Circular Flow & Business Cycle AP Macroeconomics Circular Flow & Business Cycle How the U.S. Economy works
Economic Models Economists use models to simplify our world used for economic analysis of “real world” Based on various assumptions The 2 most basic economic models are: Circular Flow Diagram Production Possibilities Frontier (PPF)
2 Sides of a Market Economy Consumers decide what to BUY! Producers decide what to SELL (MAKE) HOUSEHOLDS Demand Curve FIRMS Supply Curve
5 Factors of Production Resources used to make goods & services 1) Land- all basic natural resources 2) Labor- human work/labor 3) Physical Capital- previously produced goods 4) Human Capital education, skills, etc… 5) Entrepreneurship- managerial ability & risk taking To open a coffee shop: Labor = worker Physical Capital = Coffee Machine Land = Beans, store, etc… Human Capital = Skills of workers Entrepreneurship- = Skills of owners
Product & Factor Markets Product Market: where any good or service is sold Factor Market: where factors of production are exchanged Consumers use product market Producers use factor market
The circular flow describes how goods, services and money flow through a free market economy PRODUCT MARKET Revenue Spending Goods & services sold Goods and services bought End Result: HOUSEHOLDS FIRMS Rent is paid for Land Wages is paid for Labor Profit is paid to Entrepreneurs FACTOR MARKET Factors of production Labor, land, capital & entrepreneurship Wages, rent, and profit Income = Flow of inputs and outputs = Flow of dollars
Circular Flow Questions
Economists often Disagree Do tax cuts lead to more long run economic growth? Does large Gov’t debt eventually lead to a financial crisis? Will raising the minimum wage lead to significant job loss? The answer to most economic questions is: IT DEPENDS!
Business Cycle Historically every economy moves through cycles
Alphabet Economic Recoveries First Video http://www.youtube.com/watch?v=d0nvoQL4By8 Second Video http://www.pbs.org/newshour/bb/business/july-dec11/makingsense_10-07.html
Business Cycle Graphing Economic History 1980-2013
Business Cycle ? 2000 2006 Dot.com Collapse 1990’s Technology Boom 2001 2006 Housing Bubble Dot.com Collapse 2008-09 2013 Great Recession ?
Current Economics Reading Where is the U.S. today in the Business Cycle?
Youth Unemployment
Free Market Failures Market Failure occurs whenever a market does not allocate resources efficiently Examples: 1) Collusion/Price Fixing – companies limiting supply and/or fixing prices 2) Externalities – when producers do not pay for ALL costs of production Government should correct market failures through new policies examples: cap & trade policies for pollution, taxing fuel inefficient cars enforcing anti-trust laws (ex: denying the ATT & T-Mobile proposed merger)
Branches of Economics Microeconomics looks at individual parts of economy: How households & firms make decisions and interact in specific markets Macroeconomics looks at the entire economy: Economy-wide phenomena including: inflation, unemployment, interest rates & GDP (economic growth) 13