1. Introduction to Economics

2. What is Economics?
Scarcity: Economics is about the allocation of scarce resources among society’s various needs and wants.
Tradeoffs: individuals and society as whole are constantly making choices involving tradeoff between alternatives. Whether it’s what goods to consume, what goods to produce, how to produce them, and so on.
Opportunity Cost: “the opportunity cost is the opportunity lost”. In other words, every economic decision involves giving up something. NOTHING IS FREE!!
Humans' wants are unlimited, while the resources needed to meet those wants are limited and scarce

3. What is Economics?
People can’t have everything they want or need, must consider options to decide how to fulfill their needs when they face a limited supply of resources
Economics is how people seek to satisfy their needs and wants by making choices
Why must people make these choices? The reason is scarcity
Americans find it hard to understand scarcity
We have an abundance of goods and services

4. Scarcity
Limited quantities of resources to meet unlimited wants, never an unlimited supply of anything
Shortage- can’t offer goods or services at current prices (can be short term or long term)
Scarcity- always exists because there is never an unlimited quantity
Goods and services are scarce because they are made from resources that are scarce

5. Land, Labor and Capital
Four resources used to make goods and services are called factors of production
Factors of production are land, labor and capital
Land- natural resources used to produce goods (farmland and products, coal, oil, etc.)
Labor- effort used by person for which person is paid
Capital- human made resource that is used to produce goods and services, two categories physical and human capital

6. Two Types of Capital
Physical Capital- human made objects used to create goods and services
Important factor of production because it can save a great deal of time and money, increases efficiency
Human Capital- knowledge and skills a worker gains through education and experience
Entrepreneurs- (4th factor) Pull resources together
Decide how to pull together land, labor and capital to produce goods and services

7. Scarce Resources
All goods and services are scarce because land, labor and capital are limited
What goes into making French fries?

8. Opportunity Cost
Trade offs- alternatives we sacrifice when we make a decision, individuals and businesses make trade offs
Business’ make trade offs on how to use land, labor and capital resources
Societies and governments make trade offs
Economists call these decisions guns or butter, a country that chooses to make military equipment has fewer resources to devote to food production

9. Defining Opportunity Cost
One alternative is always more desirable than another, desirable alternative given up is opportunity cost
Example- Every day decision to sleep late or study , what you are willing to give up (better grades, more rest) is the opportunity cost
We select one alternative from the decisions we have to make and forgo the benefits of the others

10. Opportunity Cost You must give up something to have what you want
Examples:
The opportunity cost of watching TV on a weeknight is the benefit you could have gotten from studying.
The opportunity cost of going to college is the income you could have earned by getting a job out of high school
The opportunity cost of starting your own business is the wages you give up by working for another company
The opportunity cost of using forest resources to build houses is the enjoyment people get from having pristine forests

11. Thinking at the Margin
Deciding whether to add or use one additional unit of a resource
Need to make decisions, when is the cost no longer worth the benefit?
Thinking at the margin lets us evaluate options based on available resources
Decision making process is called cost/benefit analysis
Means making a decision about how much more or less to do
Allows us to evaluate options based on available resources
Once opportunity cost outweighs benefits no more units should be added

12. Production Possibilities Curves
Economists use graphs to decide what trade offs to make
Production possibilities curves (PPC) are used to decide ways to use productive resources, what goods and services to produce
Illustrates the possible combinations of goods or services that can be produced by a single nation, firm, or individual using resources efficiently
Using resources to produce one product means fewer resources are available to make something else

13. Efficiency, Growth and Cost
PPC can show how productive an economy is, its growth or possibility for growth
Efficiency- maximizing resources for production output of goods and services
Underutilization is using fewer resources than the economy is capable of using
Growth- availability of resources are constantly changing
Examples- increase in labor force or better technology causes growth; aging population or health crisis can stop growth

14. Efficiency, Growth and Cost
Cost- alternative we give up when we choose one product over another
Not always money
Always means opportunity cost
Increasingly expensive trade offs known as law of increasing costs
Law states that as production switches from one item to another more resources are needed to produce second item, opportunity cost increases
Technology has an effect on the PPC, production possibilities depend on the technological level and resources available

15. Economic Systems
Chapter 2

16. Economic Systems Scarcity forces societies to make decisions
Different economic systems have evolved in response to the problem of scarcity
Economic system- method used by society to distribute goods and services

17. Economic Systems What goods and services should be produced?
Three Key Economic Questions
What goods and services should be produced?
How should these goods and services be produced?
Who consumes these goods and services?

18. What to Produce? Basic Needs: Food, Clothing, and Shelter
Examples include:
Basic Needs: Food, Clothing, and Shelter
Wants: Luxury Items
Services: Education, Health Care, Defense, etc.
Each production decision has an opportunity cost

19. How should goods and services be produced?
How to use our resources
Decide how to use factors of production
Examples Include:
Size and Organization of Facilities
Time and Effort Committed

20. Who consumes these goods and services?
How are goods and services divided up?
How do societies distribute income?
How do we decide the worth of a factor of production?
Factors of payment- income people receive for supplying factors of production (rents, wages, profits)
Society places different values on different resources and products
Examples Include:
Choices in Products
The Value/Price of Products
Access to Services

21. Economic Goals and Social Values
Different societies answer these economic questions based on the importance they attach to economic goals
They pursue each of these goals at the expense of others (opportunity cost)
There are 5 major goals
1. Economic efficiency- maximize what they can get for the resources they have to work with
2. Economic freedom- different nations have different degrees of economic freedom
Americans have freedom from government intervention in the production of goods and services

22. Economic Goals and Social Values
3. Economic security and predictability- economic systems reassure people that goods and services will be available and that government will provide a safety need for needy and those with economic disadvantages
4. Economic equity- how society divides the economic pie, society does not value all jobs equally

23. Economic Goals and Social Values
5. Economic growth and innovation- economy must grow to improve its standard of living, provide jobs and income
Innovation plays a role in growth it increases production and brings new goods and services
Additional Goals- Other important concerns (health care for everybody, environmental concerns), nations must prioritize
Achieving goals comes with a trade off

24. The aftermath of Hurricane Katrina
The aftermath of Hurricane Katrina. What economic goals could help them recover from this storm?

25. Different Economic Systems
Four distinct economic systems have developed to address these key economic questions
Each reflects the values of the societies they represent
Traditional economy- relies on habit, custom and ritual
Little room for innovation and change
Family oriented and it works along gender lines
Often from small societies that have a low standard of living and a lack of modern conveniences

26. Different Economic Systems
Market Economy- decisions are made by individuals and based on exchange and profit
Individuals determine the answers to the three basic economic questions
Also known as capitalism or free market economy
Command Economy- government decides how to answer three key questions
Also known as a centrally planned economy
Mixed Economy- market based system where government plays a limited role and free markets play a role

27. The Free Market
Market – an arrangement that allows buyers and sellers to exchange things
Why do they exist?
Nobody is self- sufficient, allow us to exchange what we have for what we want
We can’t produce everything so we just produce a few or one product
This is called specialization (concentration of efforts on a limited number of activities)
Specialization allows us to sell what we make and buy what we want

28. Free Market Economy
Economic systems based on voluntary exchanges in markets called free market economy
Individuals own factors of production and answer three key economic questions
Key players in free market economy are households and firms
Households consume goods and services, own factors of production
Firms are organization that produce goods and services; take inputs (factors of production) and turn them into outputs( products)

29. Free Market Economy
Firms purchase factors of production from households
Hire workers, pay wages, borrow money to purchase capital and paying them in interest or profit in return
Area of exchange called a factor market
Goods and services firms produced are purchased by households in the product market
These exchanges are represented in a circular flow diagram that shows how individuals and businesses exchange money

31. The Self- Regulating Nature of the Marketplace
Why do these groups cooperate ?
According to Scottish social philosopher Adam Smith it is competition and our own self interest that keeps marketplace moving
Smith wrote Wealth of Nations (1776) that described how the market functions
Self Interest
He said an economy is made up of countless transactions
In each the buyer and seller consider only their own self interest and this motivates the free market

32. The Self- Regulating Nature of the Marketplace
Competition
Because of self interest consumers have an incentive to look for the best prices
Firms seek to make greater profit by increasing sales
The struggle between producers and consumers is called competition
Self interest is a motivating force and competition is a regulating force
These forces working together to regulate the market was called by Smith “the invisible hand”

33. Advantages of the Free Market
Economic efficiency- responds rapidly to changing conditions
Economic Freedom- workers work where they want, producers produce what they want
Economic Growth- competition and the profit motivate encourage growth and innovation
Additional Goals- offers a wide variety of goods and services, consumers decide what is produced (consumer sovereignty)
Weaknesses of a free market- no pure free market exists, economic equity and economic security are difficult to achieve

34. Centrally Planned Economies

35. How is a Centrally planned Economy Organized?
Direct contrast to free market economy
Central government answers key economic questions
Government owns factors of production, set quotas on what to produce
Self interest and competition absent from system
There is no consumer sovereignty

36. Socialism and Communism
Socialism political and social philosophy based on belief that democratic means should be used to distribute the wealth
Public controls centers of economic power
Government owns major industries
Communism economic and political power lies in the hands of the central government
Society can only change after a violent revolution and all government is authoritarian

37. The Former Soviet Union
Russian Revolution in early 20th century led to rise of communism and central planning
USSR concerned with status as world power
Allocated all factors of production and put resources in hands of armed forces, factories and agriculture
Agriculture and industry established quotas to and distribution systems planned by central government
Took away incentive for production, quality and innovation
Left consumers with low quality goods because state had to buy them
Makers of consumer goods and consumers experienced the burden of this opportunity cost

38. Problems with Centrally Planned Economies
Can be used to jumpstart industries and guarantee jobs and income
Disadvantages
Lack of incentive can lead to poor quality goods and diminishing production
Stalin had some success in USSR with heavy industry
Performance always falls short of ideals
Systems lack flexibility to meet consumer demands and wants
Sacrifice individual freedom for societal goals
Few countries have centrally planned economies because experiment has failed
Many countries are moving toward a mixed economy

39. Modern Economies

40. The Rise of Mixed Economies
Most contemporary economies are mixed economies that blend the market and government intervention
Limits of Laissez Faire
Smith thought free market brought greatest benefit and raised standard of living
Laissez faire doctrine that government should not interfere in marketplace
Over time market economies have evolved, needs an wants of society are difficult to meet in a totally free marketplace

41. The Rise of Mixed Economies
Governments create laws protecting property, enforcing contracts and insisting on competition
Provides incentive for innovation, and keeps one firm from dominating marketplace
Society has to assess values and prioritize economic goals
Some goals met better by market and some by government
Each nation decides opportunity cost to pursue goals (what they have to give up)

42. Circular Flow of Mixed Economy
Government purchases land, labor and capital from households in the factor market (federal employees)
Government purchases goods and services in the product market (office supplies)
Government provides goods and services through combination of factor resources (roads)
Government collects taxes from individuals, businesses and transfers it across the economy

43. Comparing Mixed Economies
Foundation of US economy is free market (private ownership of capital goods) where individuals make decisions rather than the state
At one end lies North Korea at the other is Hong Kong

44. Comparing Mixed Economies
North Korea- almost totally controlled by the government, business owned by government and imports banned
China- economy is dominated by government, many enterprises are becoming owned by individuals (privatization), China is a transition economy
Hong Kong- one of the worlds freest markets, private sector rule and there is rarely government interference except to control some rents and wages

45. American Free Enterprise

46. Tradition of Free Enterprise
America considered “land of opportunity”, can achieve success through hard work
Why has America had economic success?
Open land, natural resources, open (?) immigration, tradition of free enterprise (commitment to giving people freedom and flexibility to compete in the marketplace)

47. Constitutional Protection
Constitution guarantees rights that allow people to engage in business activities
Property rights- 5th, 14th Amendments
5th Amendment protects property rights from government interference, 14th amendment limits state governments from taking property
Government must provide a fair price for property that is taken (imminent domain)

48. Constitutional Protection
Taxation
Constitution has basic rules to tax individuals and businesses
16th Amendment (1913) gave Congress power to tax based on income
Article I, Sec. 10 gives businesses the right to make contracts, term can’t be changed by legislative action, political process can’t be used to get out of contracts

49. Basic Principles of Free Enterprise
Key characteristics: profit motive, open opportunity, legal equality, private property rights, free contracts, voluntary exchange, competition
Profit Motive- force that encourages improvement of material well being, makes people responsible for their own success and failure, rewards innovation
Open Opportunity- everyone can compete in the marketplace, allows economic mobility up and down

50. Basic Principles of Free Enterprise
Economic Rights-
legal equality everyone has the same rights
property rights right to control property and possessions
free contract decide what agreements we want to enter into
voluntary exchange decide what we want to buy and sell
competition rivalry among sellers and customers

51. Role of the Consumer
Fundamental purpose is to give consumer freedom to make economic choices
Consumers can make wishes known by forming interest groups to persuade public officials on economic issues like taxation, land use, etc.

52. The Role of Government
Expect government to carry out duties and protect Constitutional rights, and business activities
Information and free enterprise- consumers expect basic information on what we purchase, educated consumers make market work more efficiently
Protecting health, safety and well- being- government regulates industry, imposes various restrictions (consumer protection laws, environmental regulation)
Negative effects of regulation- protections costly to implement and can lead to higher prices, stifles competition

53. Promoting Growth and Stability
American economy very big, armies of economists predict whether business will grow or shrink
One way to measure economic trends is calculate Gross Domestic Product (GDP), total value of all goods and services produced by economy
GDP can predict business cycles (periods of expansion followed by contraction)
Free enterprise subject to ups and downs because economic decisions are made by business and individuals acting in their own self interest

54. Promoting Economic Strength
Government makes public policy to stabilize economy
Goals are high employment, steady growth and stable prices
Unemployment- rate 4-6% is desirable, economic policy is to create jobs
Growth- Each generation wants higher standard of living than previous generation, means economy must grow
Stability- People want stable economy; government promotes stability, keeps prices from sudden dramatic shifts
Desire stable financial institutions, money protected from fraud and mismanagement
Governments regulate business and banks to insure stability
Elective choices guide government economic policy

55. Technology and Productivity
American have higher standard of living than most other countries
Factors- work ethic, technology
Work ethic- Americans value work and purposeful activity
Technology- produces more output, allows economy to operate efficiently and productively
Gives US competitive advantages

56. The Government’s Role Government is engine of free enterprise system
Provides incentives for innovation
Funds research and development through universities, own research institutions (NASA)
Offers inventors possibility of making huge profits through patent and copyright grants
Patent- exclusive right to produce and sell product for 20 years
Copyright- exclusive right to sell creative works
Copyrights and patents protected by Constitution (Article1, Sec. 8)

57. Providing Public Goods
Shared good or service for which it would be impractical to make consumers pay for individually or to exclude non payers
Making customers fund projects in public interest is the reason behind taxation
To not exclude non-payers we believe certain facilities and services should be available to all
Everybody should be able to use public goods without reducing the benefits to any single consumer

58. Costs and Benefits of Public Goods
Cost critical in determining whether something is produced as public good
Benefit to each individual is less than cost that each would have to pay if it were provided privately
Benefits to society are greater than cost
Public goods financed by public sector (part of economy that involves transactions of government)

59. Free Rider Problem
Free rider- someone who would not choose to pay for something but would receive benefits anyway, consume what they do not pay for
Fire protection, national defense are examples
Taxes are collected to reduce this phenomenon
All people are better off if government provides service

60. Market Failures and Externalities
Market failure situation in which market does not distribute resources efficiently
Markets operate on individual choice, competition and self interest, distributes resources unevenly
Public ownership can produce positive and negative side effects called externalities
Externalities- economic side effect of a good or service that generates benefits or costs to someone other than the person deciding how much to produce or consume (side effects of economic decisions)

62. Positive and Negative Externalities
Positive externalities- Public goods that generate benefits to many people
Many believe that private sector can generate positive externalities more efficiently
Negative externalities- cause part of the cost to be paid by someone other than the producer
Government’s goals- encourage creation of positive externalities (ex. education), limit negative externalities (ex. pollution)

63. Providing a Safety Net
Free market great a generating wealth, but wealth is spread unevenly through society
Some live below poverty threshold (income level below what is needed to support a household)
Government tries to provide opportunity to lift poor out of poverty
Society recognizes need to help elderly, very young, poor, disabled; to help government provides a safety net
Many want a limited government role

64. The Welfare System
1930’s government took a more active role to ease poverty, funds redistributed in form of welfare
Great Depression started social welfare programs, increased in 1960’s during Lyndon Johnson’s “War on Poverty”
1990’s concern with population becoming dependent on welfare led to reform, arguments were that it discouraged productivity

65. Redistribution Programs
Major redistribution programs run by federal government
Cash transfers- direct payments
Temporary Assistance for Needy Families- states are given welfare funds, establish rules and work benefits, placed limits on benefits
Social Security- provides money to retired, disabled Americans
Unemployment insurance- provides money to workers that lost their jobs
Workers Compensation- provides money to workers injured on job, employers pay insurance to fund program

66. Redistribution Programs
In-Kind Benefits- goods and services provided free or greatly reduced benefits (food stamps, subsidized housing)
Medical Benefits
Medicare- health insurance for elderly, disabled
Medicaid- covers unemployed and those not covered by insurance (COBRA)
Education- education provided from preschool to college, adds to productivity of nation
Faith-Based Initiatives
Signed by Bush gives government support to religious organizations to deliver social services