The Economy and the Individual

1. The Economy and the Individual Unit 6

2. What is Economics? Chapter 18

3. The Fundamental Economic Problem Economics is the study of how we make decisions in a world where resources are limited • Individuals have needs ( required for survival) and wants (things we would like to have) • Fundamental economic problem is scarcity • We do not have enough resources to produce everything everybody wants

4. The Fundamental Economic Problem • Three Key Economic Questions • What goods and services should be produced? • Howshould these goods and services be produced? • Whoconsumes these goods and services? How are they distributed? • Economists use economic models to explain how our economy works • Models are simplified representations to predict what will happen if the economy changed

5. Making Economic Decisions • Scarcity forces us to make economic decisions • These decisions involve trade-offs • Trade-offs are made by individuals, businesses, governments and societies • Economists call term opportunity cost (cost of the next best use of your time when you decide to one thing over another) • Involves more than money, also inconvenience and discomfort to choices made

6. Making Economic Decisions Other Measures of Cost • Fixed costs- expenses that are the same no matter how many units of goods are produced, cost remains the same • Variable cost- change with number of products produced (wages, raw materials), expenses increase as business grows • Total Cost- Sum of fixed and variable cost • Marginal Cost- extra cost of producing one more unit, one measure of how to maximize profit • Marginal Revenue- change in revenue that results in one more unit being sold Cost Benefit Analysis • When marginal cost and its benefits are determined economist use a cost benefit analysis to compare marginal costs and benefits of a decision • if benefit of more production exceeds cost you continue producing, if cost outweighs benefits you reject option

7. Being an Economically Smart Citizen • U.S has a market economy (supply, demand and price help make decisions and allocate resources) • Choices made by consumers affect the products made and prices that businesses receive • Market economy is based in capitalism (where private citizens own most means of production) and free enterprise (business compete for profit without interference from government) • Economic incentives influence behavior • Incentives are rewards that are offered to get people to take certain actions

8. Being an Economically Smart Citizen • Understanding the role of the government • Economists think the role of the government should be to maintain competitive markets • Competition forces businesses to use resources efficiently • Government provides many services the private sector does not provide (schools, defense, social welfare services) • Government also reward and punishes actions • Can encourage production through subsidies • Can use taxes and fines to discourage consumption and punish lawbreakers

9. The American Economy Chapter 19

10. Economic Resources • U.S amount of output of its goods and services equaled $10 trillion or 30% of the worlds total output • Goods are tangible products • Services are work that is preformed for someone else

11. Economic Resources Factors of Production • Resources necessary to produce goods and services • Natural Resources- fields, rain, forests, minerals and other resources used to make products • Labor- physical and mental efforts people use to produce goods and services • Capital- tools, machinery, money, etc. used to make products • Capital goods are the result of production • Satisfy wants in aiding production of consumer goods • Consumer goods are produced using capital goods • Entrepreneurs- individuals who bring together factors of production, seen as the driving force of the American economy

12. Economic Resources • Success of overall economy is measured by Gross Domestic Product (GDP) • Total value of all goods and services produced in one year • Only measures final goods, sale of used goods or goods used to make something are not counted • GDP is a measure of standard of living (quality of life based on possession of necessities and luxuries that make life easier) • GDP measures quantity not quality

13. Economic Activity and Productivity • A market is a location or other situation that allows buyers and sellers to exchange certain economic products • Markets can be global regional or national • Consumers, businesses, government and foreign sectors are economic decision makers • Flow of resources, goods and services and money in a market system is circular • Model is called a circular flow diagram

14. Economic Activity and Productivity • Consumers earn their income in factor markets (where productive resources are bought an sold) • Workers earn wages, people who own land exchange it for rent, people who control capital (banks) exchange it for interest • Individuals spend their incomes in the product market (where producers offer goods and services for sale) • Business use this money to buy the factors of production they use • They do purchase some of their own output, mostly on capital goods, to produce more goods and services • Business sector is smaller than consumer sector (15-20% of GDP)

15. Economic Activity and Productivity • Government sector produces goods and services (schools, national defense, transportation, housing) it purchases productive inputs from factor markets • Receives revenues from services it provides but cost is rarely covered by fees • Most government revenue is from taxes • Uses revenues to purchase services in product markets

16. Economic Activity and Productivity • Growth of economy occurs when total output of goods and services increases over time • Growth leads to a higher standard of living • Economies try to increase productivity by using resources more efficiently • Business try to purchase more efficient capital goods and farmers try to farm the most fertile land

17. Economic Activity and Productivity • Specialization can create increased productivity • It occurs when an individual, business, etc. can produce a good or service better than anyone else • When people specialize they are more productive than when they try to do many things • Division of labor is breaking down of jobs into smaller tasks • It is a form of specialization • By doing a single task it is easier to improve the techniques of production

18. Economic Activity and Productivity • Productivity increases when businesses invest in human capital • Human capital is the skill and abilities of people • Investment in training, education, healthcare increase productivity • Employers are rewarded with higher quality products and increased profits • Workers are rewarded with higher pay and better jobs • Because of specialization the American economy has a high degree of economic interdependence • We rely on others to produce goods and services we can’t make for ourselves

19. Capitalism and Free Enterprise • American economy based on free markets and private ownership • Capitalism is where private citizens own and use factors of production to make a profitwith a minimum of government interference • Our economic system has been the most successful on the history of the world • Markets are the most important part of our economic system • Markets set prices of goods and services • Connect different parts of the economy (labor is sold on the factor market, goods and services purchased on the product market) • Where buyers and sellers meet to negotiate product prices

20. Capitalism and Free Enterprise • Under our economic system customer is most important, they decide what is produced (consumer sovereignty ) • In the U.S. we place a high value on our freedom of choice • Choice in what we buy, where we work, business have the right to sell what they want • Freedom also has costs • Individuals need to accept consequences of decisions (example: if business fails government usually won’t bail it out)

21. Capitalism and Free Enterprise • Private property rights • Give us the freedom to own, use and dispose of our own property as long as we do not interfere with others • Protected by the Constitution • Gives us the incentive to save and invest because we can keep any gains we might earn

22. Capitalism and Free Enterprise • Capitalism thrives on competition between buyers and sellers to get best products at best prices • Keeps the cost of production low and quality of goods higher • Competition rewards the most efficient producers • Forces least efficient producers out of business • Under free enterprise people are free to invest their own money into businesses to earn a profit • Profit is the amount of money left over after all of the costs of production have been paid • Profit motive is the driving force that encourages companies and individuals to improve their material well being

23. Capitalism and Free Enterprise • Voluntary exchange is the act of buyers and sellers freely and willingly engaging in market transactions • Buyer and seller benefit • Heart of the market economy • Both parties feel they will be better off (will profit) from the exchange

24. Capitalism and Free Enterprise • Why do these groups cooperate ? • According to Scottish social philosopher Adam Smith it is competition and our own self interest that keeps marketplace moving • Smith wrote Wealth of Nations (1776) that described how the market functions • Self Interest • He said an economy is made up of countless transactions • In each the buyer and seller consider only their own self interest and this motivates the free market

25. Capitalism and Free Enterprise • Competition • Because of self interest consumers have an incentive to look for the best prices • Firms seek to make greater profit by increasing sales • The struggle between producers and consumers is called competition • Self interest is a motivating force and competition is a regulating force • These forces working together to regulate the market was called by Smith “the invisible hand”

26. The Economy and You • Free enterprise system gives consumers rights and protections • Rights require consumer to take on some responsibility • We need to know what we are buying, how to get the best value and we can’t always rely on business to protect us • Consumerism is the movement to educate buyers about purchases they make, to demand better and safer products • Congress has passed laws protecting consumers since the early 20th century, there are private interests that protect consumer rights as well

27. The Economy and You • 1960’s special effort was made to protect consumer rights • Consumer Bill of Rights was developed • Right to safe products- one that will not harm health or lives • Right to be informed- protection against fraud, deceit, misleading facts that keep us from making informed choices • Right to choose- availability of products at fair process • Right to be heard- consumer interests will be heard when laws are passed • Right to redress- consumers need adequate ability to collect for damages caused by product

28. The Economy and You • Consumer Responsibility • Follow directions of warranty • Exhibit ethical behavior • Respect the rights of the producer and seller • Role as a consumer • Disposable income (money left over after all taxes on it have been paid) • Spent first on necessities of living • Discretionary income (money left over after necessities have been paid) • Income used to purchase wants

29. The Economy and You • Purchases made can be in cash (or debit card) or paid with a credit card • Credit cards can be paid all at once or in installments • If not paid all at once consumer pays interest on money owed • Late payments result in additional charges • All steps of decision making involve an opportunity cost • Need to consider goals in making purchases • If you buy now will you have enough to spend later? • Saving is an economic goal • When individual saves it helps the whole economy • Provides money for banks to loan out to others to invest and spend, allows business to expand • Person with bank account earns interest on what they have in the bank

30. Demand Chapter 20

31. What is Demand? • Supply and demand are the backbone of a market economy • Demand is the desire, willingness and ability to buy a good or service • Consumer must want it • Consumer must be willing to buy it • Customer must have the resources to buy it

32. What is Demand? • Demand schedule is a table that lists various quantitates of a product or service that someone is willing to buy and the possible prices • Demand curve is a graph that shows amount of a product that would be purchased at all possible prices • Prices are on the vertical axis and quantity is on the horizontal axis • Demand curves usually slope downward because people are normally willing to buy less of a product as the price increases and more if the price is low • Law of demand quantity demanded and price move in opposite directions

33. What is Demand? • Companies are interested in market demand (total demand of all consumers for a product) • Almost everything we buy provides utility (pleasure, usefulness, satisfaction we receive from using a product) • Utility we get from consumption changes as we consume more of the product • Diminishing marginal utility - receive less additional satisfaction (marginal utility) from each unit consumed • Concept explains why the demand curve slopes downward

34. Factors Affecting Demand • Demand for a product changes over time • Graphed using a market demand curve • When demand goes down the demand curve shifts to the left • When demand increases, curve shifts to the right

35. Factors Affecting Demand • Several factors cause market demand to change • Changes in the number of consumers • More consumers, the higher the demand • Number of consumers changes fro reasons like: higher birthrate, immigration, etc. • Changes in consumer income • Health of economy affects demand • Changes in consumer tastes • Popularity of product affects what price consumers will pay for a product • Changes in consumer expectations • Refers to the way people think about the future • If people expect a shortage the demand increases

36. Factors Affecting Demand • Changes in substitutes • Demand influenced by change in price or quality of related products • Competing products called substitutes • When two goods are substitutes a change in the price of one good causes the demand for the other good to move in the same direction • Customer can trade off one good for another if it is advantageous to do so • Changes in Complements • Some products are used together (computers and software) • Demand for one moves in the opposite direction as the price of the other

37. Factors Affecting Demand • Elasticity of Demand • All products affected differently by price changes • Demand elasticity is the extent to which a change in price causes a change in the quantity demanded • Some goods a price change can drastically affect the quantity demanded • When there are substitutes for goods and services demand tends to be elastic • Expensive items have elastic demand • Items that the purchase can be postponed have elastic • Inelastic Demand • Price changes have little effect on the quantity demanded • Demand for goods with few or no substitutes are likely to be inelastic

38. Supply Chapter 21

39. What is Supply? • Supply is the various quantities of goods and services that producers are willing to sell • Opposite of demand • Suppliers offer differing quantities of a product depending on the price buyers are willing to pay • Law of supply- principle that suppliers will normally offer more for sale the higher the price is • Profit motive motivates producers in a free market economy • The higher the price the more incentive for the producer to produce more

40. What is Supply? • Supply curve is a graph that shows the amount of product that would be supplied at all possible prices in the market • Supply curve slopes upward • The total supply schedules of all businesses that supply the same good or service is called market supply • Price is the most significant influence on the quantity supplied of any product • Businesses set prices that allow them to recover costs of capital resources put into production of goods and services • Profit is the money a business receives for products over and above its costs • Producers use profits to increase wages, invest money back into the company, keeping money for themselves and investors • Profit is the driving force for business owners

41. Factors Affecting Supply • When supply goes DOWN the supply curve moves to the left • When it goes UP the supply curve is pushed to the right • When supply increases prices come down • What causes supply to change? • Changes in the cost of resources • When resource prices fall sellers are able to offer more of the good, because it is cheaper to do so • When resource prices go up the goods become more expensive and supply decreases • Productivity • This is the degree to which resources are used efficiently • Increases productive output • More products can be produced at every price

42. Factors Affecting Supply • Technology causes supply to increase • Can make production more efficient • Allows companies to track purchases and what goods to produce • Cut business costs • Changes in government policies • New regulations can affect the cost of production and cause changes in supply • Tighter government regulation restricts supply and increases the cost of production • Relaxed regulation increases supply by lowering the cost of production • Changes in taxes and subsidies • Higher taxes mean higher costs • Subsidies by the government can lower the cost of production and encourage new producers to enter the market • Expectations of producers • If business believe demand will be lower in the future they will decrease supply • Change in the Number of suppliers • Causes changes in the market supply

43. Factors Affecting Supply • Elasticity of Supply • Supply elasticity is how the quantity of a good or service changes in response to changes in price • Elasticity depends on how quickly a company can change the amount of a product it makes in response to price changes • Products that require a producer to invest large sums of money are considered inelastic • Products that can be made quickly without huge amounts of capital and skilled labor are elastic

44. Markets and Prices • Markets bring buyers and sellers together • Forces of supply and demand work together with markets to establish prices • Prices form the basis for economic decisions • Surplus- amount by which the quantity supplies is higher than the quantity demanded • Surplus signals that the price is too high and sellers need to lower their price • Shortage amount by which the quantity demanded is higher than the quantity supplied • Shortage signals that the price is too low • Market economy eliminates shortages and surpluses • The point where supply and demand achieve balance is called the equilibrium price • It stays at this price until supply or demand changes

45. Markets and Prices • Price controls can be set by governments because they feel that supply and demand are unfair • Price ceiling is the maximum that can be charged for goods and services • Price floors are the minimum that can be charged for goods and services • Price floors are more common than price ceilings • They prevent prices from dropping too low • Minimum wage is an example of a price floor

46. Markets and Prices • Prices help businesses and consumers make decisions • What to produce- purchases help producers decide what to sell at what price • How to produce- helps to utilize labor and supplies, so producers can meet the price consumers are willing to pay • Whom to produce – business aim goods at prices their customers are willing to pay

47. Markets and Prices Advantages of prices • Prices are neutral- in a free market economy they favor neither producers or consumers • Prices are the result of competition between buyers and sellers • Prices are flexible- unforeseen events affect supply and demand • Buyers and sellers adjust consumption and production • Ability of the price system to absorb these changes is an advantage of a free market economy • Price and freedom of choice- market economy provides a wide variety of choices at a variety of prices • No one forces a consumer to pay a certain price for a product in a competitive market economy • Prices are familiar- they are familiar and understood, allows people to make economic decisions quickly and efficiently

48. Business and Labor Chapter 22

49. Types of Businesses • Sole proprietorship • Most common form of business organization • Business owned and operated by a single person • Easiest form of business to set up • Advantages • Owner receives all profits • Decisions on how to run the business can be made quickly • Disadvantages • Owner responsible for all problems related to business • Owner has unlimited liability, all personal assets of owner may be seized to pay debts • Hard to raise financial capital • Difficult to attract qualified employees, can’t offer fringe benefits (insurance, sick leave, etc.)

50. Types of Businesses • Partnerships • Owned by two or more people • Business partners bound by articles of partnership • Determine how much each member will contribute, what role each person has • How profits will be shared • How partners will be added or removed • Advantages • Multiple owners can raise more money • Owners do not pay corporate income tax • Each owner brings certain skills to help the business • Disadvantages • Legal structure is complex • Owners have unlimited liability