Transcript economic - Kenston Local Schools

Unit One
Introduction to Economics
Limits, Alternatives
and Choices
Limits, Alternatives, and Choices
• Economics is the social science that studies
how individuals, institutions and society make
choices under the condition of scarcity.
• The economic perspective recognizes that all
choices involve costs and benefits. Economic
decisions should be based on “marginal
cost/benefit analysis.” *Opportunity Cost*
• Self-Interest is a key component of a market
economy (Adam Smith) and plays a major role
in economic decision making.
The Science of Economics
depends on the Scientific Method
• The Scientific method is used to develop theories and
principles to explain the likely effects/impact of human
behavior (social science.)
• The Scientific method is a decision making process
which includes: identifying the problem, stating a
hypothesis, gathering data, analyzing data, testing the
hypothesis and then developing theories & principles
(laws.)
• The Scientific method is also known as the “Economic
Model” and uses scientific research to create & support
economic generalizations.
Economists develop economic
theories & principles at two levels
• MACROECONOMICS:
focuses on the whole or
entire economy, large
segments.
• The “Forest”
• Issues at this level
include economic growth
(GDP), Inflation (CPI),
Employment
(Unemployment Rate)
• Keynesian versus
Classical economics
• MICROECONOMICS:
targets specific units in
the economy.
• The “Trees”
• Issues at this level
include how prices &
output are determined
for particular products &
how consumers react to
price changes (*The law
of supply & demand.)
Economic studies at the Macro or
Micro level may be either:
• Positive economics
•
•
•
•
which investigates facts.
“What Is”
Hard data or just the
numbers.
The unemployment rate,
the GDP, the Core CPI.
The GDP for last quarter
was 1.5%. The
unemployment rate was
7.5% last year.
• Normative economics
incorporates a subjective
view.
• “What ought to be” or
value-based economics.
• Political/economic
policies to address
economic issues.
• The government should
cut taxes to stimulate
economic growth.
The Economizing Problem
• The economizing problem arises from a conflict between
economic wants and economic resources.
• Economic “wants are unlimited” while economic “resources are
limited” (wants exceed the available resources).
• The economizing problem is also known as the “problem of
scarcity.”
• Scarcity forces individuals and societies to make choices or
decisions on how to allocate their scarce or limited resources.
• Efficient and wise decision-making should take into account both
opportunity costs (next highest alternative) & tradeoffs
(everything given up). Choices are necessary!
“THERE IS NO SUCH
THING AS A FREE
LUNCH”
Economic Resources
The Factors of Production (inputs)
• Land includes all natural resources “gifts of nature” used in
production. Forests, minerals, oil, water are all examples of land.
“Chindia” China & India are employing larger amounts of this
resource. Approximately 2.3 billion people.
• Labor consists of the physical and mental talents of individuals.
Services provided by workers. Karl Marx believed that workers
did not receive the “Value of their Labor” under capitalism.
• Capital or capital goods includes all manufactured aids used in
production (tools, machinery, buildings.) Purchases of capital
are known as “Investment”. Capital is not money in the world
of economics.
• The Entrepreneur is the individual that displays the ability to
“combine” land, labor and capital to produce a good or
service. The entrepreneur is an innovator, “risk bearer” who is
not guaranteed a profit in a pure market economy. Bill Gates is
the world’s wealthiest person and an entrepreneur.
Income flows to the sellers of
economic resources
• The selling and buying of
economic resources
creates the “Circular
Flow of Income.”
• Income flows earned by
households for their
resources:
• Households comprise
the “resource market”
and sell resources.
•
•
•
•
• Businesses comprise
the “product market”
and buy resources.
Land
= Rent
Labor
= Wages
Capital
= Interest
Entrepreneur = Profit
• Used in the Income
Approach when
calculating GDP.
Economic resources are scarce
“Guns & Butter”
The Production Possibilities Model:
Society uses its scarce resources to produce
goods and services. The alternatives and choices it
faces can best be understood using the Production
Possibilities Curve.
Assumptions of the macroeconomic model:
Full employment: The economy is employing all its available
resources.
Fixed resources: The quantity and quality of the factors of
production are fixed.
Fixed technology: The state of technology is constant.
Two goods: The economy is producing only two goods (guns or
butter)
Production Possibilities
Curve
• The curve displays the different
combinations of goods and services that
society can produce.
• Points on the curve are attainable as
long as the economy uses all its available
resources.
• Points lying inside the curve are
attainable, but reflect inefficiency or
the underemployment of resources.
Resources are underutilized and this
point is undesirable.
• Points lying beyond the curve are
unattainable with the current resources
and technology (increases in resources &
technology needed to shift the curve.)
Law of Increasing Opportunity Cost
As the production of a particular good
increases, the opportunity cost of
producing an additional unit rises.
 As an economy produces more & more
“guns” in place of “butter” (moves closer
towards point A & further away from point
E) the employment of additional
resources becomes more inefficient.

Law of Increasing Opportunity Cost

Additional resources may be better utilized
(greater efficiently) for “butter” production than
for additional “gun” production causing an
increase in opportunity cost.

The law of increasing opportunity costs is
reflected in the shape of the production
possibilities curve (bowed out or concave,
but steeper as it moves from A to E.)
Increases in both “Guns & Butter”

Although resource supplies are fixed at any
specific moment, they change over time.
 When an increase in the quantity or quality of
resources occurs, the production possibilities
shifts outward and to the right (economic
growth/increase in GDP.)
 New or improved technological advances will
also shift the production possibilities curve
outward (computers, internet, cellular phones.)
 International trade incorporating specialization
based on comparative advantages will also
shift the production possibilities frontier
outward.
Economic Systems

Every society needs to develop an
economic system to respond to the
economizing problem of scarcity.

Economic systems differ as to who owns
the “factors of production” and the
method used to coordinate and direct
economic activity (voluntary exchange or
central planning.)
Two Major Economic Systems
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A Command system may
also be called socialism or
communism.
The government owns or
controls most of the
factors of production &
uses central planning.
Russia & other nations
have transitioned to mixed
market economies.
North Korea, Cuba, Iran,
Libya, Laos, Belarus
remain command
systems.
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A Market economy may
also be called capitalism or
free enterprise system.
It is characterized by the
private ownership of
resources and uses
markets & prices to
coordinate and direct
economic activity.
Participants are guided by
self-interest (Adam Smith
& the invisible hand.)
Pure capitalism or laissezfaire capitalism (“let it be”)
does not exist.
Characteristics of the Market System
 #1 Private Property (land and capital) is
owned by private individuals & firms. The
term Capitalism comes from the right of
individuals to own capital.
 Private property rights extend to “intellectual
property” through patents, copyrights and
trademarks.
 China and eminent domain (government
seizure of property) have been key issues over
the past few years.
 Hernando de Soto notes in his book The
Mystery of Capital, many of the poorest
countries in the world possess enormous
amounts of capital, but their ownership is
insecure because of faulty or nonexistent
property law or property rights protections.
Characteristics of the Market System
 #2 Freedom of Enterprise & Choice ensures
individuals the opportunity to obtain resources to
start a business and use resources to produce
their choice of goods to earn a profit.
 It also allows individuals the right to sell their
labor and purchase goods or services that
satisfy them.
 Legal limitations do exist and individuals may
be fined and/or imprisoned for violations.
 Economic freedom varies greatly from economy
to economy (#1 Hong Kong, #9 United States,
#150 Cuba, #157 North Korea.) Heritage Foundation
Characteristics of the Market System
 #3 Self-Interest is the motivating force and it
simply implies that each economic unit tries to
achieve its own particular goal.
 Individuals in a market system must typically
deliver something of value to others.
Entrepreneurs try to maximize profit and/or
minimize loss.
 Adam Smith & the theory of the Invisible Hand
from the Wealth of Nations (1776) “It is not
from the benevolence of the butcher, brewer,
or the baker, that we expect our dinner, but
from their regard to their own interest.”
 Workers desire the highest wage, businesses
risk for the highest profit, and consumers
search for the lowest price.
Characteristics of the Market System
 #4 Competition is based on the freedom of choice
exercised in the pursuit of a monetary return.
 Competition requires two or more buyers & sellers
acting independently ( no price fixing or collusion) in a
market. Mergers & “Economies of Scale.”
 Numerous buyers & sellers are completely free to enter
or exit a market in a purely competitive market. Real
world markets vary according to the number of buyers &
sellers (pure competition, monopolistic competition,
oligopoly, and pure monopoly.)
 The Sherman Act of 1890 and the Clayton Act of 1914
(FTC) attempted to ensure competition in all markets.
 The most famous and most recent antitrust lawsuits have
been filed against Bill Gates & Microsoft (tying and
exclusive violations) both in the United States & the E.U.
Characteristics of the Market System
 #5 Markets and prices are the coordination
features that keep a market economy from
becoming chaotic.
 A market is an institution or mechanism that brings
buyers and sellers into contact through a process of
voluntary exchange.
 The decisions made on each side of the market
determine a product & a price (voluntary exchange)
based on self-interest.
 Market signals are directed and driven by
“consumer sovereignty” and “dollar votes.”
 Those who respond to market signals are
rewarded with profit & income, those who ignore
are penalized.
Characteristics of the Market System
#6 Technology and advanced capital
goods “naturally” evolve in a market
system as producers seek greater returns
(profits).
The monetary rewards for new products
or production techniques accrue directly
to the innovator & therefore encourages
extensive use of technology.
Technology equates to greater efficiency
and increases in productivity, which both
minimizes costs and maximizes profit.
Characteristics of the Market System
 #7 Specialization is the use of resources to produce one or a few
goods or services rather than the entire range of goods & services.
 Specialization according to Adam Smith in The Wealth of Nations
enables countries to enjoy both more “guns & butter.”
 Human specialization is called the division of labor and increases
total output (GDP) by:
1. Utilizing differences in abilities and skills.
2. Fosters learning by doing the task over & over again.
3. Saves time by not “shifting” from one task to another.
 Geographic specialization works on a regional and international
basis. The United States produces commercial aircraft which it
sells abroad in exchange for video recorders from Japan. More
“guns & butter.” Specialization and trade are based on comparative
advantage (David Ricardo, 1772-1823, London, “Principles of
Political Economy & Taxation.)
Characteristics of the Market System
 #8 Use of Money is a necessary component of any
advanced economy (I.A.C.) and it serves as a medium
of exchange (legal tender.)
 Specialization requires exchange and a barter system
poses a serious problem, because of the coincidence
of wants between the buyer and the seller.
 To serve as money, an item must be generally
acceptable to sellers in exchange for their goods and
services.
 Most economies use pieces of paper (Federal Reserve
Notes) as money. But money may come in various
forms including; coins, demand deposits (checking
accounts) and near money (certificates of deposit
and money market accounts.) M1,M2,M3
Characteristics of the Market System
 #9 An Active, but Limited government is the final characteristic of
market systems in modern advanced industrial economies (I.A.C.).
 Market systems promote a high degree of efficiency, but market
failures referred to as “spillover costs-benefits or externalities”
do exist (misallocation of resources.) Price controls include price
ceilings (below equilibrium) and price floors (above equilibrium.)
 The United States government is mandated to implement
economic policies to achieve a growing economy (GDP) with a
stable price level (CPI). Fiscal & Monetary policy (expansionary
or contractionary)
 “The Employment Act of 1946” A landmark in American economic
legislation mandating the Federal government to take action in
order to maintain economic stability.
The Five Fundamental Questions

#1 What will be produced? In a market system the
types and quantities of goods to be produced is based on profit.
If firms are making a profit the good will be produced. The
greater the profit the larger the quantity being produced (vice
versa for losses.)

In a Command system the types and quantities of goods
produced & services provided have typically been determined by
a central planning committee (5 year plan of the Soviet Union.)
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Consumer sovereignty is crucial in determining the types &
quantities produced. Consumers spend their income through
“dollar votes.” Dollar votes ultimately determine which
industries exist and which fail.
The Five Fundamental Questions
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#2 How Will Goods & Services Be Produced? This
question focuses on the various combinations of resources and
technology used to produce goods or services ( “mix of the
factors”.)
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The “mix of the factors” is directly related to minimizing costs
(outsourcing and off-shoring,) because competition
eliminates high-cost producers, especially in a global
economy.
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The most “efficient production technique” depends on the
available technology and the prices of necessary inputs (land,
labor, capital, and entrepreneurial ability.)
The Five Fundamental Questions
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#3 Who Will Get the Output? Who will receive the
distribution (allocation of resources) of total output depends on
the consumers willingness and ability to pay the existing market
price.
Income is a key determinant of consumption and was a primary
concern of Karl Marx (The Father of Modern Scientific Socialism)
in relation to capitalism. Proletariat, the “Have-nots” and
Bourgeoisie, the “Haves.”
The amount of income a consumer has is dependent on
numerous factors, but include the quantities of the property and
human resources they supply (land, labor, capital, and
entrepreneurial ability.)
Resource prices (wages, interest, rent, profit) are crucial in
determining the size of a person’s income and therefore their
ability to consume.
The Five Fundamental Questions
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#4 How Will the System Accommodate Change?
Market systems are very dynamic and possess the
incredible feature of changing quickly in relation to
consumer preferences (consumer sovereignty &
dollar votes.) Always in “Flux.”
Resources can be reallocated very quickly in a
market system, because of “voluntary exchange.”
The Law of Supply & Demand explains how the
“market” will adjust to prices and quantities.
Surpluses or Shortages of a good or service cause
market prices to lower/increase, encouraging an
increase/decrease in the quantity demanded, and a
decrease/increase in the quantity supplied. The
market is always in search of the equilibrium.
The Five Fundamental Questions
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#5 How Will the System Promote Progress?
Society desires economic growth (greater output) and higher
standards of living. To accomplish these goals the economy
must promote technology & capital accumulation.
A Market system by its very nature encourages technological
advancement (profit incentive.) An entrepreneur or firm that
introduces a popular new product or finds new methods of
production increases profit and reduces costs.
In a Market system there is a rapid spread of technological
advancement throughout an industry. A “creative destruction”
may take place. The creation of new products and production
methods destroys the market positions of firms unwilling to
move forward. Technology advances require additional capital
goods.
Adam Smith & the “Invisible Hand”
• In his book, The Wealth of Nations (1776), Adam
•
•
Smith noted that market systems create a unique bond
between private interests & social interests.
Firms and individuals (resource suppliers) seek their own
self-interest which creates a framework for
competition. Firms maximize profits and
households maximize incomes.
The desire of individual firms and households to gain
maximum satisfaction (self-interest) guides the
market system without the need for government
involvement. Thus an “Invisible Hand”
Three Major Virtues of a
Market System
Efficiency of resources takes place in a market
system as they are guided into the production of
goods & services most desired by society. There
are both, allocative (“guns or butter”) and
productive (lowest per unit production cost)
efficiency.
Incentives encourage workers to sell their labor
for income and entrepreneurs to take risks &
innovate for profit.
Freedom, both personal and economic is the
foundation of a market system. Central planning
uses coercion to coordinate economic activity, a
market system is guided by “self-interest” and
“voluntary exchange.”
•The Demise of the
Command System
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Command systems throughout the world have been
vanishing. From the Soviet Union, to nations throughout eastern
Europe, and even China. Transitions to market economies
have been fast & furious. Two insurmountable problems have
caused this demise.
#1 The Coordination Problem involves the failure of
central planners to coordinate consumers, resource
suppliers and businesses. Market systems are guided by the
law of supply and demand. Prices, consumer sovereignty,
dollar votes and profit incentive determine “what & how much is
produced.” Central planning has led to extreme shortages and
surpluses in command economies, creating environments futile
for uprisings and revolution.
#2 The Incentive Problem involves the inability of a
command system to motivate both workers and producers.
Workers unable to demand higher incomes for greater
productivity, simply maintain the status quo. Entrepreneurs
have no incentive to risk or innovate, because the reward of
profit is nonexistent.
The Circular Flow Model

The Resource Market is the
place where resources or the
services of resource suppliers
are bought and sold.

The Product Market is
where goods and services
produced by businesses
are bought and sold.

Households sell resources
and businesses buy them.

Businesses combine
resources to produce and
sell goods and services.

Households receive flows of
income: wage, rent, interest,
profit.

Businesses buy
resources and sell
products.

A circular flow of income
involves both income &
consumption.

Households buy from
businesses in the product
market & thus the circular flow
of income.
Influential Economists
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Adam Smith: 1723-1790, Scotland “An Inquiry into the
Nature & Causes of the Wealth of Nations 1776.”
Invisible Hand & “Laissez-Faire
David Ricardo: 1772-1823, London “Principles of Political
Economy & Taxation 1817.” Comparative Advantage
Karl Marx: 1818-1883, Germany “The Communist
Manifesto 1848, and Das Kapital: A Critique of Political
Economy 1876.” Class Struggles & Labour Theory of Value
John Maynard Keynes: 1883-1946, Cambridge, England
“The General Theory of Employment, Interest & Money
1936.” Deficit Spending, Aggregate Demand,
Macroeconomics “In the long run we are all done.”