Economics: Unit One

1. Economics: Unit One The social science for the socially awkward.

2. Unit One: Basic Economic Concepts • Everybody faces tradeoffs. • The cost of something is what you give up to get it (opportunity cost). • People respond to incentives. • Trade makes everyone better off. • Rational people think at the margin. • Government intervention can make markets more efficient and more equitable. • Markets are a good place to organize economic activity. • A nation’s standard of living depends on its ability to produce goods and services. • When the government pumps too much money into the economy, the overall level of prices increases. • Inflation – the overall rise in prices across the economy • There is a short-term tradeoff between inflation and unemployment.

3. Unit One: Basic Economic Concepts I. Economics – The social science that deals with the problem of how to allocate a society’s scarce resources between the competing and unlimited wants and needs of its people. II. Scarcity A. Limited + Desired B. Diamonds, clean water, trees C. Not solar power, small pox, or polluted water

4. Unit One: Basic Economic Concepts III. The Basic Economic Problem – Wants and needs of humankind are unlimited but the resources to satisfy human want and need are scarce. A. Scarcity forces individuals and society’s to face choices and sacrifices. B. Society has to figure out how to best allocate scarce resources to meet the wants and needs of humanity.

5. Unit One: Basic Economic Concepts IV. Scarce resources are the factors of production needed to meet the needs and wants of society. A. Land (natural resources) B. Labor (the workforce) C. Capital – physical and human (tools, technologies, and ideas used to produce goods and services)

6. Unit One: Basic Economic Concepts V. Microeconomics and Macroeconomics A. Microeconomics 1. Interaction between households and firms 2. Supply and demand in a particular market B. Macroeconomics 1. Aggregate (total) demand and aggregate supply. 2. interactions of all nation’s households, firms, government, and foreigners in determining overall level of output, employment, GDP, and price level of a given country. 3. Informs government policy C. GDP – Gross Domestic Product 1. the total market value of all final goods and services produced during a given time period within a nation’s borders. 2. GDP is equal to the total income of the nation’s households or the total expenditures on the nation’s output. D. Unemployment – 1. Individuals actively seeking jobs remain unhired 2. Healthy unemployment numbers – between 4 and 6%

7. Unit One: Basic Economic Concepts E. Positive Versus Normative Statements 1. Positive – descriptive a. Increasing the minimum wage increases unemployment. b. Incentives affect human behavior. 2. Normative – prescriptive a. We should decrease unemployment. b. We should pay students for grades. 3. Economic policies depend upon the normative values of any given society. a. North Korea – military b. United States – upward mobility

8. Unit One: Basic Economic Concepts VI. Three goals of economic policy on a governmental level A. Full employment of nation’s labor force B. Stability in the level of prices for goods and services (low inflation) C. The continual increase in the output of goods and services (economic growth) VII. The Business Cycle A. A model showing the short-run periods of contraction and expansion in output experienced by an economy over a period of time 1. Stages a. Recession – economic slowdown b. Trough – the low economic turning point c. Recovery – expansion, growth d. Peak – the high economic turning point

9. Unit One: Basic Economic Concepts VIII. Choice and Opportunity Cost A. All economic decisions involve trade-offs B. There is always a cost (“there is no such thing as a free lunch”) C. Opportunity cost is the opportunity lost 1. What is given up 2. What else you may have bought, time, rest, fun, etc. 3. All economic transactions involve opportunity costs

10. Unit One: Basic Economic Concepts • Economic Models • Diagrams, formulas, graphs used by economists to explain economic phenomena. • Circular Flow Model • Production Possibilities Curve • Ceteris Paribus – “other things being equal” • When using a model, economists hold all other variables constant. • Ceteris paribus is used to examine how one variable effects another variable.

11. Unit One: Basic Economic Concepts X. The Production Possibilities Curve or Frontier A. Illustrates trade-off between two competing production possibilities B. The PPC models scarcity, efficiency, inefficiency, and opportunity costs C. Efficiency – Use of resources so as to maximize the production of goods and services D. Inefficiency – Underutilization of resources

12. Production Possibilities Frontier (PPF)Points along the curve are efficient

13. Unit One: Basic Economic ConceptsIndividual Production Possibilities Curve

14. Unit One: Basic Economic Concepts National Production Possibilities Curve – Constant Opportunity Cost - One to one opportunity cost - Straight line National Production Possibilities Curve – Increasing Opportunity Cost • Increasing cost • Line bows outward

15. PPC – Constant Opportunity Cost

16. PPC – Increasing Opportunity Cost

17. Unit One: Basic Economic Concepts The Law on Increasing Opportunity Cost • When you have two products that require different resources, the opportunity cost of producing item A will increase as you produce more and more of that item. • This law explains why the frontier is bowed outward – as output of a particular product increases , the opportunity cost of producing additional units rises. • This results from the fact that some labor, land, and capital resources are better suited at making certain goods than others.

18. Unit One: Basic Economic Concepts - How would we plot inefficiency on a PPC? - How is the line affected if the economy gets better? Worse? - Create a production possibilities curve between two goods. Plot the frontier, a point of underutilization, and a point of impossibility.

19. Unit One: Basic Economic Concepts XI. Productivity A. The output generated per unit of input. B. An example would be an hour of work for an employee. C. Investments in training and education will increase the productive capabilities of the population (human capital) D. Investments in technologies will increase the productive capabilities of the economy (physical capital)

20. XII. Economic Systems A. The system within a nation which allocates resources between the competing needs and wants of the government, firms, and households. B. The system answers the WHAT WILL BE PRODUCED, HOW WILL IT BE PRODUCED, FOR WHOM WILL IT BE PRODUCED questions of economics. C. Two Primary Systems 1. Command System 2. Market System

21. Unit One: Basic Economic Concepts D. COMMAND 1. The government controls all resources – the state answer all three questions. 2. Resources allocated according to government’s priorities. a. If equality is the goal, the government will distribute resources equally among the nation’s population. b. If military might is the goal, the government will allocate more resources toward building and maintaining defense. (North Korea)

22. Unit One: Basic Economic Concepts 3. No Private ownership or property rights a. The state owns all factors of production (including the land on which you live) b. Incentives are problematic c. Most economies in the world have transition to mixed and market economies because the lack of private ownership and fixed class systems have de- incentivized citizens. (China)

23. Unit One: Basic Economic Concepts E. Market Economies 1. Based on principles of a. Private ownership b. Property rights c. Pursuit of self interest (profit motive) 2. Adam Smith – Scottish social philosopher a. Laissez-faire economic theory b. The invisible hand of self interest regulates the economy

24. Unit One: Basic Economic Concepts 3. There are three characteristics to market economies a. Property Rights – private ownership of our resources b. Incentives – maximize utility (happiness) c. Prices – reflect the relationship between supply and demand 4. The circular flow of the market economy a. Voluntary and beneficial exchanges (Trade makes everyone better off) b. Two markets – product and resource c. Two actors – households and firms d. Does not account for the role of government or foreign consumers.

25. Unit One: Basic Economic Concepts 5. The Product Market – where firms supply goods and services to households a. You hire a team to mow your lawn b. You buy a shirt from the mall 6. The Factor Market (Resource Market) – where households supply the factors of production to firms. a. Labor b. Rent land to firms (Trump rents bottom level of a tower to a Starbucks) c. Provide capital to firms (Investors fund the purchase of machines to a firm for production.)

26. Unit One: Basic Economic Concepts 7.Market Failure - occurs when freely-functioning markets, fail to deliver an efficient allocation of resources. The result is a loss of economic and social welfare. 8. Market Power- the ability of a firm to profitably raise the market price of a good or service over marginal cost 9. Externality - A consequence of an economic activity that is experienced by unrelated third parties. An externality can be either positive or negative. a. Positive – well-educated labor force b. Negative – pollution emitted by a factory

28. XIII. Marginal Analysis A. Economic decisions take place on the margin 1. “additional” 2. marginal cost and marginal benefit a. One more hour b. One more dollar c. One more time hitting the snooze button 3. Firms consider marginal costs of adding extra units against marginal benefits (or revenue) 4. Consumers weigh the marginal utility of a good versus the price of a good. 5. Macroeconomics a. governments have to think on the margin when determining increases in taxes for different income levels. b. Think about household’s propensity to marginally consume or marginally save across the nation. 6. “Marginal” increases, decreases, costs will change the total.

29. XIV. Comparative Advantage, Absolute Advantage, Specialization, and Trade A. When an individual or a nation specializes in the production of a particular good or service and trades for all other goods or services, the total output and welfare of a society increases. B. Absolute advantage 1. A nation has an absolute advantage in the production of a good when it can produce it using fewer resources than another country. 2. If the US can produce 20 million televisions with 1000 workers and Japan can produce 18 million televisions with the same amount of workers, the US has an absolute advantage over Japan.

30. dsi Absolute Advantage in a Production Possibilities Table

31. C. Comparative Advantage 1. A nation has a comparative advantage in production of a certain product when it can produce that product at a lower relative opportunity cost than another country. a. To determine which country has a comparative advantage in oranges, you have to calculate the opportunity cost of oranges in the US and Japan. b. To grow 45 million oranges, the US must give up 15 million televisions. Therefore, each orange costs the US 15/45 = .33 televisions. c. To grow 36 million oranges, Japan must give up 9 million televisions. Therefore each orange costs 9/36 = .25 televisions. d. The opportunity cost of an orange in US is .33 and .25 for Japan e. Japan has a comparative advantage in the production of oranges because it costs Japan fewer televisions to make more oranges.

32. f. The opportunity cost for televisions will be reversed. For 15 million televisions, the US has to give up 45 million oranges: 45/15. One tv = 3 oranges g. Japan: 36/9 = 4 oranges h. The US has the comparative advantage in the production of televisions. 2. A country could never have a comparative advantage in the production of both products because the opportunity cost of one good is the reciprocal of the other good.

33. A. Specialization and trade should be based on comparative advantage, not absolute advantage. 1. Such trading allows each country to reduce it opportunity cost of the good it imports 2. Japan should specialize in oranges, the US in televisions 3. Both countries will benefit from trade by taking advantage of the other nation’s lower opportunity cost for the good in which it specializes. 4. The US will benefit because each orange would have cost 1/3 of a tv but, in trading with Japan, it only costs the US ¼ of a television. 5. Japan benefits because, instead of giving up four oranges for a television, they only have to give up three.

34. Which of the following must exist to allow for mutual benefit from specialization and trade between two countries? • Comparative advantage in the production of a good or service • Absolute advantage in the production of a good or service • Increasing marginal returns • Absolute and comparative advantage • Absolute advantage and increasing marginal returns

35. B. Imports – Goods produced abroad but consumed domestically C. Exports – Goods and services produced domestically but sold abroad D. Specialization – Production of goods, or performance of tasks, based upon comparative advantage

36. XV. Demand and Supply A. Unseen forces (or lines on a graph) 1. Not observed quantities 2. There is often a semantic confusion between “demand” and “quantity demanded” and a parallel confusion between “supply” and “quantity supplied.” B. The term demand or supply refers to how much is desired at every price. 1. Quantity demanded and supplied are points, demand and supply are curves. 2. Know prices, not values

37. Demand Schedule: Price, Quantity demanded

38. C. Demand Schedule (Why does demand go down as prices rise?) 1. If you are buying something, and the price goes up, you will most likely buy less. a. Substitution Reason – as price goes up, you will begin to substitute with similar, less expensive products. b. Income effect – if the price goes up, you might have to buy less (because you are limited by your income) 2. How much does the price affect your behavior ? It depends on the product (insulin versus steak). 3. What makes demand rise or fall – NOT PRICE 4. Demand (price and quantities demanded arealready included in demand)

39. D. What would shift demand? (Income, Pop, Tastes, Price of other goods)1. Income for the whole society goes up, more will be boughtIncome decreased, less will be bought2. Increase in population, more will be bought3. Fads – more or less will be bought More chicken than beef More wine than liquor4. Demand for one particular good will be affected by the price of other goods a. If the price of chicken goes way down, that will affect the demand for beef. b. Price of Complementary product rises or falls – The price of a certain printer plummets, more of that ink will be demanded.

40. E. Supply 1. A relationship between price and the quantity supplied 2. The higher the price, the greater the quantity supplied. 3. How much more depends on the product. a. If the price of pencils increases, more will be produced. Van Gogh paintings? 4. What makes supply rise and fall – NOT PRICE 5. Price is already built into supply – supply is a force that tells you at any given price, how much will be supplied. 6. So what shifts supply?

41. F. Shifting supply1. New technology – at any given price, it could be cheaper to make 2. Weather – at any given price, there could be less3. Government regulation – if government regulation raises the cost of production, than for any given price, the company will supply less.4. Price of inputs – if inputs get cheaper, the company could produce more

42. Increase price, increase in quantity supplied

43. G. Demand and Supply 1. A moment of transcendental beauty for most economists 2. Let’s put supply and demand together on a graph and let’s think about how that graph functions. a. As price goes up, the quantity supplied goes up, demanded goes down – at some point they cross. b. That point is called equilibrium.

44. Demand and Supply:Equilibrium

45. H. Equilibrium 1. If the price is below equilibrium, demand goes up but supply will go down – you will have lines of people waiting, you raise the price, and the quantity supplied and the quantity demanded will balance out. 2. If the price is too high, supply will provide the product, demand will not be bought – more and more is getting produced, piling up, sellers will slash the price, and equilibrium will be found. 3. Equilibrium – the place where demand and supply are stable or equal. 4. Equilibrium – efficient

46. Unit One: Basic Economic Concepts • The Laws of Supply and Demand • Law of Supply 1. All else is equal (Ceteris Paribus), when the price of a good rises, the quantity supplied of that good rises. • Law of Demand 1. Ceteris Paribus, when the price of a good rises, the quantity demanded of that good falls.

47. Unit One: Basic Economic Concepts J. The market is numerically sound, not morally good or just (the limitations of equilibrium) A. Not everyone is happy at equilibrium – some producers need the price to be higher and some consumers, lower. B. The supply and demand curves describes (does not dictate) how our world works - C. The market produces some outcomes that not everyone likes D. Producers might produce sugar cereals, organ trafficking, or hair loss products for men over diseases that affect poor children.

48. Models The circular-flow model, the production possibilities curve, the demand and supply graphs – simple models to illustrate how the economy around us functions. They illuminate, rather than dictate, how people interact with markets around the globe.

49. Key concepts and terms • Scarcity, economics, efficiency, equity, opportunity cost, marginal changes, market economy, market failure, externality, market power, productivity, inflation, GDP, business cycle, recession, trough, recovery, unemployment, circular-flow diagram, production possibilities frontier (curve), microeconomics, macroeconomics, positive statements, normative statements, absolute advantage, comparative advantage, imports, exports, market, competitive market, quantity demanded, law of demand, demand schedule, demand curve, substitutes, complements, quantity supplied, law of supply, supply schedule, supply curve, equilibrium, equilibrium price, equilibrium quantity, surplus, shortage, law of supply and demand, specialization. • Graphs • Production possibilities frontier (curve) • Demand and supply curves showing equilibrium • Demand and supply curves showing shifts in demand and supply