from households (a business pays a worker a day’s wage) Businesses sell goods & services to households & households pay for goods and services they buy from businesses (a consumer buys a sofa from a furniture company) Factor markets (firms make factor payments)- Entrepreneurs hire labor for wages & salaries, land is provided for rent, & money is loaned by the people or invested Product markets - When individuals receive income they spend it on goods & services offered for sale Product markets - Businesses receive money from selling goods & services to individuals Factor Markets-This money pays for land, labor, & capital bought in these markets, then use this to produce more goods/services
- #38 Our economy needs a balance of freedom for individuals but also protection! 1. “Let them do” –people and businesses make their own economic choices. relatively free of government intervention, allows us to act within our best interest within the law (can’t sell alcohol to underagers or hire child labor, free to own most productive resources and start new businesses 2. Free to compete with one another, but all involves risk, among sellers helps lower prices. Same legal rights to seek profit and consumption in a marketplace Government laws & agencies regulate but not operate most of businesses Incentive to keep rewards so produce better products or produce more, encourages entrepreneurship and is largely responsible for the growth of a free enterprise economy. Right to buy, sell, & control use of our property (including intellectual) - You can do what you want with it, unless gov’t takes away for public use but must be fairly compensated – patents & copyrights (motivate people to be creative & succeed!)