© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/eOSullivan/Sheffrin Prepared by: Fernando Quijano and Yvonn Quijano CHAPTERCHAPTER 3 Markets and Government in the Global Economy

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Why Do Markets Exist? Markets exist because we arent self- sufficient but instead consume many products produced by other people.Markets exist because we arent 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.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.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Specialization and the Gains From Trade We can use the principle of opportunity cost to explain the benefits from specialization and trade.We can use the principle of opportunity cost to explain the benefits from specialization and trade. PRINCIPLE of Opportunity Cost The opportunity cost of something is what you sacrifice to get it.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Production per Hour and Opportunity Cost BrendaSam Bread produced per hour 61 Shirts produced per hour 21 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

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Opportunity Cost and Comparative 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.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin How Do Markets Operate? Exchanges occur in two markets: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.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.Product or output market: The organizations that produce goods and services sell their products to consumers.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin The Circular Flow Diagram The circular flow diagram is a diagram showing the flow of money and goods between markets.The circular flow diagram is a diagram showing the flow of money and goods between markets.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Households as Sellers and Buyers In labor markets, households sell their labor to firms for wages. About 75% of income is earned by households.In labor markets, households sell their labor to firms for wages. About 75% of income is earned by households.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Households as Sellers and Buyers In capital markets, households provide savings that firms use to purchase physical capital. Households receive interest or a share of the firms profits in return.In capital markets, households provide savings that firms use to purchase physical capital. Households receive interest or a share of the firms profits in return.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Households as Sellers and Buyers In natural resource markets, households sell natural resources to firms to use as inputs in the production process.In natural resource markets, households sell natural resources to firms to use as inputs in the production process.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Households as Sellers and Buyers Inputs flow from households into factor markets where they are purchased by firms and then transformed into products.Inputs flow from households into factor markets where they are purchased by firms and then transformed into products.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Households as Sellers and Buyers Products flow from firms to product markets where they are purchased by households.Products flow from firms to product markets where they are purchased by households.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin The Global Economy and Interdependence Export: A good produced in the home country (for example, the United States) and sold in another country.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).Import: A good produced in a foreign country and purchased by residents of the home country (for example, the United States).

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Major Imports and Exports of the United States, 1999

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Major Trading Partners of the United States, 1999

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Protectionist 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).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).

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin History of Tariff and Trade Agreements General Agreement on Tariffs and Trade (GATT): An international agreement that has lowered trade barriers between the United States and other nations.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.World Trade Organization (WTO): An organization that oversees GATT and other international trade agreements.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin History of Tariff and Trade Agreements North American Free Trade Agreement (NAFTA): An international agreement that lowers barriers to trade between the United States, Mexico, and Canada (signed in 1994).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.European Union (EU): An organization of European nations that has reduced trade barriers within Europe.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin History of Tariff and Trade Agreements Asian Pacific Economic Cooperation (APEC): An organization of 18 Asian nations that attempts to reduce trade barriers between their nations.Asian Pacific Economic Cooperation (APEC): An organization of 18 Asian nations that attempts to reduce trade barriers between their nations.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Currency Markets and Exchange Rates Foreign exchange market: A market in which people exchange one currency for another.Foreign exchange market: A market in which people exchange one currency for another. Exchange rate: The price at which currencies trade for one another.Exchange rate: The price at which currencies trade for one another.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Exchange Rates in July 2001NationCurrency Value in Dollars (U.S. $ equivalent) Units per Dollar (Currency per U.S. $) AustraliaDollar BrazilReal Britain Pound sterling CanadaDollar FranceFranc GermanyMark Hong Kong Dollar IrelandPunt IsraelShekel JapanYen MexicoPeso Saudi Arabia Rial

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Global Interdependence Multinational corporation: An organization that produces and sells goods and services throughout the world.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.Worldwide sourcing: The practice of buying components for a product from nations throughout the world.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Global Interdependence Financial liberalization: The opening of financial markets to participants from foreign countries.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.International Monetary Fund: An organization that works closely with national governments to promote financial policies that facilitate world trade.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Government in a Market Economy The government has five general responsibilities in a market-based economy:The government has five general responsibilities in a market-based economy: Providing goods and services. Providing goods and services. Redistributing income. Redistributing income. Taxation. Taxation. Regulation of business practices. Regulation of business practices. Trade policy. Trade policy.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Percentage of Government Spending on Various Programs

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Criteria for a Tax System The benefit-tax approach suggests that a persons tax liability should depend on his or her benefits from government programs.The benefit-tax approach suggests that a persons tax liability should depend on his or her benefits from government programs. Vertical equity: the idea that people with more income or wealth should pay higher taxes.Vertical equity: the idea that people with more income or wealth should pay higher taxes. Horizontally equitable: the idea that people in similar economic circumstances should pay similar amounts in taxes.Horizontally equitable: the idea that people in similar economic circumstances should pay similar amounts in taxes.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Percentages of Government Revenue from Different Sources

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Tax Rates in Different Nations

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Government Regulation of Markets 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.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.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Alternative 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.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.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e OSullivan/Sheffrin Alternative 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.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.Privatizing: The process of selling state firms to individuals.