McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved. 2-1 CHAPTER TWO Economics: The Creation and Distribution of Wealth

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved. 2-2 Economics: Study of how societies use scarce resources to produce goods & services and distribute them among competing parties. Land Land Labor Labor Capital Capital Entrepreneurship Entrepreneurship Knowledge Knowledge

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved. 2-3 Subareas within Economics Macroeconomics: Examines the economy as a whole Macroeconomics: Examines the economy as a whole Microeconomics: Examines the structure and behavior of particular economic sectors Microeconomics: Examines the structure and behavior of particular economic sectors

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved. 2-4 The Fundamental Questions of Economics $ What is produced and in what quantities? $ How is it produced? $ How is output distributed? Adapted from: Adapted from: Edwin Mansfield Economics (New York: W.W. Norton, 1976), p.8

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved. 2-5 Three Economic Systems Communism Socialism Capitalism (Highly Controlled ) (Little Control ) Mixed

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved. 2-6 Communism Public (government) ownership and control of factors of production Public (government) ownership and control of factors of production Central planning/controlled economy Central planning/controlled economy ‘From each according to his ability; to each according to his needs’ ‘From each according to his ability; to each according to his needs’

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved. 2-7 Criticisms of Communism Inefficiencies Inefficiencies Inaccurate demand estimates Inaccurate demand estimates Production and distribution bottlenecks Production and distribution bottlenecks Lack of incentive and innovation Lack of incentive and innovation Party elite enjoy unfair advantages Party elite enjoy unfair advantages

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved. 2-8 Socialism Government control of critical industries and resources Government control of critical industries and resources Significant government regulation & ‘safety nets’ for citizenry Significant government regulation & ‘safety nets’ for citizenry Goal of social equality/more even distribution of wealth Goal of social equality/more even distribution of wealth

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved. 2-9 Criticisms of Socialism Lack of incentive & innovation Lack of incentive & innovation Government red tape and foot dragging Government red tape and foot dragging Excessively high tax rates Excessively high tax rates

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Industrialized Nations Tax Rate Source: Parade Magazine, Apr. 12, 1998.

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Capitalism Private Property Private Property Profit/Ownership Profit/Ownership Freedom of Competition Freedom of Competition Freedom of Choice Freedom of Choice

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Criticisms of Capitalism Inequality of wealth- causes national & world tension Inequality of wealth- causes national & world tension Potential environmental damage Potential environmental damage Lack of ‘safety nets’ to protect the powerless from the powerful Lack of ‘safety nets’ to protect the powerless from the powerful

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Supply Curve Quantity(S) High High Low Price(P) S

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Demand Curve Price(P) Quantity(D) High HighLow D

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Quantity High HighLow Price EQUILIBRIUM POINT Market Equilibrium SD Surplus Shortage

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Quantity High HighLow Price A Price Ceiling Market Equilibrium SD

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Quantity High HighLow Price A Price Floor Market Equilibrium SD

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Degrees of Competition Sellers OneMany Monopoly Oligopoly MonopolisticCompetition Pure Competition

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Pure Competition Many Buyers Many Sellers Many Sellers Identical Products

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Monopolistic Competition = Many Sellers With Perceived Differences Restaurants Restaurants Landscape Contractors Landscape Contractors Beauty Salons Beauty Salons Colleges Colleges

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Oligopoly = Few Sellers Tobacco Tobacco Breakfast Cereals Breakfast Cereals Oil refining Oil refining Automobiles Automobiles

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Monopoly = One Seller Diamonds Diamonds Utilities Utilities

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Government’s Role in Economics Enforces Rules/Regulations Enforces Rules/Regulations Provides Public Goods Provides Public Goods Transfers Payments Transfers Payments Fosters Competition Fosters Competition Contributes to Economic Stability Contributes to Economic Stability

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved The Business Cycle: Economic Booms & Busts Recession Recovery Depression Recovery Recession

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved The Full Employment Act of 1946 Promote Economic Growth Promote Economic Growth Provide for Full Employment Provide for Full Employment Maintain Stable Prices Maintain Stable Prices

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Measuring Economic Growth The Gross Domestic Product (GDP) is the total dollar value of goods and services produced in an economy during a period of time (year or quarter). The Gross Domestic Product (GDP) is the total dollar value of goods and services produced in an economy during a period of time (year or quarter). C+I+G+X n =GDP=$11 trillion C+I+G+X n =GDP=$11 trillion

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Labor Productivity /3 of workforce produced U.S. food needs /3 of workforce produced U.S. food needs 2000 – 1/50 of workforce produces U.S. food needs 2000 – 1/50 of workforce produces U.S. food needs

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Types of Unemployment Frictional Frictional Seasonal Seasonal Cyclical Cyclical Structural Structural

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Price Levels in the Macroeconomy Inflation is a sustained increase in the general level of prices Inflation is a sustained increase in the general level of prices Demand-pull inflation Demand-pull inflation Cost-push inflation Cost-push inflation Disinflation is a decrease in the rate at which prices are rising (falling inflation) Disinflation is a decrease in the rate at which prices are rising (falling inflation) Deflation is a sustained decrease in the general level of prices Deflation is a sustained decrease in the general level of prices

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved What Makes Up the Consumer Price Index SOURCE: SOURCE: U.S. Bureau of Labor Statistics

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Governmental Tools for Managing the Macroeconomy Fiscal Policy (President & Congress) Fiscal Policy (President & Congress) Taxation Taxation Governmental Spending Governmental Spending Monetary Policy (Federal Reserve) Monetary Policy (Federal Reserve) Controlling the Money Supply through Interest Rate Adjustments Controlling the Money Supply through Interest Rate Adjustments

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Where Does the Government Get Its Money Source: Federal Budget for Fiscal 2001

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved FEDERAL BUDGETFEDERAL BUDGET

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved How Much is the Federal Debt? The debt has reached $5.6 trillion The debt has reached $5.6 trillion If $1,000 bills were stacked: If $1,000 bills were stacked: $1 Million = 4.29 Inches $1 Million = 4.29 Inches $1 Billion = Feet $1 Billion = Feet $1 Trillion = 67 Miles $1 Trillion = 67 Miles The debt is equal to miles in $1,000 bills The debt is equal to miles in $1,000 bills

McGraw-Hill/ Irwin © 2002 by The McGraw-Hill Companies, Inc. All Rights Reserved Using Fiscal and Monetary Policy RecessionInflation Fiscal Policy Lower taxes Increase gov’t spending Raise taxes Decrease gov’t spending Monetary Policy Lower interest rates Raise interest rates