What is Economics?

What is Economics? • Economics is the social science that studies how societies (individuals, businesses, and Government)allocate their scarceresources to satisfy unlimited wants. • Three IMPORTANT words • Allocate – to assign, allot, distribute • Scarce – insufficient to meet demand, not enough to go around for all • Resources – “things” available to a society that are used to attempt to satisfy unlimited wants.

The principal problem of Economics is… Scarcity

“The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics”. --Thomas Sowell

SCARCITY YOU CAN’T HAVE EVERYTHING YOU WANT! The inability of limited resources to satisfy people’s wants Lesson 1: Scarcity

Scarcity It’s about RESOURCES and WANTS.

You can’t eliminate scarcity

But you can learn to deal with it!

When faced with SCARCITY of resources, decisions have to be made about how to use those resources Trade-offs Opportunity Costs

Trade-Offs vs. Opportunity Costs What's the difference?

Trade-Offs …are all the alternatives in making a decision Opportunity Cost …the cost of the next best use of money, time, or resources (you’re 2nd Choice)

Trade-offs … Are all of the alternatives that go into making a decision…. In this case let’s say you have many different choices of what you want to do on Saturday night.

Here are all of your Choices on Saturday night…which are… • Go on a Date • Hang out with friends • Watch TV • Read a good book • Hang out with parents • Go to bed early These are all of your trade-offs Opportunity Cost is different, though…

Remember… Opportunity Cost is the next highest valued alternative. (The 2nd Best Choice)

Macro[national] economics – concerned • with the economy as a whole Macro • examines the “forest, not the trees, • leaves, or specific pieces of bark.” . Great Forest! 2. Micro [details of the big picture] – concerned with specific economic units or individual markets under a microscope. Emphasis is on individual households, industries, or firms [like the # of workers employed by Ford] [Concerns the components of the economy] Micro examines the “trees, leaves, & pieces of bark, rather than the forest.” Nice bark!

Macro[large](telescope)“whole economy” [economy-wide issues]Micro[small](microscope]“segment of the economy” [issues in the economy] . “Beautiful, beautiful forest!” “Check out those pieces of bark!. Production MicroeconomicsMacroeconomics How much steel Total industrial output How much office space Gross Domestic Product Prices Price of individual goods Price of medical care Rate of inflation Employment Jobs in the steel industry Total number of jobs Economy’s unemployment

Introduction to Economics What is Economics? Two fields of Economic study: Micro and Macro Economics is divided into two main fields of study Microeconomics: Studies the behaviors of INDIVIDUALS within an economy: Consumers and producers in particular markets. Examples: The Automobile market in Switzerland, the market for movie tickets in Zurich, the market for airline tickets between the US and Europe, the market for vacations to Spain, the market for international school teachers. Macroeconomics: Studies the total effect on a nation's people of all the microeconomic activity within that nation. The four main concerns of macroeconomics are: 1) total output of a nation, 2) the average price level of a nation, 3) the level of employment (or unemployment) in the nation and 4) distribution of income in the nation Examples:Unemployment in Canada, inflation in Zimbabwe, economic growth in China, the gap between the rich and the poor in America

Resources or “Factors of Production” Land – Natural Resources • Acreage, rivers, lakes, ports, natural resource (oil, precious metals, minerals) Labor – Human Resources • Physical and Mental talents that produce goods and services Capital – “stuff you use to make other stuff” All manufactured goods and services used in producing consumer goods. Examples: Tools, machinery, equipment, trucks to carry goods, airplanes, etc. Entrepreneurship – 1. Someone who takes the initiative in using or combining the above Resources to produce a good or service. 2. Someone who is innovative, a risk taker, and makes basic business decisions. Remember -- ALL THESE RESOURCES ARE IN LIMITED SUPPLY THEY ARE SCARCE!!!!

The FourFactors of Production Resources beget production, which beget income, which beget wealth. . 1. Land [natural resources] – Nature’s items [“gifts of nature”] A. In the earth - coal, oil, water, fossil fuels, etc. B. On the earth – vegetation and water C. In the atmosphere – sun, wind, and rain [Land is the starting pointof all production. “Stuff” from which everything is made. Water Wind “Gifts of Nature” Fossil fuels Sun

. 2. Labor [human resources] {“effort”} anyone who works [“paid work”] [Labor is the “brain-power” and “muscle-power” of human beings] A. Physical – pro athletes & lumberjacks B.Intellectual – ministers, doctors & lawyers *Most important resource – 70% of input cost “Hired Help”

Real Capitalv.FinancialCapital . REALCAPITAL [tools, machinery, & factories] Can produce something directly with these FINANCIALCAPITAL [stocks, bonds, and money] Can’t produce anything directly with these

. 3. Capital Resources – all “man-made inputs” used in the production process (tools, machinery, and physical plants). A. Capital goods – goods [machinery, buildings, & tools] used to produce other goods. [crane, Ford plant, hammer] [products meant for “future consumption”] B. Consumer goods – products meant for “immediate consumption”. “Real Capital” [machinery, physical plants & tools] [capital is a factor of production] v. “Financial Capital” [stocks, bonds, & $] [not factors of production] A product can be both a consumer good & a capital good –depends on its use. Ex: Jet aircraft used by a movie star to visit friends (consumer good). The same aircraft used by a business manager to serve customers [capital good]. Ex: F150 pick-up to deliverproduce[capital good]or take family to church [consumer good] “man-made inputs”

Rent Wages Interest Profits Land Labor Capital Entrepreneur . 4. Entrepreneurship – starting a new business or introducing a new product. “Sparkplugs” who introduce the product or start the new business. He combines land, labor, & capital to produce products. Resource payments. The resource owners receive rent [for the use of their land; wages[for their labor];interest [payment for financial capital], and profits[for their entrepreneurial ability].

Introduction to Economics The productive Resources Payments for resources: Since resources are scarce, there is a cost associated with their use. Firms (resource demanders) must provide households (resource suppliers) with a payment for their resources. For LAND: Firms pay households RENT. Landowners have the option to use their land for their own use or to rent it to firms for their use. If the landowner uses his land for his own use, the opportunity cost of doing so is the rent she could have earned by providing it to a firm. For LABOR: Firms pay households WAGES. To employ workers, firms must pay workers money wages. If a worker is self employed, the opportunity cost of self-employment is the wages he could have earned working for another firm. For CAPITAL: Firms pay households INTEREST. Most firms will take out loans to acquire capital equipment. The money they borrow comes mostly from households' savings. Households put their money in banks because they earn interest on it. Banks pay interest on loans, which becomes the payment to households. If a household chooses to spend its extra income rather than save it, the opportunity cost of doing so is the interest it could earn in a bank. For ENTREPRENEURSHIP: Households earn PROFIT for their entrepreneurial skills. An entrepreneur who takes a risk by putting his creative skills to the test in the market expects to earn a normal profit for his efforts.

FREEDOM OF ENTERPRISE & CHOICE PRIVATE PROPERTY ROLE OF SELF-INTEREST COMPETITION Characteristics of Market Systems

FREEDOM OF ENTERPRISE & CHOICE PRIVATE PROPERTY ROLE OF SELF-INTEREST COMPETITION ACTIVE, BUT LIMITED, GOVERNMENT MARKETS & PRICES Characteristics of Market Systems

1. Private Property – the right of individuals to exercise control over things owned. Freedom to negotiate binding legal contracts. Contracts are legally binding in oral or written form. [A verbal agreement is binding only if it involves a small sum of money over a short period of time and does not involve real estate purchases.] 2. Freedom of Enterprise(business) & Choice Can move within the economy to any job, to buy or sell property, or start a business. The consumer is “sovereign” (king) in the economy. His dollars vote as it is he who decides what gets produced. The U.S. has over 100,000 business failures each year. K-Mart? 3. Role of Self-Interest–each producer or consumer tries to do what is best for themselves. Self interest is the main force driving the economy. Producers aim for maximum profits. Consumers seek the lowest prices & highest quality.

5. Markets & prices. Markets bring the buyers and sellers into contact. Prices send signals. High prices send signals to increase production and for other producers to enter the market. Low prices send signals to decrease production and for producers to exit the market. 6. Limited Government Intervention in the economy. The role of government was one of “laissez faire.” [“hands off”] In the words of Adam Smith, the government should not interfere with the operation of the economy except serve as an arbitrator in settling disputes. The government’s role: (according to Smith) a. provide defense, b. administer justice, and c. maintain certain public institutions. Arbitrator [settling disputes]

THE MARKET SYSTEM AT WORK The Three Fundamental Questions... 1. What will be produced? 2. How will the goods be produced? 3. Who will get the goods and services?

COMPETITION AND THE INVISIBLE HAND The Case for the Market System Efficiency, Incentives, and Freedom Adam Smith said the “invisible hand” determines what gets produced, how, & for whom. It is the invisible hand that moves us along the PPC. The invisible hand is now called the market mechanism. Its essential feature is the price signal.

Scarcity Unlimited Wants Limited Resources Choices WHO will receive the G/S produced? WHAT G/S to produce? HOWwill the G/S be produced? Most needy or most money BASIC ECONOMIC PROBLEMS Answers to the above determine: ECONOMIC SYSTEMS TRADITIONAL COMMAND FREE MARKET

Economic Systems– the way society produces products • Traditional • Pure Command • Pure Market • Mixed a. Capitalism b. Democratic Socialism c. Authoritarian Socialism [Communism] The way the 3 basic questions are answered Determines an economic system. • Traditional-[where “CUSTOM RULES”] I. Used to be

2.PURE COMMAND - where the “GOVERNMENT RULES”. The government controls all resources. What, How, and For Whom answered by the government. Karl Marx 3. PURE MARKET – where “INDIVIDUALS RULE”. Individuals and firms control all resources. The government has no say. WHAT, HOW & FOR WHOM are decided by individuals. Adam Smith • MIXED – all countries have mixed economic systems • How are these words used in everyday life? • Traditional 2. Command 3. Market

A Mixed Economy • A mixed economy is one that uses both market signals and government directives to allocate goods & resources. • Most economies use a combination of market signals and government directives to select economic outcomes.

ADAM SMITHWEALTH OFNATIONS – 1776 [explained the free market concept] The “INVISIBLE HAND” – when individual consumers/ producers compete to achieve their own private self-interest. The “role of government”[“LAISSEZ-FAIRE” – “HANDS OFF”] is limited to national defense, public education, maintaining the infrastructure, and enforcing contracts. Smith said the market system was best because it encouraged specialization, resulting in increased output & more economic growth. Government was like an “INVISIBLE FOOT” – government action to benefit particular groups. Keynes will say the G can act as a pressure gauge, letting off excess steam or building it up as needed. [active-not all inclusive role] No “G” In loving memory of mercantilism So mercantilism died as economic theory. My name is mercantilism. Smith’s book was anattack onmercantilism. Wealth doesn’t come from an accumulation of gold and silverbut from more productive people. A nation is wealthier if its citizens Are more productive. It is the ability of people to produce products and trade in free markets that creates a nation’s wealth. Mercantilism

Adam Smith’s famous Pin Factory Example One man could do maybe 1 pin per day[1 man = 1 pin] Now if there is specialization 1 man draws the wire out 1 man straightens the wire 1 man cuts the wire 1 man sharpens the point 1 man flattens the head There are 18 distinct operations - some perform 2 or 3 operations 10 people do 48,000 pins perday 1 man = 4,800 pins per day • Three circumstances come from this specialization. • Increased dexterity (learning by doing) • Saving time (lose time when you move • to different operations) • Invention of machines (fosters inventiveness)

Introduction to Economics The Production Possibilities Curve What is the PPC? The PPC illustrates the possible combinations of goods or services that can be produced by a single nation, firm, or individual using resources efficiently Italy's PPC 10 B D What does it show? That nothing is free and that everything has an opportunity cost. If society wants more pizzas, it must give up robots. Robots A C What basic economic concepts can it be used to model? ·Scarcity, tradeoffs, opportunity cost, economic growth, efficiency, unemployment. 200 Pizzas Understanding the PPC: The graph above shows that Italy can produce EITHER 10 robots OR 200 pizzas, or some combination of the two products, as long as it remains on or within its PPC. A point inside the PPC is attainable but not desirable. A point outside the PPC is desirable but unattainable.

Introduction to Economics The Production Possibilities Curve Italy's PPC Assumptions about the PPC: 10 A ·The PPC is attainable only if a nation achieves full-employment of its productive resources ·The nation's resources are fixed in quantity ·Assumes the nation must chose between only two goods ·The economy is closed, i.e. does not trade with other countries ·Represents only one country's economy 9 E B 7 Robots D C 2 Questions to consider about the PPC: 195 65 130 1) Which point(s) are attainable and desirable? WHY? 2) Which point(s) are attainable but not desirable? WHY? 3) Which point(s) are unattainable? Is this point desirable? Explain. 4) Which point will mean more consumption in the future? Explain. 5) Which point means more consumption now? Explain. 6) Why is the PPC bowed outwards? 7) How does the PPC illustrate opportunity cost? Tradeoff? Scarcity? Pizzas

Introduction to Economics The Production Possibilities Curve 1) Which point(s) are attainable and desirable? ·Points on the PPC (A, B and C) are attainable through full employment, and thus desirable because they represent efficient use of Italy's resources. 2) Which point(s) are attainable but not desirable? ·Point D is inside the PPC, thus represents inefficient use of resources, and most likely high unemployment, and is thus undesirable. 3) Which point(s) are unattainable? Is this point desirable? ·Point E is beyond Italy's production possibilities and is thus unattainable. It is desirable because it represents greater consumption of both pizzas and robots. Italy's PPC 10 A 9 E B 7 Robots D C 2 4) Which point will mean more consumption in the future? ·Point A represents more consumption in the future, because Robots are a capital good, used to make other products for consumption. If Italy produces more robots now, it may mean more consumer goos in the future. 5) Which point means more consumption now? ·Point C because pizza is a consumer good. Households don't buy and use robots, but they do like to eat pizzas. 6) Why is the PPC bowed outwards? ·The Law of Increasing Opportunity Cost 195 65 130 Pizzas

Introduction to Economics The Production Possibilities Curve Italy's PPC Law of increasing opportunity cost: As the production of a particular good increases, the opportunity cost of producing an additional unit rises. constant opportunity cost 10 9 8 7 6 5 4 3 2 1 0 A Robots Rationale: Economic resources are not completely adaptable to alternative uses. Many resources are better at producing one type of good than at producing others. B C D Pizzas and Robots: Assume Italy was producing 200 pizzas and 0 robots. Surely, many of the resources (land, labor and capital) being used to make pizzas would be better suited to making robots. As Italy starts making its first two robots it has to give up very few pizzas, since only those resources that are suited for robot production will be used. At first, 2 robots "cost" Italy only 5 pizzas. But as the country makes more and more robots, the opportunity cost increases, because at some point pizza makers will have to build robots. As Italy approaches 10 robots, the opportunity cost of the last two robots is 130 pizzas, as resources better suited for pizza production are employed in robot factories. 20 40 60 80 100 120 140 160 180 200 Pizzas Italy's PPC increasing opportunity cost 10 9 8 7 6 5 4 3 2 1 0 A Robots B C D 20 40 60 80 100 120 140 160 180 200 Pizzas

Introduction to Economics The Production Possibilities Curve Italy's PPC How does the PPC illustrate: ·Scarcity? ·Tradeoffs? ·Decisions? ·Resources? ·Opportunity costs? ·Actual output? ·Potential output? A 9 E B 7 Robots D And some more challenging ones: C 2 ·Unemployment? ·Economic growth? ·Economic development? 195 65 130 Pizzas

PRODUCTION POSSIBILITIES Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Robots(thousands) Q 1 2 3 4 5 6 7 8 Pizzas(hundred thousands) Unemployment & Underemployment Shown by Point U More of either or both is possible U

PRODUCTION POSSIBILITIES Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Notes... Economic Growth Robots(thousands) Q 1 2 3 4 5 6 7 8 Pizzas(hundred thousands) The ability to produce a larger total output - a rightward shift of the production possibilities curve caused by...

PRODUCTION POSSIBILITIES Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Notes... Economic Growth Robots(thousands) Q 1 2 3 4 5 6 7 8 Pizzas(hundred thousands) 1. Increase in resources - 2. Better resource quality - More of either or both is possible 3. Technological advances -

PPC A B C A P I T A L G O O D S G C D F E Consumer Goods 40. At what letter is there unemployment [recession]? 41. What letters represent resources being used in their most productive manner? [full employment, full production, and best available technology] 42. What letter represents an improvement in technology, therefore a new PPC frontier line? 43. The (straight line/curve) illustrates the “line ofincreasing cost”? 44. The (straight line/curve) illustrates the “law of constant cost.” 45. At what letter would there be the most economic growth in thefuture if a country were producing there now? 46. What is the opportunity cost when moving from “C” to “D”; Eto B; & do we have to giveanything up when moving from F to D? F A,B,C,D,E G A Capital Consumer no

PPC Practice Questions 1. An economy that is fully employing all its productive resources but allocating less to investmentthan toconsumption will be at which of the following positions on the PPC to the right? a. A b. B c. C d. D e. E 2. Which of the following best explains the shape of the PPC for the two-commodity economy shown above? a. Opportunity cost of producing another unit of each stays the same. b. Opportunity cost of producing another unit of each decreases. c. Opportunity cost of producing another unit of each increases. 3. Which of the following is true of the PPC on the right? a. Point Q is attainable but undesirable. b. Point R is unattainable but undesirable. c. A technological improvement of watches would move the economy from T to P. d The opportunity cost of moving from S to T is the # of watches given up. 4. If we move from B to C on the graph (right), the opportunity cost is? a. AH units of good Y b. OG units of good Y c. EF units of good X d. HG units of good Y A H G O B C

PPCPracticeQuestions[continued] 5. Which of the following would cause the PPC shown (right) to shift outward? a. Reopening steel plants that had been closed b. Rehiring laid-off workers c. Using machinery for missile production instead of steel production d. Using machinery for steel production instead of missile production e. Developing a more efficient steelmaking process 6. Base on the graph (right), which statements are true? I. The opportunity cost of moving from P to R is 10 units of Y. II. The opportunity cost of moving from R to P is 8 units of X. III. The opportunity cost of moving from Q to R is 0 units. a. I only b. III only c. I & II only d. I, II, & III Missiles Steel X

Introduction to Economics Product and Resource Markets What is a Market? A place where buyers and sellers come together In economics, we will study two types of market Product Markets Households buy goods and services produced by firms Resource Markets Firms buy productive resources from households

Introduction to Economics Product and Resource Markets Resource Markets Product Markets Who are the buyers? Who are the sellers? What is bought and sold? Which way does money flow? What are the goals of firms and households? Why does everyone benefit? Who are the buyers? Who are the sellers? What is bought and sold? Which way does money flow? What are the goals of firms and households? Why does everyone benefit? firms Households firms households Capital, land, labor goods and services from households to firms From firms to households Maximize profit (firms) and utility (households) Maximize income (households), minimize costs (firms) Because exchanges are mutual and voluntary Because exchanges are mutual and voluntary

Introduction to Economics Product and Resource Markets Resource Market: ·Households supply productive resources (land, labor, capital) ·Firms buy productive resources from households. In exchange for their productive resource, firms pay households: -Wages: payment for labor -Rent: payment for land -Interest: payment for capital -Profit: payment for entrepreneurship ·Firms seek to minimize their costs in the resource market ·Firms employ productive resources to make products, which they sell back to households in the product market Product Market: ·Consumers buy goods and services from firms ·Households use their money incomes earned in the resource market to buy goods and services ·Expenditures by households become revenues for firms ·Firms seek to maximize their profits ·Households seek to maximize their utility (happiness) Notice the CIRCULAR FLOW of resources and money between these two markets!

What is Economics?