Module 1: Basic Economic Concepts

Labor

The quantity and quality (skills, knowledge, and physical health) of human efforts available to produce goods and services

Scarcity

The condition that exists because human wants exceed the capacity of available resources to satisfy those wants

Allocate

Apportion or distribute

Capital (resources)

Goods made and used to produce other goods and services (e.g. buildings, tools, and equipment)

Land

Natural resource that can be used to produce goods and services (e.g. water, mineral deposits, forests, and actual fields)

Economics

The study of how people, firms, and societies choose to use scarce sources

Economics is the study of

Decision-making, or how we choose to use the limited resources we have to get the most of what we want

Macroeconomics

The study of economics concerned with the economy as a whole at a national level

Macroeconomics deals with:

1. Total output & income

2. Total employment

3. Movement in the average price level (inflation)

Microeconomics

Study of individual households, groups, firms, and markets in an economy

Resources

What is used to produce goods and services

4 Factors of Production (Resources)

1. Land

2. Labor

3. Capital

4. Entrepreneurship

Needs

Food, water, clothing, shelter, healthcare, and basic education

Wants

Desires that can be satisfied by consuming a good or service; not a basic need

Entrepreneurship

Human resource with the ability to take risks to make new products or uses of products

Marginal benefit

The additional gain from consuming or producing one more unit of a good or service; can be measured in dollars or satisfaction

Marginal cost

The increase in a producer's total cost when it increases its output by one unit

Opportunity cost

The second-best alternative (or the value of that alternative) that must be given up when scarce resources are used for one purpose instead of another

Marginal analysis

A decision-making tool for comparing the additional or marginal benefits of a course of action to the additional or marginal costs

Production Possibilities Frontier (or Curve)

A table or graph that shows the different combinations of two goods or services that can be produced in a given period of time with a fixed amount of resources

A point along the production possibilities curve indicates

The economy is operating at full efficiency

A point inside of the production possibilities curve indicates

The economy is operating inefficiently; resources are not being used or are not being used efficiently

A point surpassing the production possibilities curve indicates

An impossible allocation of resources, or a combination that can't be made with the amount of resources available

If a point is moving closer to the production possibilities curve

More resources are being fully deployed

If the production possibilities curve is moving closer to an impossible point

There is an indication of economic growth, such as a change in resources or advances in technology

The best decisions are made at the

Margin

Something is worthing doing if

The marginal benefit is greater than the marginal cost

Economic models

Simplified representations of the real world that let us test economic theories

Examples of economic models

1. Supply and demand

2. Production Possibilities Frontier

Economic models are limited because

They cannot take every single real-world factor or possibility into account

The Three Basic Questions are

1. What should we produce?

2. How should we produce it?

3. For whom are we producing it?

What is the significance of the three basic questions?

Allows countries to decide the best way to allocate its scarce resources and meet the needs of its population

What are the two most common basic economic system models?

Pure capitalism and command economy

Pure capitalism

A free market system in which the government does not get involved and individuals must answer the basic economic questions

Laissez-faire

"Leave it alone", or government should have a limited role in the economy

Command system

An economic system in which the government or collective republic owns all resources and all decisions are made through central planning rather than individual wants and demands

Traditional/customary economy

System in which basic economic questions are answered based on custom and practice

Mixed economy system

Consists of the other three types of economy; there is no pure version of a free market or command system

What is the government's role in the economy?

Keeping markets competitive, provide public goods, prevent negative effects on society, protect property rights and uphold contracts, offer economic support, and provide legislation to modify prices or raise incomes of specific groups

Keeping markets competitive

Prevents the formation of trusts and monopolies that could corner the market and drive prices up while lowering the quality of goods

Monopoly

A heavy influence in the supply and price of a product when the number of sellers or producers is small enough

Public goods

Goods that everyone shares (e.g. public parks, roads, airports, etc.)

Negative externality

Harmful side effect that affects an uninvolved third party during the production or consumption of a good (e.g. pollution)

Spillover costs

When the production of a good causes costs to result on other people not involved (e.g. bad health from pollution at a nearby factory)

How does the government offer economic support to those in need?

Through transfer payments; money is taken from taxes and transferred to people who may not be able to take care of themselves (e.g. social security and unemployment)

Income tax serves as a method of

Wealth redistribution

Adam Smith

Scottish economist who believed that the government should have a limited role in the economy only through health care, transportation, and education and that individuals work to better themselves

Invisible hand

A term coined by Adam Smith to describe the self-regulating nature of the marketplace tied to supply and demand, competition, and individual self-interest

Friedrich Hayek

Austrian economist who believed in free markets and that the success of society was driven by creativity, entrepreneurship, and innovation

Milton Friedman

American economist who believed that the money supply should grow at a constant annual rate to allow for natural growth, or monetarism

John Maynard Keynes

British economist who believed that the government should increase spending and lower interest rates to stimulate demand during economic downturns (Keynesian economics)

Characteristics of a Market Economy

1. Voluntary exchange

2. Private property

3. Price system

4. Profit incentive

5. Competition

6. Financial institutions

7. Limited role of government

Voluntary exchange

Trading goods and services with other people because both parties expect to benefit from the trade - creates wealth

Private property

Involves the right to exclusive use, legal protection against invaders, and the right to transfer property to others; defined, enforced, and limited through the process of government

Price system

The amount of money that people must pay when they buy a good or service / the amount they receive when they sell a good or service

Prices in a free market are set by

The forces of supply and demand

The price system encourages

The efficient production and allocation of goods and services consumers demand

Profit incentive

The desire that persuades entrepreneurs to establish new businesses or expand existing ones, improve products, and cut costs of production

Profit

The difference between a business's total revenues and its total costs

Profit incentive spurs on

Efficiency, growth, and economic progress

Competition

Attempts by two or more individuals or organizations to acquire the same goods, services, or productive and financial resources

Financial institutions

Banks, credit unions, pension funds, insurance companies, mutual fund companies, and other organizations that bring together savers, borrowers, buyers, and sellers of stocks and bonds

Financial institutions play an important role in

Fostering economic growth and employment of resources in a market economy

Capitalism depends on two key groups of decision makers in the economy:

Businesses and households

Households

Groups of individuals who live together that make economic decisions

Businesses

Non-government producers of products and services

Circular Flow Model

A model that shows the flow of goods and services and the interaction among households and businesses

What are the two interacting markets in the circular flow model?

The resource market and the product market

Resource market

Consists of households providing businesses with the factors of production

In a resource market, businesses

Provide money income in the form of wages, rents, interests, or profits to the households based on the resource(s) utilized (costs)

Product market

Consists of households using the money income they earn to purchase goods and services from businesses

Revenue

Income from the product market to businesses

Production and consumption

Result of decision making from the cycle between businesses and households

Production and consumption is balanced in the sense that

Households demand the highest price possible when supplying their factors of production, similar with businesses when they supply their goods and services

Equilibrium price

Price at which quantity demanded equals the quality supplied

If money income or wages are too high,

More workers will join the workforce - decreasing the price of workers to an equilibrium price

If prices are too low for a product or service,

Businesses will drop out of supplying that product - increasing the price for it