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Introduction to Economics So, what is economics, and why do we is why study it? study
I t may help to understand that nearly all of It economics stems from one concept. economics This is the concept of “scarcity.” Scarcity, as used in economics, is different than the term with which most people are familiar. Most people, when they hear that something is scarce, think of something that is rare or hard to come by. hard I n economics, for something to be scarce, it In need not be rare or hard to come by at all. need Scarcity, in economics, is when there is more wanted than what is available at a zero price tag (for free). price Let’s consider an example…
– Think of breakfast cereal. Think – Certainly breakfast cereal is not a product that Certainly anyone would consider rare or hard to come by. anyone – I f, however, breakfast cereal was free, there If, would not be enough for everyone to go into the grocery store to take all that they want without running out. without – Breakfast cereal, then, is considered scarce by Breakfast economists. economists. Because breakfast cereal is scarce, a system needs to be in place to determine who gets what is available. This kind of system is called a “rationing device.” called Who should get the breakfast cereal that is Who available? Should it be the hungriest people? Should it be the families with the most children? Should it be distributed equally to all? equally
– How the question of distribution is answered How reflects the value system of the society as a whole. whole. I n this country, we use prices as our rationing device. rationing
– I f you want the good and you are able to pay If the price for the good, you may have the good. the – I f you want the good and you are unable to pay If unable the price for the good, you may not have the not good. good. When more people are willing and able to pay for the good than there is available, there is what is called a shortage (more is wanted than what is available at the current market price). at ). This concept is covered later. Be sure you understand the difference between scarcity and shortage. scarcity So, because there is scarcity, we study everything that affects or is affected by scarcity. There are three main questions: scarcity.
– How much of a good or resource is available?
How much labor, land, money, product, etc.? – How will that limited/scarce good or resource be How used—what will be produced? used—what
Should we produce good A or good B? How much of it Should should we produce? Should we consume or reinvest? should – How will the goods or resources be distributed? How
What rationing device should be used? What The definition of economics, then, is the study economics then, of the production, distribution, and consumption of scarce/limited resources for the purpose of satisfying insatiable/unlimited wants wants Different societies answer the three economic questions differently. As we stated earlier, the manner in which these questions are answered reflect the values of the society as a whole. reflect We will now look at a brief overview of two We different societies/economic systems and how these questions are answered. these Socialism/Command Economy Socialism/Command
Under Socialism (referred to as command economy in Under the text), most resources are governmentally owned and/or controlled. and/or
– They own the farms, factories, natural resources, etc. They The government’s central planners are also the ones that decide how those resources should be used...what should be produced.
– They usually restrict production to practical products and They don't want to use resources on frivolous items...even though that may be what the people may want. Under socialism, the people are expected to trust the government like a child would trust a parent figure to make decisions that are in the best interest of the people. In return, the government is supposed to act as a parent to its people and make decisions that are fair and equally providing for all members. The three economic questions are answered by the government central planners in a way intended to benefit the common good so that all are provided for equally. all The system relies on everyone agreeing to work hard for the common good.
– Everyone works as hard as they can and takes out Everyone of the system only what they need, leaving the rest for those who need more than they do and can't contribute as much to the whole (children, older people, etc.). people, I n this way, all are provided for equally and adequately, at least that's how the theory goes. I n reality, there is so much corruption on the part of the government, usually, that they will often provide more for their friends and family and less for people who displease them. who Capitalism/Market Economy Capitalism/Market
With Capitalism (called “market economy” in With the text), resources are owned privately.
– Private property ownership is one of the keys to Private capitalism. capitalism. Because individuals own the resources and all means of production, it is the individuals who decide what will be produced. Mr. Smith may decide to go into production of a product. He does so with the motivation of selling them to make money for himself. If he is unable to sell his good or service, that tells him that it is not something that people want and he will switch to something else. I n this way, products and services that are provided under capitalism may not always be those that are the most practical, but they are what the people want. If it wasn’t what the people wanted, they wouldn't spend their money on them and production of those items would stop. We can see that, under capitalism, the people, themselves, make the decisions as to how resources are used. A s for how goods and services are to be distributed, that is the rationing device that has been talked about...prices. about...prices. A ll products have a price on them. If an individual wants it, he can choose to use his income on it, therefore decreasing the amount he has available to him to purchase other goods. Under capitalism, each citizen must make choices as to how to use the income he/she earns. I f he/she wants more income to use for more purchases, this motivates the worker to work harder and more efficiently so as to make more money to provide more for themselves. I n this way, the incentive to work is always there and people under capitalism tend to work harder than under socialism. The three economic questions, under capitalism, are answered by the people and the market forces, with an underlying motive of self interest and profit. self In summary then… In
Capitalism is driven by the people and their wants Capitalism and their willingness to work hard to get what they want, thus keeping the economy rolling. Socialism is driven, in theory, by a desire to make sure all people are provided for equally and that everyone should work hard, not for themselves, but for the goodness of all. for Here in the US, our economic system is a mixture of the two. We have elements of both capitalism and socialism. capitalism
– Capitalism: profit motive; supply and demand Capitalism: market forces driving economy; price as rationing device, private property ownership, etc. device, – Socialism: minimum wage; social security; Socialism: student financial aid; public schools; environmental regulations; occupational safety regualations, etc. regualations, Our answers to production, distribution, and consumption questions, as well as virtually all other questions, are often answered using economic reasoning: economic if benefit of doing something outweighs the if cost, do it. If the cost exceeds the benefit, don’t do it don’t Examples of economic reasoning… Examples
– Should I go to college or work full time?
I f the benefit of a college education is greater than the If cost of missing out on income/benefits/etc. that I could get from working, I will go to college. get – Should I go to class or sleep in? Should
I f the benefit of sleeping one morning is greater than the If cost of missing the information presented in class that morning, I will sleep. morning, We perform this sort of decision making all day long, every day of our lives. day We weigh the costs and the benefits and will We say “yes” if the benefits outweigh the costs, and we’ll say “no” if the costs outweigh the benefits. benefits. Not all costs are the same. Not
– Monetary costs represent the money that you must sacrifice when you make a choice to go with one option over another…to buy a good, to purchase a service, etc. to – Opportunity costs represent the opportunity you sacrifice when you choose an option. It is the value of the next best alternative that you could have chosen. have – Both costs are important, and both must be Both considered when making decisions—when using economic reasoning (cost/benefit comparison). economic Examples of opportunity cost Examples
– – – Instead of going to class you could…? Instead of buying that sweater you could…? I nstead of owning your own business you Instead could…? could…? – I nstead of manufacturing a particular product Instead line you could…? line How you answer these questions…your How next best alternative to these options… next would be your opportunity cost for making would each of these choices. each Now, let’s shift gears for a moment to take a look at trade and why we do it. look Trade occurs when you want something you don’t have Someone else has that something and is willing to part with it in exchange for something you have
– – – Could barter with items you own Could pay with money Could provide a service Both parties are better off after the exchange Both (otherwise they wouldn’t have agreed to it) (otherwise Societies, too, are usually made better off through specialization and trade. For example, if no trade existed between countries, we would need to provide for all our own needs. we We would need to grow our own food…wheat, beef, We bananas, etc, build our own cars, and drill for our own oil. own All other countries would need to do the same. A ll For us, we are able to grow wheat and raise For beef cattle efficiently due to our tremendously large and fertile land mass. large Bananas, cars, and oil are more costly for us to Bananas, produce due to our climate, our natural resource base, and our labor pool. resource Honduras would have an easier time with banana production due to their climate, but a much more difficult time with beef, automobile, and oil production. production. Saudi Arabia would be able to produce oil efficiently Saudi as they have an abundance of this natural resource, but wheat and automobile production would be more costly. costly. J apan has little land mass so would have trouble with Japan wheat, beef and oil production, but with many cheap laborers could produce cars more efficiently. laborers Obviously, if each country were to specialize in the good that they are able to produce most efficiently, the US could produce wheat and beef; Honduras could specialize in banana production, Saudi Arabia could specialize in oil production, and Japan could specialize in auto production. auto By doing this, more of each good can be produced, the countries can trade with each produced the other to acquire all goods needed, and all goods are produced more cheaply, efficiently, and abundantly for all. and Each country is able to end up with more of all Each goods. This is called GAINS FROM TRADE. goods. What do we mean when we say that more of each good can be produced, if only one country is producing? country The US can grow more wheat if it can devote The its resources to wheat production rather than divert resources to produce other goods. divert The US is able to produce wheat so efficiently that little production of other goods is sacrificed when wheat production is increased. This would not be the case in Saudi Arabia. With the arid land, many resources would be needed to increase wheat production so much of other production would be lost. of What we have described here is called “comparative advantage.” “comparative Comparative advantage occurs when a person or country is able to produce a good or service at a lower opportunity cost than others. service The US has a comparative advantage in wheat The production. Saudi Arabia has a comparative advantage in oil production. advantage Before we go any further, we should discuss some basic information with regard to graphs. some We use graphs in economics to illustrate We various ideas and concepts. various The use of graphs
Graphs are based on number lines… horizontal -1 0 1 2 3 4 5 6 7 Vertical: V ertical:
4 3 2 1 0 -1 Put the two number lines together, intersecting at the zero points to form a graph 1,4 5,2 Graphs are used to show relationships between two things for example…the possible price of an item and how many would be sold at that price Pr i c e o f paperbac k book s $ 3 .0 0 $ 4 .0 0 $ 5 .0 0 $ 6 .0 0 $ 7 .0 0 Num ber of book s t hat w ould be sold 40 35 30 25 20 The numbers on the chart on the previous slide can be entered onto a graph like this.
Price 7 6 5 4 3 20,$7.00 25,$6.00 30,$5.00 35,$4.00 40,$3.00 10 15 20 25 30 35 40 45 Quantity Sold We can connect the points to form a line that shows the relationship between the price we could charge for books and how many we could sell could By matter of convention, monetary variables By are always placed on the vertical axis are I n economics, a line on a graph is always called a curve, even if it is straight curve The curve we have drawn is called downward The sloping sloping downward sloping curves indicate an inverse inverse relationship …that is, as the price of the books go UP, the number sold goes DOWN go the two things being related work in the opposition to each other opposition A nother example…the less sleep you get at Another night, the more tired you will be (le sleep, ss night, m tired). ore A curve that is upward sloping conveys a upward direct relationship direct for example…as the number of hours worked for inc ase , total income will incre re s total ase i nc i ncre the two things being related work in the same the direction direction A nother example…the farther you drive, the Another more gas you use (m driving, m gas) ore ore more Now that we have a basic understanding of graphs, let’s return to the course… graphs, We have discussed how different countries are We better suited for production of different goods. This is because their resources are better suited to those tasks. to Resources can be either equally suited to or Resources better suited for different tasks. better Let’s look at some examples… Let’s consider the resource of your time. L et’s Y ou may be trying to get into shape for an upcoming marathon and trying to work at your job to earn money for tuition. job Y ou can spend all your time working out, but you will not earn any money by doing this. you Y ou can spend all your time working at your job, but you will not advance your fitness level. level. Y ou could also split your time. Consider the following combinations: following
Hours per day working out 0 5 10 Hours per day earning money 10 5 0 We can see that every hour you add to your work out, you give up one hour of earning money. The opportunity cost of each hour or working out remains the same, from the first hour to the tenth (the opportunity cost of one hour of working out is the sacrifice of one hour of earning money). sacrifice Y our time is equally suited to working out or earning money. money. This is an example of constant opportunity costs. We can also put these combinations on a graph… graph…
Hours working 10 out 5 5 10 Hours earning money This is called the “production possibilities frontier” showing the possible production combinations using the resource of your time. combinations The straightness of the line illustrates the The constant opportunity costs. constant Now let’s consider the labor resource of carpenters. We have this resource available to us and decide to make a couple of products. We decide on tables and earrings. We We can use all of our laborers to make We tables…all to make earrings…or a combination… combination… Tables per day 100 90 75 50 0 Earrings per day 0 10 20 30 40 Here we can see that our carpenters could make 100 tables per day, but then no earrings would be made. I f we decide we want to branch out into earrings, we take those carpenters who would best make earrings and switch them to earring production. We lose out on producing 10 tables to make 10 earrings. tables Opportunity cost of 10 earrings= tables. 10 We decide to make more earrings. Of the remaining carpenters, we take the group of who would best be able to make earrings. These ones aren’t quite as good as the first, so we will lose out on even more table production than the first loss…this time we lose out on 15 tables to make 10 earrings. tables Opportunity cost of 10 earrings= tables. 15 We want to make even more earrings, so we take the next best qualified group of carpenters for earring production and switch them over. This time, we lose an even larger share of our table production. We lose out on 25 tables. table Opportunity cost of 10 earrings= tables. 25 Finally, we decide to produce earrings exclusively. Using all of our carpenters for earring production, we lose our last bit of table production. This last group of carpenters to switch over is the least suited for earring production and so it takes many of them to make the same 10earrings…50 tables are lost. make Opportunity cost of 10 earrings= tables. 50 Hopefully you can see that, in this example, our resource is better suited for one task (table production) than another. As a result, when trying to make the switch, ever increasing amounts of production will be lost. amounts This is an example of increasing opportunity This costs. costs. Let’s put these combinations on a graph L et’s
100 tables 75 50 25 25 50 75 earrings This the production possibilities frontier for the two goods of tables and earrings, using the carpenters as our labor resource. carpenters We can see that this is a curve, and not a We straight line. This illustrates the increasing opportunity costs. opportunity L et’s take a closer look at the production possibilities frontier… possibilities defined: the graph of all resources (inputs) defined: being devoted to one product (output) or all devoted to another and all possible combinations between combinations
Good A Good B T he next several slides will refer to this graph graph
Good A A E C D as we take a closer look at the various parts of the production possibilities frontier
You m usethepage ay up/dn ke to re r ys fe back. B
Good B Point A - all resources that are available are devoted to the production of Good A devoted Point B - all resources that are available are Point devoted to the production of Good B devoted Point C – operating at a level lower than what is possible. At this point we are not using all available resources (inefficiency)...at pt. C, if we were to use all the available resources, it would result in more of Good A or more of Good B or more of both more efficiency - getting as much output for as few inputs as possible: anywhere on curve including both ends both Point D - using some resources for both industries…this point, as well as points A and B are all efficient points of production… are anywhere along the curve represents an anywhere efficient level of production efficient Point E - not enough resources available to reach this point- this combination is unattainable without some increase in resources or some other advance advance
– I f there is some increase in resources (ex. discovery of If new source of power, influx of immigrants, opening of previously unavailable land for development, technological breakthrough, etc.), all production possibilities would increase (more of either kind of product, m...
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