Basics of Economics

An Introduction

Bell Ringer

• There are 14 students, yet I only have ten pieces of candy.

• How do I decide who gets a piece?

• Hand out candy.

• Offer a choice: instead of candy you can have one point extra credit.

• But first, depending on your choice, what will you give up?

Essential Questions

• What is economics (micro/macro)?• What are the basic economic principles (scarcity, trade offs,

opportunity costs, factors of production, types of economic systems, production questions-how each system answers them; continuum)?

• Why does scarcity exist?• How does scarcity impact the economic decisions of individuals?• What are the four factors of production?• Why is productivity an important indicator of the management of

scarcity?• What types of economic systems exist?• How does each economic system answer the production questions

and deal with scarcity?• What is the role of profit?

Economics

• Economics is the study of how people, societies, industries, and governments choose to use resources.

•  Microeconomics is a branch of economics that studies the behavior of individual households and firms in making decisions on the allocation of limited resources– Typically, it applies to markets where goods or services are

bought and sold. – Microeconomics examines how these decisions and behaviors

affect the supply and demand for goods and services, which determines prices, and how prices, in turn, determine the quantity supplied and quantity demanded of goods and services.

Economics

• Macroeconomics  is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole, rather than individual markets.– This includes national, regional, and global

economies.– Macroeconomists study aggregated indicators such

as GDP, unemployment rates, and price indices to understand how the whole economy functions.

Founding Principles

Scarcity•  is the fundamental economic problem

of having seemingly unlimited human wants and needs in a world of limited resources

– It states that society has insufficient productive resources to fulfill all human wants and needs.

– Alternatively, scarcity implies that not all of society's goals can be pursued at the same time; trade-offs are made of one good against others.

• Trade off is when you give up one thing for another.

• It therefore, heavily impacts how the thr

Opportunity Cost• the value of the next-highest-valued

alternative use of that resource.

• If, for example, you spend time and money going to a movie, you cannot spend that time at home reading a book, and you cannot spend the money on something else.

• If your next-best alternative to seeing the movie is reading the book, then the opportunity cost of seeing the movie is the money spent plus the pleasure you forgo by not reading the book.

"Economics is the science which studies human behavior as a relationship between given ends and scarce means which have alternative uses."-- Lionel Robbins,  An Essay on the Nature and Significance of Economic Science (London: MacMillan, 1932)

The impact of scarcity and opportunity cost

• People and the economy have to make decisions about what to produce and what to buy under the condition of scarcity

• Producers make what they think consumers will buy so the resources they use and the price associated with them are determined by the perceived profit that can be made

• Consumers have to decide between wants and needs in order to determine what to spend their limited resources on.– Wants: things they are not necessarily to sustain life– Needs: things necessary to life; i.e. food, shelter, water.

The Decision-Making Model

The Four Factors of Production

• Land, labor, capital & entrepreneurship

• Used to answer the basic economic questions

• Are the resources (essential ingredients) of economic activity

• Goal of economic activity = productivityo Amount of goods & services the

economy createso Depends on how producers combine

the 4 factors

Four Factors

Capital• Has a few meanings

• Financial capital

• An investment resource used in production

o Invests in new businesses or expands already existing businesses

• Capital goods:o Products that can be used in the

production of different products but that are not part of the new product

o Examples: machinery, buildings, stocks of raw materials

Entrepreneurship

• Human resource that brings land, labor, and capital together by starting, operating, and expanding businesses

• Create productivity through their enterprise

• Operate businesses to make a profito Reward for the economic

risk of entrepreneurs

Four Factors

Land

• An economic resource as property

• Landowners earn money from property through:o Charging Rento Leasingo Selling

• Land adds natural resources to productiono Renewable Resources:

treeso Nonrenewable Resources:

minerals, fossil fuels

Labor

• Provided by workers

• Also known as human capitalo A person’s potential for

economic productivity

• Some potential comes naturally:o Talent for drawingo Being good at math

• What helps develop human capital?o Educationo Trainingo Good Habits of Character

Productivity

• Economies strive to achieve maximum productivity

• Definition: the relationship between the 4 factors that go into production & the goods and services that come out of production

• Increases to the extent that input creates more output

• In general a society’s degree of productivity determines its average standard of living

• The level of wealth, comfort, material goods and necessities available to a certain socioeconomic class in a certain geographic area.

• Increased by the efficient use of production

• An economy is efficient when the cost of producing a given good or service is as low as possible and equal to its price

• In an efficient economy, resources are used in ways that maximize their intended values

• Actions that make the economy more efficient increase its overall wealth

Economic Systems and Scarcity • Capitalism or Market Economy• Communism or Command Economy• Mixed Economy• Traditional Economy• The type of economic system determines:

– How scarcity will be handled by society• Answers three production questions:

– What will be produced– How it will be produced– For Whom to produce

– The level of government involvement• Planning, allocation of resources, role of private property,

and market regulation

In a PURE MARKET ECONOMY there is no government involvement in economic decisions. The government lets the market answer the three basic economic questions:

1. What will be produced? Consumers decide what should be produced in a market economy through the purchases they make. Producers react to consumer choices using supply and demand

2. How will it be produced? Production is left entirely up to businesses. Businesses must be competitive in such an

economy and produce quality products at lower prices than their competitors. Quantity and price is determined by the relationship

between production costs and supply and demand

3. For whom to produce? In a market economy, the people who have more money are able to buy more goods and

services.

Adam Smith & The Wealth of Nations

• 1776

• Showed how the market economy could increase productivity & wealth

• This type of economy later dubbed capitalism

Capitalism/ Free Enterprise System

• Full Market Economy• free enterprise system

• laissez faire

• Based on private ownership of industry and competition

• Most associated with democracy

• Makes two assumptions about human beings:o People have a right to own private

property (property & capital that belongs to individuals)

o People work from self-interest (their own gain)

In a PURE COMMAND ECONOMY there is complete government involvement in economic decisions. The government answers the three basic economic questions:

1. What? In a command economy, government officials decide what will be produced and in what amount.

2. How? Production is left entirely up to the government. The government owns the means of production. Businesses and property belong to the government.

3. For whom? In a command economy, the government decides for whom to produce without considering market demand. A command economy is

designed to keep a few people from becoming rich while the rest of society struggles or winds up in poverty.

The Communist Manifesto• Written by Karl Marx & Friedrich Engels

• Reaction to exploitations of workers during first stages of Industrial Revolution in Europe

• Argued that the economy would be fair only if workers controlled productiono In fact, governments have operated communist

economieso All businesses are owned & operated by the

government for the benefit of all citizenso Cooperation replaces competitiono People work their fair share willinglyo The state provides everyone equally with what

they needo No private propery

Mixed Economy

• Nearly all modern world economies have characteristics of both market and command economic system.

• Some mixed economies lean more towards free markets and some tend to lean more toward command structures.

Mixed Economy

• what to produce: businesses; can include government planning; especially during times of war

• How to produce it: businesses based on supply and demand but certain elements are regulated or subsidized by government

• For Whom is it produced for: consumers; sometimes determined by government

Keynesianism• The Great Depression showed that

capitalist economies do not always balance themselveso In response, the economist John Maynard

Keynes developed a theory called Keynesianism

• Keynesianismo Says that fiscal policy (government

spending & taxation) and deficit spending (the spending of borrowed money by the government to combat recession) can balance the economy

Mixed EconomyThe United States is not totally a market economy. It is a mixed economy.

Example 1: The economy of the United States is based on private enterprise. However, some industries (for example, power companies and railroads in some areas) are under collective ownership.

Example 2: The United States government is involved in the economy through laws and regulations governing businesses, and it provides socialistic programs, such as welfare, Medicaid, and Medicare.

Example 3: The government monitors how stocks are traded, outlaws monopolies, and will intervene if inflation gets out of control.

HOWEVER, the United States government tries to let the market operate as freely as possible.

Mixed Economy

China is not a totally command economy It is a mixed economy. It places strict controls on its economy, and many of the larger industries are owned by the state. In recent years, though, China’s desire to compete economically in the world has led it to allow some private ownership and business.

It is possible to look at economic systems along a continuum.

Typically, the continuum runs from a Pure Command Economy to a Pure Market Economy.

On a continuum, from Pure Command Economy to Pure Market Economy, economic freedom runs from none to total.

On notebook paper, draw and label this continuum.

1. Place the economy of the United States on your continuum.

2. Place the economy of Cuba on your continuum.

3. Place the economy of the People’s Republic of China on your continuum.

•On this continuum, the economy of the United States would be placed closer to the right-hand side of the line than the left-hand side. •China would be placed much closer to the left-hand side of the scale. •Cuba would be placed closer to China than the United States.

(Of course, the placements on the continuum could change if political or economic changes are made in these countries.)

As you can see, when studying different economic systems, it is good to view them on a continuum.

Quick review: On this continuum where would you place the China? Cuba? Where do you think you should place Mexico?

Task:

In a well-written paragraph, explain why the United States economy is placed where it is placed on this continuum.

Why the United States is placed where it is on this continuum? The economy of the United States is not a pure market but instead is a mixed economy leaning toward market. The United States has some market elements in the economy. The United States also has some elements of a traditional economic system . For example, goods are often exchanged or bartered at a flea market. The United States also has some command elements. For example, the U. S. government controls the production of some goods (like nuclear weapons) or decides who will get some goods (such as food stamps).

Traditional

• A traditional economy is defined by three characteristics– It is based on agriculture, fishing, hunting, gathering

or some combination of the above.– It is guided by traditions.– It may use barter instead of money

• Typically located in third world nations that are considered to have emerging economies

• All economies are thought to have evolved from traditional roots

• Is not usually placed on a continuum

Application

• Think of a resource that is scarce in your personal life: it could be a tangible or intangible resource– Why is it scarce? – How do you determine its utilization?– What is the opportunity cost associated with

this above decision?

Application

• Go to http://www.heritage.org/index/country/brazil• Determine the type of economy for the following

nations:– Brazil – Hong Kong – Venezuela– Estonia

• For each provide evidence for your answer.• Finally, place each on a market continuum.