ECONOMICS FOR MANAGERS

1 of 32Visit UMT online at www.umtweb.edu© Prentice Hall 2003Economics: Principles and Tools, 3/e

Chapter 3, ECON125

ECONOMICS FOR ECONOMICS FOR MANAGERSMANAGERS

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Chapter 3, ECON125

CHAPTER 3CHAPTER 3

Markets and GovernmentMarkets and Governmentin the Global Economyin the Global Economy


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Why Do Markets Exist?Why Do Markets Exist?

Markets exist because we aren’t self-sufficient but instead consume many products produced by other people.

The typical person is not self-sufficient but instead specializes by working at a particular job and uses his or her income to purchase goods and services.


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Specialization and theSpecialization and theGains From TradeGains From Trade

We can use the principle of opportunity cost to explain the benefits from specialization and trade.

PRINCIPLE of Opportunity CostThe opportunity cost of something is what you sacrifice to get it.


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Production per HourProduction per Hourand Opportunity Costand Opportunity Cost

Brenda Sam

Bread produced per hour 6 1

Shirts produced per hour 2 1

Opportunity cost of one loaf of bread 1/3 shirt 1 shirt

Opportunity cost of one shirt 3 loaves of bread

1 loaf of bread


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Opportunity Cost andOpportunity Cost andComparative AdvantageComparative Advantage

Comparative advantage: The ability of one person or nation to produce a good at an opportunity cost that is lower than the opportunity cost of another person or nation.

Absolute advantage: The ability of one person or nation to produce a particular good at a lower absolute cost than that of another person or nation.


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How Do Markets Operate?How Do Markets Operate?

Exchanges occur in two markets:Factor or input market: The owners of the factors of production–natural resources, labor, physical capital and human capital–sell these inputs to organizations that use the inputs to produce goods and services.

Product or output market: The organizations that produce goods and services sell their products to consumers.


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The Circular Flow DiagramThe Circular Flow Diagram

The circular flow diagram is a diagram showing the flow of money and goods between markets.


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Households as Sellers and Households as Sellers and BuyersBuyers

In labor markets, households sell their labor to firms for wages. About 75% of income is earned by households.


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In capital markets, households provide savings that firms use to purchase physical capital. Households receive interest or a share of the firm’s profits in return.


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In natural resource markets, households sell natural resources to firms to use as inputs in the production process.


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Inputs flow from households into factor markets where they are purchased by firms and then transformed into products.


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Products flow from firms to product markets where they are purchased by households.


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The Global EconomyThe Global Economyand Interdependenceand Interdependence

Export: A good produced in the “home” country (for example, the United States) and sold in another country.

Import: A good produced in a foreign country and purchased by residents of the “home” country (for example, the United States).


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Major Imports and ExportsMajor Imports and Exportsof the United States, 1999of the United States, 1999


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Major Trading PartnersMajor Trading Partnersof the United States, 1999of the United States, 1999


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Protectionist PoliciesProtectionist Policies

Protectionist Policies: Rules that restrict the free flow of goods between nations, including tariffs (taxes on imports), quotas (limits on total imports), voluntary export restraints (agreements between governments to limit imports), and nontariff trade barriers (subtle practices that hinder trade).


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History of Tariff and Trade History of Tariff and Trade AgreementsAgreements

General Agreement on Tariffs and Trade (GATT): An international agreement that has lowered trade barriers between the United States and other nations.

World Trade Organization (WTO): An organization that oversees GATT and other international trade agreements.


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North American Free Trade Agreement (NAFTA): An international agreement that lowers barriers to trade between the United States, Mexico, and Canada (signed in 1994).

European Union (EU): An organization of European nations that has reduced trade barriers within Europe.


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Asian Pacific Economic Cooperation (APEC): An organization of 18 Asian nations that attempts to reduce trade barriers between their nations.


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Currency Markets and Exchange Currency Markets and Exchange RatesRates

Foreign exchange market: A market in which people exchange one currency for another.

Exchange rate: The price at which currencies trade for one another.


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Exchange Rates in July 2001Exchange Rates in July 2001

Nation CurrencyValue in Dollars

(U.S. $ equivalent)Units per Dollar

(Currency per U.S. $)

Australia Dollar 2.51 1.96Brazil Real 0.41 2.41Britain Pound sterling 1.41 0.71Canada Dollar 0.66 1.51France Franc 0.1291 7.74Germany Mark 0.4332 2.3077Hong Kong Dollar 0.1282 1.799Ireland Punt 1.07 0.92Israel Shekel 0.24 4.19Japan Yen 0.0079 125.75Mexico Peso 0.1095 9.12Saudi Arabia Rial 0.27 3.75


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Global InterdependenceGlobal Interdependence

Multinational corporation: An organization that produces and sells goods and services throughout the world.

Worldwide sourcing: The practice of buying components for a product from nations throughout the world.


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Global InterdependenceGlobal Interdependence

Financial liberalization: The opening of financial markets to participants from foreign countries.

International Monetary Fund: An organization that works closely with national governments to promote financial policies that facilitate world trade.


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Government in a Market Government in a Market EconomyEconomy

The government has five general responsibilities in a market-based economy:

Providing goods and services.

Redistributing income.

Taxation.

Regulation of business practices.

Trade policy.


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Percentage of Government Percentage of Government Spending on Various ProgramsSpending on Various Programs

Local Expenditures (1996)

Administration and other 32%

Education 42%

Health and hospitals 9%

Police protection 5%

Public welfare 5%Highways 5%

State Expenditures (1998)

Administration and other 20%

Education 35%

Public welfare 25%

Health and hospitals 8%

Highways 8%Police and

corrections 4%

Federal Expenditures (1999) Net interest 13%

Other 14%

National defense 16%

International affairs 1% Health 8%

Medicare 11%

Social security 23%

Income security 14%


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Criteria for a Tax SystemCriteria for a Tax System

The benefit-tax approach suggests that a person’s tax liability should depend on his or her benefits from government programs.

Horizontally equitable: the idea that people in similar economic circumstances should pay similar amounts in taxes.

Vertical equity: the idea that people with more income or wealth should pay higher taxes.


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Percentages of Government Percentages of Government Revenue from Different SourcesRevenue from Different Sources

Local Revenue (1996)

Property 45%

Individual income taxes 3%

Other 4% Sales 10%

Charges and miscellaneous

38%

General State Revenue (1998)

Corporate income taxes 4%

Charges, fees, other21% Sales 26%

Intergovernmental revenue 28%


Federal Revenue (1999)

Social insurance and retirement receipts 33%

Other 8%


Corporate income taxes 10%


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Tax Rates in Different NationsTax Rates in Different Nations

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Government Regulation of Government Regulation of MarketsMarkets

Mixed economy: A market-based economic system in which government plays an important role, including the regulation of markets, where most economic decisions are made.


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Alternative Economic SystemsAlternative Economic Systems

Centrally planned economy: An economy in which a government bureaucracy decides how much of each good to produce, how to produce the goods, and how to allocate the products among consumers.


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Alternative Economic SystemsAlternative Economic Systems

Transition: The process of shifting from a centrally planned economy toward a mixed economic system, with markets playing a greater role in the economy.

Privatizing: The process of selling state firms to individuals.

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