Basic Economic Concepts Economics: the discipline that deals with the allocation of scarce resources for the purpose of fulfilling society’s needs and wants Scarcity: all economic problems stem from the fact that our needs and wants are unlimited, but our resources are limited

3 Basic questions In deciding how to deal with scarcity, every society must answer these basic questions: – What goods and services should be produced? – How should goods and services be produced? – How should goods and services be distributed? OR For whom should goods and services be produced?

Factors of Production Also known as productive resources – Land, or natural resources – Labor, or human resources – Capital resources or capital goods – entrepreneurship

Basic concepts, continued Goods: tangible items of value Services: intangible items of value; acts that are performed Consumer goods: items of value that are produced for final use by the purchaser – Durable goods: last 3 years or longer – Non-durable goods: can be used up quickly

Economic Decision-making Trade off: giving up one thing to have another Opportunity cost: – When making a decision, the next best alternative that was given up is the opportunity cost of that decision Production Possibilities: – the maximum combinations of goods and/or services an economy can produce when all productive resources are fully used

Economic Decision-making Cost-benefit analysis: a comparison of the costs (negatives) of an action to its benefits (positives)

Circular Flow of Economic Activity

Comparative Economic Systems What other types of economic systems exist? – Traditional: allocation of scarce resources and economic activities are the result of ritual, habit, or custom – Command: allocation of scarce resources is the result of planning of a central authority that makes most of the decisions – Mixed, or modified system: an economy that exhibits characteristics of several types of economies

Market Economy Also called capitalism, free enterprise, free market economy An economy in which privately owned businesses have the freedom to operate for a profit with limited government intervention

What are the Characteristics of a Market Economy? The characteristics of a market economy were observed by Adam Smith, a Scottish economist and philosopher in 1776, who put his observations into a book called The Wealth of Nations. The characteristics he observed are: – Profit motive: the desire to improve one’s condition, often by making money – Private property rights: the freedom to use and control one’s own property as he wishes

Market economy, continued Productivity: the degree to which productive resources are used efficiently to increase production of goods/services. Reflects the relationship between inputs and outputs. Division of labor: dividing a job into a number of different tasks, to be performed by separate workers Specialization: concentrating, and therefore becoming expert at, a particular job or task

Market economy, continued Voluntary exchange: buyers and sellers freely and willingly entering into market transactions Competition: the actions among sellers to attract consumers away from other businesses Laissez faire: idea that government should not interfere with business activities— “Let it be” Invisible hand: individuals pursue their own self interest, which through competition and voluntary exchange, benefits all of society

Goals of the U.S. Market Economy Freedom: Individuals’ economic freedom of choice is protected and fostered. Power of government and other interest groups is constrained. Growth: Increasing the productive capacity of the society Stability: Maintaining an economic environment characterized by little or no inflation and no rapid price fluctuation

Goals (continued) Security: protecting individuals against such economic risks as unemployment, bank failure, poverty, business failure, etc. Full Employment: Resources, including workers, are being used to capacity. In practice, this means keeping unemployment levels at or below 5%.

Goals (continued) Efficiency: Optimal use of scarce resources; preventing waste and ensuring most benefit for the least cost. Equity: People within society are treated fairly.