Chapter 1 - Economic Issues and Concepts
Chapter 1: Economic Issues and Concepts
1.1 The Complexity of the Modern Economy • Economy: a system in which scares resources are allocated among competing uses. Economies tend to be complex systems and scares resources include land, labour and machines (capital). The Self-‐Organizing Economy (Invisible Hand) • “The great insight of economists is that an economy based on free-‐market transactions is self-organizing.” • With Market Economies, there is a “spontaneous economic order” because they are based on the self-‐interests of consumers who make decisions independently based on the prices in open markets. With this – the collective outcome is coordinated based on the independent decisions of several different groups. • “...Things that people want within the constraints set by the resources that are available to the nation.” • Smith recognizes that not all economic interactions are motivated by benevolence (kindness) in a modern economy. Efficient Organization • Efficiency: resources available are organized in a way so that all the goods and services that people require are fulfilled while being produced with the least possible amount of resources. Main Characteristics of Market Economies • Self-‐Interest: Individuals pursue their own self-‐interests. • Incentives: Sellers want to sell more when prices are high, buyers want to buy more when prices are low. • Market Prices and Quantities: P and Q are determined in free markets where potential sellers compete to sell their products to potential buyers. • Institutions: Economic activity is governed and monitored by institutions that tend to be set up by the government. Private property, freedom of contract and the rule of law are the most important institutions; they are defined by contracts, legislation and enforcement. 1.2 Scarcity, Choice and Opportunity Cost • Because we live in a world of scarcity, where not everyone can have everything that they desire, this brings choice, the decision that people must make of what they will and will not have. • “Economics is the study of the use of scares resources to satisfy unlimited human wants.” Resources • Land includes natural endowments such as forests, lakes, minerals and oil. • Labour includes all mental and physical human resources. • Capital includes all manufactured aids to production such as tools, machinery and buildings.
Land, labour and capital make up the Factors of Production. Goods are tangible and Services are intangible, both goods and services are produced and consumed to satisfy the wants of people. Scarcity and Choice • Scarcity implies that choices must be made, and making choices implies the existence of costs. Opportunity Cost • Every time a choice is made, opportunity costs are incurred. When you choose one thing over another, you are sacrificing one thing for another. • Opportunity cost is the cost of using resources for a particular purchase measured by the benefit that is given up by not using them in the best alternative way. • Cost measured in terms of other goods and services that could have been obtained instead. Production Possibilities Boundary • Its shape is concave because it demonstrates how the opportunity cost of either good increases as we increase the amount of it that is produced. • Scarcity is indicated on the boundary by the unattainable combinations that lie outside the boundary. • Choice is demonstrated by the need to choose among the alternative attainable points along the boundary. • The negative slope of the boundary demonstrates Opportunity Cost because it shows the possible combinations that can be achieved when using all resources efficiently. • When more of one good is produced, the opportunity cost of producing it rises. Four Key Economic Problems Microeconomics is the study of the causes and consequences of the allocation of resources as it is affected by the workings of the price system and government policies that seek to influence. Below are two questions that fall within Microeconomics. • What is produced and how? I.e. what goods are produced and which ones are not? • What is consumed and by whom? I.e. what determines the distribution of a nations total output among its people? Macroeconomics is the study of the determination of economic aggregates, such as total output, total employment, the price level, and the rate of economic growth. • Why are resources sometimes idle? I.e. why are resources not being used when they are available? (Working within the PPC) • Is productive capacity growing? I.e. what are the determinants of growth and are there undesirable effects of growth in productive capacity? 1.3 Who Makes the Choices and How? The Flow of Income and Expenditure • Flows of income and spending pass through markets • Good markets are where goods and services are bought and sold • •
Factor markets are markets where those that own various factors of production, sell their services • Distribution of Income refers to how the nation’s total income is distributed among its citizens, and it is mostly determined by how much those in factor markets can get for their services Maximizing Decisions • There are consumers, producers, and the government • Everyone is a maximizer because they want to maximize their earnings • What they gain from the economy can also be referred to as utility • Therefore, we can assume that maximizers make decisions to maximize their profits Marginal Decisions • Those looking to maximize utility must weigh the costs and benefits of their decisions at the margin • Marginal Cost – how much extra you must pay to get one extra unit • Marginal Benefit – how much extra satisfaction you will get from buying that one unit • If looking to maximize your utility, like most people usually are, you will only buy that extra unit if you know that the satisfaction you will get from it will outweigh its cost • “Consumers and producers who are maximizers make marginal decisions-‐ whether to buy or sell a little bit more or less of the many things that they buy and sell.” • Voting in an election is an example of when a marginal decision is not being made The Complexity of Production Specialization • Specialization of Labour – when jobs are allocated to different people because individual workers specialize in the production of particular goods and services • Specialization is efficient because (1) individual abilities differ and individuals can perform jobs that they do well, and (2) because a person who specializes in one thing will get better at it the more they work at it, as opposed to being just alright when it comes to other kinds of skills. The Division of Labour • Specialization within the production of a particular product • Mass Production – highly specialized tasks, highly specialized machinery, and each individual does one or very few tiny tasks that build towards the production of any or one product • Artisans and Flexible Manufacturing – lean production and flexible production are ways that production can organized so that a team of people are all capable of doing each others job, but instead they work together instead of doing one specialized job. Markets and Money • Markets are places where buyers and sellers can transact with one another •
Market Economy – a society where people specialize in productive activities so that they can meet most of their material wants and needs through voluntary market transactions with other people • “Specialization must be accompanied by trade. People who produce only one thing must trade most of it to obtain al the other things that they want.” • Successful barter transactions require a double coincidence of wants • “Money greatly facilitates specialization and trade.” Globalization • “Through the ongoing process of globalization, national economies are ever more linked to the global economy, in which an increasing share of jobs and incomes is created.” 1.4 Is There an Alternative to the Market Economy? Types of Economic Systems Traditional Economies • An economy that’s behaviour is based on tradition, custom and habit • Little change in pattern of goods produces from year to year • Production allocated to members based on tradition • Traditional systems work best in unchanging economies Command Economies • Economic behaviour is determined by a central authority (ex. government) • Centralization of decision making • Central planning of an entire economy must take into consideration not only current data but future data and trends in labour supplies, peoples wants and technological developments Free-‐Market Economies • Most economic decisions are made my private households and firms • Decisions are decentralized • Main coordinating device is the set of market determined prices (which is why a lot of free-‐market economies are called price systems) Mixed Economies • Any real economy is a mixed economy which is a mixture of traditional, command and free-‐market economies • Some decisions could be made by firms and households and some by the government The Great Debate • Command economies vs. Market economies • Planned economies failed as they depressed the living standards of their citizens • When people moved towards more free-‐market economy systems, living standards improved immensely • With the framework of a mixed economy, there are many alternatives among many different and complex mixes have free-‐market and government determination of economic life. Government in the Modern Mixed Economy •
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“Key institutions are private property and freedom of contract, both of which must be maintained by active government policies. The government creates laws of ownership and contract and then provides the institutions, such as police and courts, to enforce these laws.” Market failures are when well defined situations in free markets do not work Job loss when firms reorganize (new technology) and become more efficient
1.1 The Complexity of the Modern Economy • Economy: a system in which scares resources are allocated among competing uses. Economies tend to be complex systems and scares resources include land, labour and machines (capital). The Self-‐Organizing Economy (Invisible Hand) • “The great insight of economists is that an economy based on free-‐market transactions is self-organizing.” • With Market Economies, there is a “spontaneous economic order” because they are based on the self-‐interests of consumers who make decisions independently based on the prices in open markets. With this – the collective outcome is coordinated based on the independent decisions of several different groups. • “...Things that people want within the constraints set by the resources that are available to the nation.” • Smith recognizes that not all economic interactions are motivated by benevolence (kindness) in a modern economy. Efficient Organization • Efficiency: resources available are organized in a way so that all the goods and services that people require are fulfilled while being produced with the least possible amount of resources. Main Characteristics of Market Economies • Self-‐Interest: Individuals pursue their own self-‐interests. • Incentives: Sellers want to sell more when prices are high, buyers want to buy more when prices are low. • Market Prices and Quantities: P and Q are determined in free markets where potential sellers compete to sell their products to potential buyers. • Institutions: Economic activity is governed and monitored by institutions that tend to be set up by the government. Private property, freedom of contract and the rule of law are the most important institutions; they are defined by contracts, legislation and enforcement. 1.2 Scarcity, Choice and Opportunity Cost • Because we live in a world of scarcity, where not everyone can have everything that they desire, this brings choice, the decision that people must make of what they will and will not have. • “Economics is the study of the use of scares resources to satisfy unlimited human wants.” Resources • Land includes natural endowments such as forests, lakes, minerals and oil. • Labour includes all mental and physical human resources. • Capital includes all manufactured aids to production such as tools, machinery and buildings.
Land, labour and capital make up the Factors of Production. Goods are tangible and Services are intangible, both goods and services are produced and consumed to satisfy the wants of people. Scarcity and Choice • Scarcity implies that choices must be made, and making choices implies the existence of costs. Opportunity Cost • Every time a choice is made, opportunity costs are incurred. When you choose one thing over another, you are sacrificing one thing for another. • Opportunity cost is the cost of using resources for a particular purchase measured by the benefit that is given up by not using them in the best alternative way. • Cost measured in terms of other goods and services that could have been obtained instead. Production Possibilities Boundary • Its shape is concave because it demonstrates how the opportunity cost of either good increases as we increase the amount of it that is produced. • Scarcity is indicated on the boundary by the unattainable combinations that lie outside the boundary. • Choice is demonstrated by the need to choose among the alternative attainable points along the boundary. • The negative slope of the boundary demonstrates Opportunity Cost because it shows the possible combinations that can be achieved when using all resources efficiently. • When more of one good is produced, the opportunity cost of producing it rises. Four Key Economic Problems Microeconomics is the study of the causes and consequences of the allocation of resources as it is affected by the workings of the price system and government policies that seek to influence. Below are two questions that fall within Microeconomics. • What is produced and how? I.e. what goods are produced and which ones are not? • What is consumed and by whom? I.e. what determines the distribution of a nations total output among its people? Macroeconomics is the study of the determination of economic aggregates, such as total output, total employment, the price level, and the rate of economic growth. • Why are resources sometimes idle? I.e. why are resources not being used when they are available? (Working within the PPC) • Is productive capacity growing? I.e. what are the determinants of growth and are there undesirable effects of growth in productive capacity? 1.3 Who Makes the Choices and How? The Flow of Income and Expenditure • Flows of income and spending pass through markets • Good markets are where goods and services are bought and sold • •
Factor markets are markets where those that own various factors of production, sell their services • Distribution of Income refers to how the nation’s total income is distributed among its citizens, and it is mostly determined by how much those in factor markets can get for their services Maximizing Decisions • There are consumers, producers, and the government • Everyone is a maximizer because they want to maximize their earnings • What they gain from the economy can also be referred to as utility • Therefore, we can assume that maximizers make decisions to maximize their profits Marginal Decisions • Those looking to maximize utility must weigh the costs and benefits of their decisions at the margin • Marginal Cost – how much extra you must pay to get one extra unit • Marginal Benefit – how much extra satisfaction you will get from buying that one unit • If looking to maximize your utility, like most people usually are, you will only buy that extra unit if you know that the satisfaction you will get from it will outweigh its cost • “Consumers and producers who are maximizers make marginal decisions-‐ whether to buy or sell a little bit more or less of the many things that they buy and sell.” • Voting in an election is an example of when a marginal decision is not being made The Complexity of Production Specialization • Specialization of Labour – when jobs are allocated to different people because individual workers specialize in the production of particular goods and services • Specialization is efficient because (1) individual abilities differ and individuals can perform jobs that they do well, and (2) because a person who specializes in one thing will get better at it the more they work at it, as opposed to being just alright when it comes to other kinds of skills. The Division of Labour • Specialization within the production of a particular product • Mass Production – highly specialized tasks, highly specialized machinery, and each individual does one or very few tiny tasks that build towards the production of any or one product • Artisans and Flexible Manufacturing – lean production and flexible production are ways that production can organized so that a team of people are all capable of doing each others job, but instead they work together instead of doing one specialized job. Markets and Money • Markets are places where buyers and sellers can transact with one another •
Market Economy – a society where people specialize in productive activities so that they can meet most of their material wants and needs through voluntary market transactions with other people • “Specialization must be accompanied by trade. People who produce only one thing must trade most of it to obtain al the other things that they want.” • Successful barter transactions require a double coincidence of wants • “Money greatly facilitates specialization and trade.” Globalization • “Through the ongoing process of globalization, national economies are ever more linked to the global economy, in which an increasing share of jobs and incomes is created.” 1.4 Is There an Alternative to the Market Economy? Types of Economic Systems Traditional Economies • An economy that’s behaviour is based on tradition, custom and habit • Little change in pattern of goods produces from year to year • Production allocated to members based on tradition • Traditional systems work best in unchanging economies Command Economies • Economic behaviour is determined by a central authority (ex. government) • Centralization of decision making • Central planning of an entire economy must take into consideration not only current data but future data and trends in labour supplies, peoples wants and technological developments Free-‐Market Economies • Most economic decisions are made my private households and firms • Decisions are decentralized • Main coordinating device is the set of market determined prices (which is why a lot of free-‐market economies are called price systems) Mixed Economies • Any real economy is a mixed economy which is a mixture of traditional, command and free-‐market economies • Some decisions could be made by firms and households and some by the government The Great Debate • Command economies vs. Market economies • Planned economies failed as they depressed the living standards of their citizens • When people moved towards more free-‐market economy systems, living standards improved immensely • With the framework of a mixed economy, there are many alternatives among many different and complex mixes have free-‐market and government determination of economic life. Government in the Modern Mixed Economy •
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“Key institutions are private property and freedom of contract, both of which must be maintained by active government policies. The government creates laws of ownership and contract and then provides the institutions, such as police and courts, to enforce these laws.” Market failures are when well defined situations in free markets do not work Job loss when firms reorganize (new technology) and become more efficient
